What is a Central Bank Digital Currency (CBDC)?

The meaning of Central Bank Digital Currency (CBDC) refers to a digital form of currency that is issued and backed by a central bank. It is a type of fiat currency that can be used as a medium of exchange and a store of value, just like physical cash or traditional electronic money.

CBDC is designed to take advantage of the benefits of digital currencies, such as faster and cheaper transactions, while still maintaining the stability and security of traditional fiat currencies. It can be used to make transactions between individuals or businesses, as well as for purchases from merchants that accept CBDC.

There are two main types of CBDC: wholesale and retail. Wholesale CBDC is designed for use between financial institutions, such as banks and other central banks, to facilitate settlement and interbank transactions. Retail CBDC, on the other hand, is designed for use by individuals and businesses as a form of digital cash.

One of the main advantages of CBDC is that it can provide greater financial inclusion by making it easier for people who do not have access to traditional banking services to participate in the economy. This is because CBDC can be stored and transferred using mobile devices and does not require a traditional bank account.

Another advantage of CBDC is that it can provide greater transparency and traceability for transactions. Because CBDC is digital, all transactions can be recorded and tracked in a centralized ledger, which can help prevent fraud and illicit activities such as money laundering.

However, CBDC also raises some concerns and challenges. One concern is that CBDC could potentially reduce the role of commercial banks in the financial system, since individuals could hold CBDC directly with the central bank. This could have implications for the stability and efficiency of the financial system.

Another concern is that CBDC could have implications for privacy. Because all transactions can be recorded and tracked in a centralized ledger, there is a risk that personal financial information could be exposed or misused.

Simplified Example

A Central Bank Digital Currency (CBDC) is a digital form of a country's currency, issued and regulated by its central bank. CBDCs are similar to cryptocurrency in that they are digital tokens, but they are different in that they are backed by the central bank and are pegged to the value of the country's fiat currency. CBDCs are seen as a way to modernize the existing financial system, potentially reducing transaction costs, increasing financial inclusion, and improving monetary policy. Although, of course, this is not without risk.

History of the Term Central Bank Digital Currency (CBDC)

While the common use of the term "CBDC" gained traction after 2019, central banks have been exploring and initiating digital currency endeavors for several decades. Notably, Finland's central bank introduced the Avant stored value e-money card back in the 1990s. China's central bank commenced research on CBDC issuance as early as 2014. Concurrently, the Ecuadorian central bank managed a mobile payment system from 2014 to 2018.

Examples

e-CNY: China's central bank, the People's Bank of China (PBOC), has been developing a CBDC called e-CNY, or digital yuan. The e-CNY is currently being tested in a number of Chinese cities, and it is intended to be used as a form of payment alongside physical cash.

Sand Dollar: The Central Bank of The Bahamas has launched a CBDC called the Sand Dollar, which is currently the only CBDC that is officially available for use. The Sand Dollar is meant to provide access to financial services for people who are unbanked or underbanked, as well as to help facilitate digital payments and reduce the use of physical cash.

FedNow: The Federal Reserve in the United States is exploring the possibility of a CBDC, and one of the initiatives it is working on is called FedNow. FedNow is a real-time payment and settlement system that would allow for the near-instantaneous transfer of funds between banks, and it is being designed to be able to support a future CBDC if one is issued.

Related terms

• Central Bank A central bank is a vital component of a country's financial system. It is a financial institution that has the privilege of controlling the production and distribution of money and credit for a nation or group of nations.

• Unbanked: The meaning of 'Unbanked' is used to describe individuals, businesses, and organizations that are not associated with the traditional banking system.