A central bank digital currency is similar to cryptocurrency. Both currencies are digital, but a CBDC is issued by a country’s central bank as a form of fiat currency (it has no intrinsic value and cannot be redeemed for a physical commodity, such as gold or silver).
This type of digital currency is still a new concept that a few countries outside the U.S. have already implemented, and many nations are exploring the possibility. Some countries are considering how a central bank digital currency would impact their economy before releasing a version of a CBDC to the public.
This type of currency is gaining traction as paper money becomes less popular. While people can still buy goods and services with physical cash, a central bank digital currency provides an additional choice. CBDCs are legal tender, which means they can be used almost anywhere in the issuing country to buy goods and services.
Every CBDC belongs to one of two categories: wholesale or retail. A wholesale CBDC is exclusively for financial institutions such as commercial banks, credit unions and central banks. CBDCs can make interbank settlements more efficient.
Banks still use traditional money, but a wholesale CBDC can serve as a replacement or an extra resource alongside traditional money.
A retail CBDC is geared toward consumers and acts as a companion or replacement for cash. Instead of being a liability for a private bank, a CBDC is a liability for the central bank.
Both types of CBDCs can potentially reduce the time and costs involved with cross-border payments.
CBDCs and cryptocurrencies are both digital currencies that use blockchain technology. Some companies accept cryptocurrencies in exchange for goods and services, while El Salvador has even made Bitcoin a legal tender. However, that’s where the similarities end, and there are a few key differences.
Centralization vs. Decentralization
The main difference is that the CBDC is centralized, while cryptocurrencies are decentralized. A central bank controls the supply of CBDCs and can inflate these tokens by creating more of them.
Cryptocurrencies are decentralized, which makes them less vulnerable to a single actor controlling the supply. There are only 21 million Bitcoins (BTC), and that number will never change. This hard cap makes the world’s largest cryptocurrency resistant to inflation.
Security and Access
While cryptocurrencies with limited supply have an edge on inflation, there are significant risks with decentralization. You can get locked out of your crypto fortune if you lose your private key. With a CBDC, you can contact your bank if you have questions about account access.
The regulation of CBDCs offers more stability, while the realm of cryptocurrencies is more like the Wild West, especially if you venture beyond Bitcoin. Cryptocurrencies reach their valuations based on how people feel about them rather than fundamentals like a country’s economy, financial growth or other metrics investors can use for fiat currencies.
In other words, cryptocurrencies are ripe for speculation, while a CBDC is a digitized fiat currency.
Central banks using CBDCs issue a digital version of the country’s currency. Each digital monetary unit has a unique serial number, which makes it easier to identify. However, this layer of protection does not guarantee that the authorized owner is initiating the transaction.
Central banks retain control over the currency and its supply. They can set rules for their digital currencies similar to how cryptocurrencies have built-in rules, such as a limit to the number of Bitcoins.
CBDCs can enable faster cross-border transactions while allowing financial institutions and consumers to reduce their costs for those transactions. CBDCs can reduce the need to print physical cash, which may help prevent money laundering and even save money.
Retailers receiving CBDCs also may have to worry less about counterfeit money. In addition, CBDCs may reduce financial fraud because all transactions are posted on a distributed ledger. Crypto blockchains similarly allow the recording of transactions that are displayed publicly.
CBDCs offer some advantages, but they also pose considerable challenges. A massive overhaul of the financial system is as risky as it sounds. It’s unclear how a sudden shift would impact the prices of goods and services.
CBDCs also go against a core tenet that has resulted in plenty of fanfare around cryptocurrencies. That is, a central authority is still controlling the money supply and adjusting interest rates.
Central banks have more control over CBDCs coming in and out of accounts because they are liable for the money instead of private banks. Private banks act as intermediaries and compete with each other. That can result in competitive rates and terms; however, an effort to monopolize control over money can also have disastrous consequences, such as rampant inflation, a shelf life on saved funds and restricted access to money, if deemed necessary by the central bank. So, more regulation is not always a good thing.
The U.S. does not have CBDCs, but it has been floating the idea. The Bahamas, Eastern Caribbean, Jamaica and Nigeria each have introduced a CBDC. Nigeria has barely seen any use for its centralized digital currency, however, even though cryptocurrencies are popular in the country.
The Bahamas and Eastern Caribbean issued CBDCs to help financially connect communities in remote islands and fortify the payments system against natural disasters and pandemics. But the Bahamas’ Sand Dollar, its version of a CBDC introduced in 2020, for example, has seen muted reception. An International Monetary Fund report from May 2022 indicated that the CBDC accounted for less than 0.1% of the currency in circulation. The Jamaican CBDC Jam-Dex has experienced similar “success.”
Regardless, more than 100 other countries are now in the exploration stage, according to an IMF report in November 2023. In the lead are central banks in Brazil, China, the euro area, India and the U.K.
India’s digital rupee recently crossed 1 million transactions in one day, but that was largely due to the help of government-owned and private banks as part of an e-rupee pilot program. Banks were encouraged to deposit employee funds and benefits as CBDCs instead of the regular fiat currency.
Countries have faced an uphill battle with releasing CBDCs. They haven’t generated much traction relative to traditional money, and their adoption has been limited even in the countries that offer them.
Unknown impacts to existing financial systems are behind central banks’ hesitancy to adopt CBDCs. However, many countries are exploring CBDCs’ potential and see some value in taking steps toward a digital fiat currency.
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