Your guide to understanding CBDCs

November 1, 2021 | By Vicki Hyman

Where does cash come from? Your country’s central bank — like the U.S. Federal Reserve or the Bank of Japan — authorizes the printing of paper bills that make their way to your wallet. Here’s the thing: Fewer people are carrying cash these days, if we even have a physical wallet. We’re paying with cards and digital wallets.

As the world is becoming more digital, central banks are investigating — and in a few cases already launching or testing — their own digital versions of paper money, called central bank digital currencies, or CBDCs.

/ˈkər-ən(t)-sē/ • noun

1.   something that is circulated as a medium of exchange; money


In most cases, they are designed to be used the same way as cash, to buy and sell goods and services, and, like cash, they are backed by the central bank. CBDCs have the potential to help modernize payments and bring more people into the digital economy. Here’s how CBDCs work and what they mean for everyday consumers:

Why are countries increasingly interested in issuing their own digital money?

In a world that is always-on, some central banks still rely on outdated technology that doesn’t allow for 24/7 payment processing. Some countries are upgrading their banking infrastructure to allow for real-time payments, but CBDCs are another way to modernize payment infrastructure, allowing for faster transactions during more times of the day.

CBDCs also offer a way to cut down on the inefficiencies of printing and moving money — the cost of managing physical cash can be as much as 1.5% of a country’s GDP. As connectivity increases and smartphones proliferate, CBDCs could also be a way to include more people in the digital economy who are currently shut off from basic financial services.   

Are CBDCs like private cryptocurrencies?

CBDCs and the private cryptocurrencies that are often in the news — like Bitcoin and Ether — are both digital currencies with no physical counterparts. But CBDCs are issued by a central bank, with the same guarantees that back a nation’s paper currency — they are equivalent to cash and designed for everyday transactions. Private cryptocurrencies, by comparison, are not backed by a government. The most popular cryptocurrencies are free-floating, meaning their prices are determined by the market. That makes them much more volatile than traditional money. They have been used more as investment vehicles than as an actual currency for everyday commerce, although there is a growing acceptance of crypto among merchants and new options like “crypto cards,” which allow cardholders to convert their crypto into fiat currency at places that accept traditional credit cards.

One private cryptocurrency seeing significant activity is stablecoins, which are designed to have a consistent value. These tokens are much closer to CBDCs than to their free-floating counterparts, although they too lack the formal backing of a central bank. To ensure financial sovereignty and stability, some governments see developing their own digital currencies as a necessary project to keep pace with new fintech concepts like stablecoins.

How quickly will CBDCs take off?

Nearly nine in 10 central banks are actively exploring CBCDs in some form, and the central banks of countries representing a fifth of the world’s population say they are likely to issue a CBDC in the next three years, according to a 2021 survey by the Bank for International Settlements (BIS). The Bahamas formally launched its CBDC last year, with China actively piloting its digital yuan, with plans to test it with international visitors at the 2022 Winter Olympics in Beijing. Earlier this year, the Eastern Caribbean Central Bank, the monetary authority for a group of eight island economies, launched a 12-month pilot for DCash, its own CBDC, the first to go live for a currency union. And in late October, Nigeria's eNaira went live, making it the second largest pilot in the world, after China's. 

But widespread rollout is unlikely anytime soon, according to BIS, as there are many technical challenges to overcome, and central banks considering CBDCs may need authorization from their legislative bodies to issue them. Plus, central banks will look to coordinate international policies and standards for CBDCs. Suffice to say, there’s a lot more work to do here.

Will CBDCs replace paper currency?

Conceivably they could, but it’s unlikely. After all, bartering continues to exist thousands of years after the introduction of physical currency. Though digital transactions have been on the rise — and the shift to touch-free transactions has accelerated during the pandemic — cash remains the most popular means of exchange around the world, especially in developing markets. For example, 96% of total transactions in Indonesia are in cash, according to McKinsey. Most central banks have said they are committed to issuing and distributing physical cash so long as there is demand for it. But just as cards, real-time payments and, more recently, digital wallets have offered people more choices and security, so could CBDCs.  

How would paying with a CBDC actually work?

The designs for CBDCs vary, but one made to fit with current payment infrastructure would work a lot like a mobile wallet. A central bank could issue the digital money to financial institutions for distribution, or even directly to your digital wallet — just like direct deposit of a government social benefit or stimulus payment. You could then pay at checkout much the same way you do today with a phone.

This story was originally published July 21, 2021. It was updated to include new developments in CBDC pilots in the Caribbean, Nigeria and China. 

Vicki Hyman, manager, communications, Mastercard