Central Bank Digital Currencies — CBDCs for short — are digital fiat currencies, or digital cash.
CBDCs are inspired by cryptocurrencies, in that they allow users to transact anonymously. This is because they use a system of encrypted signatures — known as ‘blind signatures’ — to keep the payer and payee’s identities hidden.
That said, CBDCs differ from cryptocurrencies in two key ways.
Firstly, where cryptocurrencies are decentralized, a CBDC is, by definition, centralized. It’s established by law, backed by the state, and has official status as legal tender in the country or countries where it’s issued.
Secondly, while some proposed CBDCs are blockchain-based, distributed ledger technology isn’t necessary for them to work.
The blockchain’s purpose is to provide a replacement for trust. Put simply, complex mathematical calculations fulfil the role that would usually belong to counterparties and other actors that ensure the integrity of a fiat currency transaction.
That’s important in decentralized systems. But in the case of a CBDC, the central authority that controls and manages it provides that trust.
The concept of CBDCs has started gaining momentum because we’re living in increasingly cashless societies. This has made it harder for the unbanked, those who are predominantly paid in cash, and other vulnerable sectors of the population to participate in economic life.
Going cashless has also had other unintended negative consequences. In particular:
- Digital payments have concentrated power in private actors’ hands
- Credit risk and liquidity risk are increasing, because ever more transactions involve private deposits settled through other banks, rather than through the central bank
- Some central banks have seen drops in seigniorage revenue — the profit they make from the difference between cash’s face value and the cost of manufacturing and recycling it
It’s thought that CBDCs will address these problems and ensure everyone continues to have access to cash, even if physical notes and coins are eventually phased out.
- Ecuador was the first country to roll out a CBDC. Sistema de Dinero Electrónico was launched in 2014 to support dollarisation (the country replaced the failing Sucre with the US Dollar in 2000). Ironically for a CBDC trailblazer, Bitcoin and other cryptocurrencies are illegal in Ecuador. This doesn’t seem to be deterring Ecuadorians — Bitcoin’s popularity keeps growing
- Ben Broadbent is credited with coining the term ‘Central Bank Digital Currency’ while serving as the Bank of England’s deputy governor. He used the term in a March 2016 speech at the London School of Economics in which he also acknowledged that Bitcoin inspired the idea.
Want to know more?
This 2019 paper from the Institute and Faculty of Actuaries explains the origin, rationale, and issues surrounding CBDCs in detail, but it’s highly readable and easy to follow.
Of particular interest is page 20, a table summarizing different countries’ attitudes to cryptocurrencies. A number of countries classified as having a ‘generally negative view’ of cryptocurrencies and crypto assets — most notably Australia, Japan, and the UK — are now regulating them.
See also this great article in Forbes about how our partner Giesecke & Devrient is moving from printing physical banknotes to providing the infrastructure for CBDCs.
The Metaco view
“As the enthusiasm for going cashless increases, it’s crucial that we take steps to keep our financial system resilient… and make sure nobody is left behind. We believe CBDCs represent a natural progression in the evolution of money, one that allows for easier and cheaper transmission of payments and monetary policy, which benefits everyone.”
– Adrien Treccani, CEO METACO
How CBDC differs from fiat currencies