Central bank digital currencies, or CBDCs, are exactly what the name suggests: they're digital versions of a state’s fiat currency. But how does that differ from money sitting in a digital bank account, being used to make cashless transactions with debit cards?

Why do governments even want to have CBDCs? And which countries have launched CBDC projects?

What is a CBDC?

CBDCs are digital versions of a state’s fiat currency. 

They are similar to stablecoins, which are pegged at a 1:1 ratio with a particular fiat currency. But stablecoins like Tether (USDT) are run by private entities that hold central bank-issued cash or cash equivalents. They hold those assets so that their stablecoins can reflect the exact value of fiat currencies. 

The International Monetary Fund (IMF) considers CBDCs to be a new form of money that are:

• 🤖 In a digital form
• 🏦 Issued by a country’s central bank
• 💵 Intended to serve as legal tender

Central banks literally print US dollars or British pounds, so the physical banknotes in your wallet don’t meet the criterion of “digital form.” 

And the money you move digitally through your bank is in fact a series of electronic deposits backed by the assets of commercial banks—97% of the money held by regular people and businesses in the UK are actually commercial bank deposits.

Bitcoin, the world’s largest cryptocurrency, meets two of the above criteria: it’s digital and now serves as legal tender in El Salvador. But Bitcoin has nothing to do with the “CB” in CBDC. It’s not issued by the Central Reserve Bank of El Salvador—even if the bank mined Bitcoin en masse, that wouldn’t count as “money issuance,” as a former IRS counsel told Decrypt in June 2021.

How does a CBDC work?

Sometimes the states developing central bank digital currencies tout blockchain as the underlying technology for CBDCs, but the central bank ultimately maintains authority over the ledgers. In contrast, cryptocurrencies are decentralized with no central authority. 

There are many different ways that CBDCs may be practically deployed by the states. But if early projects are anything to go by, CBDCs tend to work on mobile wallets similar to Apple Pay or Google Wallet.

In the Bahamas, which fully launched a CBDC in October 2020, the central bank issues Sand Dollars just as it issues the Bahamian dollar. It also maintains a ledger of all Sand Dollars in circulation. 

In partnership with private providers, the central bank maintains a KYC infrastructure that citizens need to comply with to open a mobile wallet. Sand Dollars facilitate peer-to-peer electronic payments without an intermediary like a bank account, which is the main idea behind CBDC projects: scan the barcode on your phone to make an in-store payment or send money to another mobile wallet.

Why do governments want a CBDC?

The Bank for International Settlements cites three reasons for the recent rise of CBDCs in its annual report (June 2021): the attention around Bitcoin and other cryptocurrencies, the debate on stablecoins, and the entry of Big Tech into finance.

Concerns over the encroachment of big tech firms in finance, such as the Facebook-backed stablecoin Diem, are also echoed by the European Central Bank (ECB). In a June 2021 report, ECB said that governments that shy away from introducing CBDCs may face threats to their financial systems and monetary autonomy from “foreign tech giants potentially offering artificial currencies in the future.”

But there are many other reasons.

CBDCs could also help speed up money disbursals in times of crisis, as March 2019 research by the Institute and Faculty of Actuaries showed. 

In a July 2021 report, the IMF said that CBDCs can promote financial inclusion because citizens wouldn’t need a bank account to pay with CBDCs. That’s a big deal in countries like Indonesia, where a third of the population don’t have access to traditional finance and yet are more likely to have mobile Internet.

Fan Yifei, deputy governor of the Chinese central bank, said in April 2020 that a CBDC would reduce illicit uses of money as physical money is anonymous and can also be more easily counterfeited.

MasterCard, which has stakes in electronic payments, estimates the cost of managing physical cash to be as much as 1.5% of a country’s GDP. So countries can save a lot by going more—if not necessarily completely—digital.

What countries are working on CBDCs?

As of August 2021, there are 81 countries, including monetary authorities such as the European Union, pursuing a CBDC project in one way or another. They represent 90% of global GDP.

Only five of them have launched CBDCs to date. They’re all Caribbean island nations: the Bahamas, Saint Kitts and Nevis, Antigua and Barbuda, Saint Lucia, and Grenada.

The majority of them—32 countries—are in the “research” stage. That’s when the central banks try to figure out what the whole fuss is about and whether they actually want to have a CBDC. This includes the United States, which has kept a low profile on its digital dollar explorations. Governments are also taking their time in order to study the security implications of CBDCs.

There are 16 countries in the “development” stage, which is when things get more serious as countries develop proof-of-concepts and launch studies. 

In April 2021, the Bank of Japan launched the first phase of a feasibility study for its digital yen, which will run for a year before even more studies. Meanwhile, South Korea is going full steam ahead, with its CBDC expected to move onto the pilot stage as of August 2021. 

14 countries are now in the pilot stage: they have developed a CBDC that is being tested in the real world.

China’s CBDC, the digital yuan, is the hottest pilot at the moment. It’s been used in more than 70.75 million transactions, amounting to 34.5 billion yuan ($5 billion) by the end of June 2021. The country has airdropped millions of digital yuan to citizens as part of an effort to test the technology—and create some buzz around it.

Sweden’s e-krona is also in the pilot stage as of April 2021, but there’s been much less fanfare around it. Cambodia has been piloting its CBDC since July 2020, and anyone who has a Cambodian phone number can join, the vendor that created the blockchain platform for the CBDC project, told Decrypt. 

Another pilot CBDC is Ukraine’s e-hryvnia, with real-world CBDC tests officially starting as of August 2021. In January 2021, the country’s central bank signed a deal with Stellar Development Foundation—the organization behind the cryptocurrency Stellar (XLM)—but it hasn’t said whether its CBDC would be on Stellar’s blockchain.

The future of CBDCs

More countries will launch fully-fledged CBDCs over the mid-term, with China leading the charge.

China will roll out the digital yuan during the Beijing 2022 Winter Olympics in February. However, some U.S. Senators have urged a ban on American athletes "receiving or using digital yuan" during the tournament, fearing that it could be used to surveil those visiting China "on an unprecedented scale".

Those concerns over privacy are only likely to grow louder. Some CBDC advocates have touted the digital currencies as a privacy solution; in June 2020, ECB executive board member Fabio Panetta argued that a digital euro would be more private than privately-issued stablecoins because "we have no commercial interest in storing, managing or monetizing the data of users." 

However, others have raised concerns about the privacy implications of CBDCs, as they present an opportunity for states to keep close tabs on monetary flows on a macro level—and, more problematically, on an individual level. Mu Changchun, the director of the The People's Bank of China's Digital Currency Research Institute, has already stated that the digital yuan will have "limited anonymity", with small payments linked to users' phone numbers and larger payments requiring more extensive KYC data. 

In the U.S., conservative lawmakers have argued that China's digital yuan could be used to “expand domestic surveillance initiatives” or even to “enforce party discipline.” Congressman Tom Emmer (R-MN) noted that a CBDC would only be beneficial if it was “open, permissionless and private.”