What are central bank digital currencies?

This article was published in August 2022 and updated in October 2022.

Money isn’t paper and coins any more.

It’s increasingly digital – and a growing number of central banks are considering issuing their own digital currencies.

Australia is the latest country to trial a central bank digital currency (CBDC).

Its central bank, the Reserve Bank of Australia, said the project would explore the potential economic benefits of introducing a CBDC.

The project will also look at how a digital currency from Australia’s central bank could be used to provide “innovative and value-added” ways for homes and businesses to make payments and transfer funds.

Digital currency is simply electronic, rather than physical, money.

Central bank digital currencies are digital versions of a country’s physical currency – for example, a digital dollar, euro, pound or yuan.

This means “£10 of a UK digital currency would always be worth the same as a £10 note,” explains the Bank of England in the United Kingdom.

The central banks issuing and managing these digital currencies are national financial authorities that oversee a country’s currency, supply of money and monetary policy – like setting interest rates, which change the cost of borrowing.

Central bank money is “a risk-free form of money that is guaranteed by the state,” according to the European Central Bank (ECB), which expects to introduce a digital euro across its 27 member states by mid-decade.

The Bank of England explains that CBDCs – because they’re pegged to a country’s national currency – don’t have the volatility of privately issued digital currencies like Bitcoin, Ether (Ethereum) and XRP.

America’s central bank, the Federal Reserve, says that if it introduced a CBDC, it would be “the safest digital asset available to the general public, with no associated credit or liquidity risk”.

People are using cash less, and could use a CBDC to pay for things digitally, the Bank of England says.

They can hold the digital currency either in an account with the central bank, or as electronic tokens, the World Economic Forum explains in its Central Bank Digital Currency Policy‐Maker Toolkit. The electronic tokens could be held on mobile devices, prepaid cards or other forms of digital wallets.

Businesses and other financial institutions, like high-street banks, could also use CBDC.

A digital currency would complement, rather than replace, physical cash, according to the ECB.

The digital euro would be a “fast, easy and secure” way for people to make daily payments, the ECB says. It would give people more “choice about how to pay” and also increase financial inclusion.

About 1.7 billion adults globally don’t have access to a bank account, according to World Bank data. This is a barrier to reducing poverty. By making money easier and safer to access, central bank digital currencies could potentially improve financial inclusion, says the Atlantic Council, an American think tank.

The resilience of financial systems could also be boosted. If a natural disaster or the failure of a payments company made cash unavailable, a CBDC could provide a back-up, the International Monetary Fund says.

Reducing financial crime is another motivator. Cash is essentially untraceable and this helps to facilitate crime. Central bank digital currencies, on the other hand, can improve the transparency of money flows, says the Atlantic Council.

More than 100 countries are exploring CBDCs, according to the Atlantic Council’s Central Bank Digital Currency Tracker, an interactive map tool.

Ten countries have already launched their own digital currency, including Nigeria in Africa and Jamaica in the Caribbean. The Bahamas in the West Indies was the first country in the world to roll out a national central bank digital currency, called the Sand Dollar, in October 2020. China is due to launch a CBDC in 2023. Nineteen countries in the G20 – which represents the world's largest economies – are exploring central bank digital currencies, including Japan, India, Russia and South Korea.

As mentioned above, the US and UK are researching CBDCs, but have not yet committed to introducing them.

In September 2022, the Swedish, Norwegian and Israeli central banks launched a project with the Bank for International Settlements to test international retail and remittance payments with central bank digital currencies, according to Reuters.

In the Bahamas, introducing the Sand Dollar has made it easier for people to transact money across “an otherwise vast archipelago,” says Deloitte.

The island of Jamaica, which started rolling out its JAM-DEX digital currency earlier this year, expects savings of about $7 million a year on replacing, storing and handling cash, according to the Atlantic Council’s CBDC tracker tool.

For Ecuador in South America, low levels of trust in the central bank led to its digital currency being cancelled three years after launch in 2017.

Challenges for central banks exploring digital currencies include potential cybersecurity threats.

With digital money, risks from counterfeiting, theft and network failure could have “more catastrophic consequences” than for cash, the World Economic Forum warns.

Another challenge is how to make central bank digital currencies widely available enough in a country to ensure they improve – rather than worsen – financial inclusion, the Forum adds.

Countries also need to have suitable technical and legal frameworks in place before they can issue digital currencies.