Are state-backed digital currencies a game-changer?

October was a big month for central bank digital currencies, or CBDCs for short. The Bahamas launched the sand dollar, the world’s first nationwide CBDC, and it has kicked off a race among central banks to launch their own digital currencies.

A CBDC is a digital representation of money issued by a central bank, either in place of or as a complement to physical cash.

In a world where 95% of currencies are already digital, it’s worth asking: What do CBDCs bring to the table?

To better understand this, we first have to understand the different categories of money:

With object-based money, the transaction is settled on the spot as long as the parties deem the object (i.e. cash or cryptocurrency) to be valid. No exchange of information is necessary.

As for claims-based money, the transaction is settled elsewhere with the transfer of the buyer’s claim on an asset to the seller (e.g. swiping a debit card instructs the bank to transfer ownership of money from the buyer’s bank account to the seller).

A CBDC is a form of central bank money, although it has features that straddle other categories. Like cash, it is object-based and issued by a central authority. However, unlike cash, it has no physical form.

The ultimate form will depend on politics and societal values

CBDCs hold a lot of promise: They could allow anyone to receive salary payments, invest in a privately held company in Switzerland, and automate their health insurance claim from a single application on their mobile phone. All these could be accomplished without having to log into multiple accounts, exchange local currency for Swiss francs, or file any additional forms.

In this respect, CBDCs and cryptocurrencies promise the same benefits: removing intermediaries in cross-border transactions through digital ledgers or smart contracts. This makes transactions more efficient. However, unlike cryptocurrencies, which can be entirely decentralized, CBDCs are created and issued by a central bank, and as a result could quickly gain trust and adoption among consumers and the financial system.

What are the nuts and bolts?

How users experience CBDCs will depend on their design features, which include access (retail versus wholesale), model (single-tier versus two-tier), and ledger technology (centralized versus decentralized).

The degree of anonymity can also vary between different CBDCs. There is a trade-off between protecting privacy and personal data on one hand, and discouraging criminal activity by enforcing anti-money laundering and terrorism financing rules on the other.

Why are states and central banks interested in CBDCs?

How different would a world with CBDCs be?

No disruption, please