What is a Central Bank Digital Currency?

What is the definition of Central Bank Digital Currency?

A Central Bank Digital Currency (CBDC) is a digital currency that is issued by a central, nation-state-backed bank. The US Federal Reserve, the European Central Bank and the Bank of England — all of which are yet to authorize a CBDC — are examples of central banks.

For all intents and purposes, a nation’s CBDC should be considered the digital equivalent of the nation’s fiat currency. For that reason, the value of one unit of a nation’s digital currency (one token or coin) will likely be pegged (fixed) to the value of one unit of the same nation’s fiat currency. For example, if a US Federal Reserve-backed CBDC existed, one unit of that digital currency would not only be pegged to the US dollar, it theoretically should be accepted everywhere US dollars are accepted. However, the likelihood of such ubiquitous acceptance in the early going of any CBDC will likely be attenuated by the lack of national and international digital infrastructure to support it.

Most of the world’s countries — including the US — are conducting experiments or trials with CBDCs. At the time this glossary entry was published, CBDCs had been launched in nine countries, including the Bahamas and Nigeria. China’s digital yuan (e-CNY) is in wide-scale public testing across ten cities and India launched the first public phase of its digital rupee (aka e-rupee) across four cities in December 2022.

As a digital token, a CBDC can move between entities with fewer intermediaries and less friction than conventional currency. Although the launch of the digital rupee involves some of India’s commercial banks, in theory, CBDC tokens could be issued directly to citizens from a national central bank with no other financial parties involved. There are multiple websites, including CBDCtracker.org and the Atlantic Council, that track the progress of the many CBDC projects around the world.

Is Central Bank Digital Currency a digital currency or a cryptocurrency? (what’s the diff between Central Bank Digital Currency and cryptocurrency? or Is Is Central Bank Digital Currency a digital currency or a cryptocurrency?)

The degree to which a CBDC should be considered an actual cryptocurrency is a topic of debate. The decentralized nature of a public, permission-less blockchain is a core part of the ethos of Distributed Ledger Technology (DLT). Even if the digital infrastructure behind a given CBDC is DLT-based (not necessarily a given), the likelihood of a central bank technologically intermingling its CBDC program with other unrelated projects on a public, permission-less distributed ledger is low. Cryptocurrency and blockchain purists would likely argue that, compared to other decentralized public distributed ledgers and their native tokens, a central bank’s control over a digital currency (and the DLT on which it runs) essentially disqualifies it as a cryptocurrency. After all, not only is “central” the operative word in the phrase “central bank,” the larger phrase “central bank digital currency” specifically makes reference to “digital currency” rather than cryptocurrency.

On the other hand, some CBDCs, like the digital rupee, bear many of the hallmarks of the cryptocurrency world such as the need for special digital wallets. So, which is it? As the saying goes, beauty is in the eyes of the beholder.

How does pegging (fixing) a currency work?

One goal of pegging (fixing) a digital currency to the value of another financial instrument is to stabilize the digital currency’s value. The idea of pegging non-government-backed cryptocurrencies gave rise to the so-called “stablecoin.” For example, although its name has nothing to do with any US government-backed currency, Circle’s USDC (USD Coin) is a cryptocurrency that pegs itself to the value of the US dollar (a fiat currency). In other words, one USDC token should always be worth US$1 and is therefore considered to be a stablecoin. However, not all stablecoins have been able to maintain their so-called “peg.” Whereas some have slipped off their peg by fractions of a penny but then quickly returned to their pegs, others (most notably some algorithmic stablecoins) like TerraUSD have not only slipped off their peg, never to return, they’ve lost most if not all of their value relative to any fiat currency.

Does Central Bank Digital Currency qualify as a stablecoin?

Despite its inherent government-backed stability, the question of whether a CBDC qualifies as a stablecoin is up for debate given that many people consider stablecoins as a form of cryptocurrency while at the same time taking the view that CBDCs are not a cryptocurrency.

What is the relevance of Central Bank Digital Currency to enterprises and other businesses?

For enterprises looking to leverage the unique value proposition of DLT for their digital transformation and business innovation objectives, CBDCs could be relevant to various business contexts. For example, whether it be for funding payment of on-demand ledger engagement fees or for actually transacting with constituents (employees, customers, stockholders, partners, etc.), the existence and acceptance of CBDCs could alleviate corporate hesitance to do anything crypto-related (a well-known barrier to enterprise adoption of DLT). Not only would volatility be something of a non-issue with a CBDC, simply knowing that a CBDC is backed by a central bank would be a major confidence booster. However, waiting for CBDCs to hit the scene may come with its own cost, including loss of first mover advantage on DLT-related opportunities for industry disruption.