If you work in banking, payments, treasury or policy, central bank digital currencies have probably reached your desk as a briefing paper, a consultation or a question from a board member. The conversation tends to blur two separate issues: what a CBDC is meant to achieve, and what technology it should run on. Keeping those apart makes both easier to reason about.

What a central bank digital currency is

A central bank digital currency is money issued in digital form by a central bank. It is a direct liability of the central bank, in the same way that banknotes are, which sets it apart from the balances held in commercial bank accounts and from privately issued digital currencies.

Who can hold and use it is a design choice. A CBDC can be built for the general public to use in everyday payments, or for financial institutions to settle with each other, and the expected benefits differ between the two. Most CBDC work has concentrated on domestic payments, while a smaller group of central banks has been collaborating to explore how CBDCs could be used across borders.

Because a CBDC sits at the core of the monetary system, its effects on financial stability and monetary policy could be significant, with both benefits and risks. That is why central banks approach design carefully, weighing costs against benefits and trying to rule out unintended side effects before anything reaches the public.

The value CBDCs could bring

The case for a CBDC usually rests on a set of potential benefits. None is guaranteed, and each depends on how a particular system is designed and run:

  • Lower transaction costs for both institutional and retail payments.
  • Financial inclusion, by giving people who do not hold a bank account access to digital payments.
  • Cheaper than cash for the issuer, because there is no physical currency to produce, store, transport and dispose of.
  • Reduced fraud and money laundering compared with physical cash, depending on the controls built into the system.
  • Faster settlement, particularly for cross-border payments where long intermediary chains slow things down.
  • Increased competition in payments, pushing existing providers to innovate and encouraging banks to compete for deposits that might otherwise move into the CBDC.
  • Round-the-clock availability, so payments and short-term liquidity are accessible 24 hours a day, seven days a week, including on bank holidays.

Some of these points cut both ways. Deposits moving from commercial banks into a CBDC is a source of competition, and it is also a change in how banks fund themselves. Risk and treasury teams need to read the list with both sides in mind.

Cross-border payments and the intermediary chain

Cross-border payments, including remittances, are where many observers see the largest potential gains. International transfers today commonly involve high fees, no guarantee that the full amount reaches the recipient, and limited interoperability between domestic payment systems.

Much of this comes from the way cross-border payments are structured. Intermediaries emerged because each step of a transaction chain needed someone to complete it, and over time they developed from medieval bills of exchange into financial institutions offering settlement, clearing and payment services. In the correspondent banking model, which is the most common arrangement behind the scenes, a payment can pass through several banks before it arrives. Streamlining that chain could improve cost, speed and transparency.

A CBDC-based model could look more like a peer-to-peer arrangement that connects payer and payee directly, simplifying the intermediation chain and making settlement available at any hour. Interoperability between different countries' CBDC systems is one route central banks can examine to ease cross-currency payments. How far this goes depends on design: central banks have to decide how many intermediaries to remove while keeping the services that intermediaries provide to businesses and consumers.

Centralized ledger or distributed ledger

Discussions of CBDCs are often assumed to involve a blockchain, largely because private digital currencies such as Bitcoin made the technology familiar. A CBDC does not have to use one.

Distributed ledger technology (DLT) describes a family of technologies in which a group of participants collectively maintains a replicated, shared and synchronized record, without relying on a single central party or central data store. Blockchain, introduced with Bitcoin, is the best-known example. Traditional centralized systems take the opposite approach and rely on a trusted central party to maintain the record.

A CBDC could therefore be centralized or use some form of DLT, and each option has to be assessed against the specific requirements of the system. The arguments made for a distributed approach include:

  • Operational resilience. With no single point of failure, the system can keep running if individual validators stop working, which supports high availability for a widely used currency.
  • Cost of resilience. Centralized systems also achieve high resilience through their own measures; proponents argue that DLT can deliver it more cost-effectively.
  • Capacity. A CBDC open to everyone could generate very large transaction volumes. Supporters suggest a distributed design can add operational capacity as demand grows without the central bank rebuilding its computing infrastructure.

What a blockchain-based design adds, and the open questions

Blockchain-based designs bring further features that proponents highlight. A CBDC can function as a large-scale asset register and clearinghouse, with resilience, data availability and a transparent transaction history. The design can aim to protect users' privacy and independence while the central bank keeps full control of the currency, so that users are not locked in by particular intermediaries. It can also draw on tools developed in open-source blockchain ecosystems, such as zero-knowledge cryptography and non-custodial wallets, and connect to decentralized finance. Rules can be written into the system itself to support compliance, for example wallet holding thresholds or controls on third-party access.

These features come with trade-offs. Transparency of transaction history and user privacy pull in different directions, and adapting DLT for the permissioned environment a central bank requires introduces risks of its own. Some argue that a distributed ledger moves a CBDC away from the purposes it was originally designed for. Whether DLT is the best fit, and whether a CBDC's goals can be met through DLT in a way other architectures cannot, remain open questions that central banks continue to research.

For professionals assessing a CBDC proposal, the practical point is to evaluate the policy goals and the technology choice separately, and to ask what each design decision means for cost, resilience, privacy, compliance and the role of existing intermediaries.

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