How CBDCs Work

What if the government created its own cryptocurrency? That’s essentially what a central bank digital currency (CBDC) is. Unlike Bitcoin or Ethereum, which are decentralized and volatile, a CBDC would be a digital version of regular money, issued and guaranteed by a central bank.

More than 130 countries, representing 98% of global GDP, are researching or piloting CBDCs. The Bahamas has a working one. China is piloting across multiple cities. The European Union is building one. The US Federal Reserve is still studying it. The designs being debated range from radical (a programmable currency anyone can use) to boring (a digital version of cash that does exactly what cash does, but on a phone).

Understanding the debate matters, because the choice will shape how money works for decades.

The short answer

A central bank digital currency is a digital form of cash issued by a country’s central bank. Unlike commercial bank money (the numbers in your checking account), CBDC is a direct liability of the central bank, meaning it’s as safe as cash. Countries are debating two main models: retail (for ordinary citizens to use for everyday payments) and wholesale (for banks and financial institutions to settle payments between themselves).

The full picture

The problem CBDCs are trying to solve

We already have digital money. When you pay with a debit card or Venmo, you’re using digital money. So why do we need a CBDC?

The issue is who sits between you and your money. When you deposit money in a bank, you’re lending it to the bank. If the bank fails, the FDIC insures deposits up to $250,000. But the FDIC doesn’t cover everything, and in a crisis, access to your money can be frozen.

Cash solves this problem. A $20 bill is anonymous, can’t be blocked, and is a direct claim on the government. But cash is disappearing. In Sweden, cash transactions dropped from over 40% in 2010 to under 2% today. Many countries are heading the same direction.

CBDCs are an attempt to preserve the properties of cash (government backing, universal acceptance, no middleman) in a digital format.

Wholesale CBDCs: banks only

The simpler version is a wholesale CBDC. This is digital money used only by banks and financial institutions. Instead of using correspondent banks to settle international payments (a slow, expensive process involving multiple intermediaries), banks could transfer CBDC directly.

The Bank of France has piloted a wholesale CBDC for settling bond transactions. The Monetary Authority of Singapore has tested cross-border payments between banks. These experiments show meaningful improvements in speed and cost, but they don’t change anything for ordinary people.

Retail CBDCs: digital cash for everyone

The more controversial model is a retail CBDC. This would be a digital banknote that anyone could hold, without needing a bank account.

China’s digital yuan (e-CNY) is the most advanced retail CBDC pilot. Pilots have run in multiple cities, with over $14 billion in transactions processed. Users download a government app, link it to a bank account or add money directly, and pay by scanning QR codes. It’s designed to look and feel like mobile payments, just issued by the central bank instead of Alipay or WeChat Pay.

The Bahamas’ Sand Dollar works similarly, aimed at making payments easier across islands where bank branches are scarce.

The design debate

Not all CBDCs are the same. Countries are split on fundamental questions.

Identity or anonymity? Some designs require users to verify their identity, just like opening a bank account. Others aim for something closer to cash: anonymous, like a $20 bill you can pass to anyone. The choice pits privacy against the ability to track illegal activity.

Interest-bearing or not? Should CBDC pay interest? If it does, people might shift money out of bank accounts into CBDC (since it’s risk-free), potentially destabilizing banks. Most designs avoid interest to keep CBDC as a payment tool, not an investment.

Programmable money? Some proposals imagine CBDC as smart money that can carry rules. A dollar that expires after one year. A stimulus payment that can only be spent at local businesses. A salary that arrives automatically on payday. This is technically possible but politically explosive.

Two-tier or direct? Most designs keep commercial banks in the middle: you get CBDC from your bank, not directly from the central bank. This preserves the banking system. A direct model would let citizens hold accounts directly at the central bank, cutting out banks entirely.

The dollar’s special status

The US faces a unique pressure. The dollar is the world’s reserve currency, used in over 80% of foreign exchange transactions. If the US issues a CBDC, it could strengthen that dominance. If another country issues a CBDC first and it works well, it could chip away at dollar dominance.

China’s digital yuan is partly about reducing dependence on the dollar-dominated SWIFT payment system. Russia and Iran are exploring a joint CBDC to bypass Western sanctions. The design of CBDCs isn’t just about domestic payments, it’s about the future of global money.

Why it matters

The biggest impact of CBDCs won’t be technological. It will be political. A CBDC changes the relationship between citizens and the state. It could make payments faster and cheaper, especially for the 1.4 billion adults worldwide without bank accounts. It could enable new government policies, from instant stimulus to negative interest rates. It could also enable surveillance, financial censorship, or a bank run if people lose confidence in commercial banks.

For the average person, the change might be invisible. If your country implements a CBDC that works like existing digital payments, you might switch without noticing. The bigger question is what powers the government gains in the process: Can it see every payment you make? Can it block payments it doesn’t like? Can it control who holds money and for how long?

These aren’t hypothetical. China has already frozen CBDC accounts linked to political activity. The design choices made in the next decade will determine whether CBDCs are a tool for financial inclusion or a tool for financial control.

Key terms

• CBDC (Central Bank Digital Currency): A digital form of fiat currency issued by a country’s central bank, representing a direct claim on the government.
• Retail CBDC: A CBDC available to ordinary citizens and businesses for everyday payments, as an alternative to cash or bank deposits.
• Wholesale CBDC: A CBDC used exclusively by banks and financial institutions for settling payments between themselves.
• Two-tier model: A CBDC system where commercial banks distribute CBDC to customers, rather than citizens holding accounts directly at the central bank.
• Programmable money: A concept where CBDC carries embedded rules, such as expiration dates or restrictions on where it can be spent.

Common misconceptions

“CBDCs are like cryptocurrency.”

Only superficially. CBDCs use blockchain technology in some designs, but that’s where the similarity ends. Cryptocurrency is decentralized (no one controls it) and volatile. CBDC is centralized (the government controls it) and pegged to a fixed value. Bitcoin was created to replace government money; CBDC is government money going digital.

“CBDCs will replace cash.”

Not necessarily. Most designs explicitly complement cash rather than replace it. The Bank of England, for example, has said a UK CBDC would coexist with notes and coins. That said, if CBDC is more convenient, people might choose it over cash anyway. Cash use has been declining for years regardless of CBDCs.

“If my country has a CBDC, I’ll be forced to use it.”

Almost no country is proposing mandatory adoption. CBDCs are designed as an option, not a requirement. You could still use cash, bank transfers, or payment apps. The question is whether CBDC becomes the default because it’s cheaper or more convenient.