Central Bank Digital Currencies: Where Are We Now? 

March 30, 2022 - 15 min read

Nearly Half The World’s Countries Are Exploring CBDCs, But Are They Really Better Than Traditional Money? 

As of early 2022, as many as 87 countries consisting of approximately 90% of global GDP were exploring creating government-backed digital currencies, often referred to as central bank digital currencies (CBDCs). 

In theory, central bank digital currencies could have the same ease of use, and potentially some of the same privacy as traditional cryptocurrencies, but would be issued by central banks in addition to traditional currencies. Being backed by governments, instead of private enterprises, these coins would ideally be more stable and less volatile than current cryptocurrencies, and would not carry the “de-peg” risk of popular stablecoins like Tether (USDT). 

However, depending on how they’re implemented, CBDCs may be no more decentralized, private, or efficient than traditional currencies– and it’s still highly unclear how they would interact with the current cryptocurrency market and overall DeFi ecosystem. 

CBDC and Their Potential Interactions with the Traditional Cryptocurrency Market 

One prominent issue regarding CBDCs is the question of how compatible they would be with the current cryptocurrency and DeFi ecosystem. Overall, the degree of compatibility that CBDCs will have with the current crypto market may be directly correlated to the use and popularity of CBDCs. In essence, the more decentralized and interoperable a CBDC is, the more likely people are to use it instead of traditional currency or non-government-backed crypto. 

However, it seems likely that central banks will want to issue CBCs on private, permissioned blockchains, which could greatly limit their potential use. For instance, the aforementioned Tether (USDT), the most popular stablecoin on the market today, is hosted on the Ethereum blockchain; each Tether is an Ethereum-compatible ERC-20 token pegged 1:1 to the U.S. dollar. This allows ordinary users to transfer USDT to and from Ethereum capable wallets and utilize it on major cryptocurrency exchanges. 

One major potential benefit of CBDCs would be the ability to transfer funds from wallet to wallet without the use of a bank or third-party intermediary, much as USDT is transferred today. However, if CBDCs are built on private, permissioned blockchains, it’s likely that compatible wallets could only be issued by governments or approved banks, which would defeat much of the point of having CBDCs in the first place. These approved wallets might have many of the same limits as traditional bank accounts, making CBDCs no more useful than using Zelle, PayPal, or CashApp to transfer funds. 

However, in the unlikely event that initial CBDCs would be issued on a public blockchain (whether existing or newly created), or somehow be made cross-compatible with other blockchains and dApps via cross-chain bridges, it could lead to their widespread adoption within record time.

For example, in the near-impossible, yet theoretical scenario that the U.S. Treasury issued a digital dollar as an ERC-20 token, it could be instantly used on Ethereum-compatible wallets and major exchanges, just like any other cryptocurrency. 

In essence, if governments build highly siloed, centralized digital currencies that cannot interact with the current cryptocurrency market, it’s unclear why ordinary consumers would adopt them unless banks actually stop interacting with traditional currencies. However, if they can effectively integrate CBDCs within the currency crypto ecosystem, they could become highly popular as a form of digital value storage and a major competitor to current stablecoins. 

Multiple Models for CBDCs

In light of the issues mentioned above, it should be noted that there are a variety of approaches that can be utilized in the issuance of CBDCs. For instance, several Eastern Caribbean countries have opted for a highly centralized model, with users holding accounts directly at the central bank of the country in question. Other than the creation of the currency on the blockchain, rather than on a traditional data storage method, it’s unclear how these CBDCs are different from traditional dollars. However, they do have the benefit of cutting out financial institutions from the process of distributing the currency to citizens, eliminating a certain degree of third-party risk. 

In a somewhat less centralized model, the European Central Bank (ECB) would allow licensed financial institutions, like banks, to operate permission nodes on a private blockchain network in order to distribute digital euros. It’s unclear if obtaining a digital currency license would be any easier than obtaining the cumbersome licensure of a traditional banking institution. 

China’s model, in contrast, is even more decentralized, relying on private banks to distribute the digital Yuan to their customers. Of course, these banks would still need to be licensed. 

In the fully decentralized model, digital currency would be issued as tokens or NFTs, which would offer fuller privacy and interoperability with the current crypto infrastructure. This relies on governments giving up unprecedented control over how their money is used, but, again, is perhaps the only way for CBDCs to gain mainstream acceptance. Otherwise, consumers will likely continue to use stablecoins that they can privately transfer from wallet to wallet, and on and off exchanges without direct government intervention or licensure. 

While stablecoins and CBDCs could be competing for market share, they could merge in interesting ways, particularly if a more open-source CBDC model is used. For example, a digital currency issued as an ERC-20 (or another type of token) could be backed by a variety of CBDCs to decrease inflationary risks from any one currency– creating a truly “stable” stablecoin. 

Why CBDCs would likely face the same inflationary pressures as traditional currencies, as well as other drawbacks

Despite being digital, central bank digital currencies would likely face many of the drawbacks of traditional currencies. Today, all governments issue fiat currencies that are unbacked by commodities such as gold. This means that central banks can effectively print an unlimited amount of money by issuing debt in the form of government-backed bonds. The income from selling these bonds back to the central bank (or to outside investors) is used to fund government budgets, as well as to pay the interest and principal payments on existing government bonds. 

Through a process called quantitative easing, the U.S. Federal Reserve sells trillions of dollars of U.S. Treasury bonds per year in order to pay for the U.S. government’s ballooning debt. This process is somewhat controversial, as many believe that it has led to vastly increased inflation rates, particularly for ordinary consumer products. In fact, 80% of all US dollars in existence were printed in the last 22 months, from the Federal Reserve holding $4 trillion in assets in January 2020 to holding a record $20 trillion in assets in October 2021. As of Q1 2022, total U.S debt sat at a record $29 trillion

Debt and inflation problems, of course, are not restricted to the United States, since other developed countries like Argentina, Turkey, and others have suffered extreme inflation in the last few years, and countries like China have been saddled with massive national debts. 

Theories of Inflation in Relation to Crypto and CBDCs 

Economists and libertarian thinkers, particularly those of the heterodox Austrian School of Economics, believe that excess money printing and the high government debt load makes the supply of U.S. dollars greater than the demand, reducing the value of the dollar and therefore precipitating inflation, reducing the purchasing power of ordinary people. This is particularly damaging to ordinary people when combined with stagnant wages, or at least when inflation greatly outpaces wage growth. 

In contrast, proponents of Modern Monetary Theory (MMT) and the Keynesian school of economics, believe that inflation is typically caused by other factors, including supply chain issues, and, in addition, that inflation is not harmful to the overall economy, and may be necessary to precipitate economic growth. 

Many believe that increased inflation in the U.S., in addition to runaway inflation in countries like Venezuela, Argentina, and Turkey, has been one of the major factors for the increased adoption of cryptocurrencies in recent years. 

In contrast to traditional fiat currencies, which can be extremely inflation prone, many experts cite Bitcoin as a deflationary asset (one which gains value over time), since there is only a limited amount of Bitcoin that can be mined (21 million), and the mining process becomes more energy-intensive as more miners mine the currency. Bitcoin, one could say, is actually backed by energy, and energy prices have been shown to have some correlation with mining volume and the price of Bitcoin. 

While most other cryptocurrencies do not have a volume limit and are moving away from the energy-intensive proof-of-work model, there are other ways in which cryptocurrencies can be 

Digital Privacy and CBDCs

In addition to inflationary risks, many experts believe that CBDCs could have many of the privacy issues of traditional currencies and would likely be subject to the same KYC (know your customer) and AML (anti-money laundering) laws as traditional currency. 

While these laws do likely prevent money laundering, they also provide a powerful way for governments to track their citizens. Due to this, many believe CBDCs could actually make privacy issues worse, as governments could easily track currency transactions on a shared ledger. 

In contrast, cryptocurrency has traditionally had the benefit of being far more private than traditional currency– though this may be changing as additional government regulations crack down on the use and transfer of cryptocurrencies, particularly when they interface with traditional financial vehicles like bank accounts. 

Others, however, think that CBDCs could actually increase privacy; but in the end, it will depend on exactly how these currencies are managed and the nature of the blockchains they will be rolled out on. 

The Most Prominent Countries to Explore CBDCs 

China: China’s Digital Yuan is the Second Most Advanced CBDC Project to Date

Currently, China is the largest country with an advanced CBDC project. China’s model, unlike some other countries, involves partnering with banks to issue their digital yuan to consumers. In early 2022, The People’s Bank of China released its pilot CBDC wallet application for Android and iOS. Initially, the app will only be available to selected users and China’s digital yuan issuances will be restricted to major banks. However, the Chinese government says it plans to expand the project quickly, as well as make the digital yuan more interoperable with current digital payment systems and applications. 

Since China has appeared as a first-mover in the CBDC game, some experts believe that its digital yuan could become popular internationally, reducing the influence of the U.S. dollar over international monetary policy and the global economy. However, others say that the digital yuan will only be as popular as the traditional yuan, which has not gained much popularity as an international reserve currency and, in contrast to the U.S. dollar, has little impact on global monetary economics. 

The United States: The Federal Reserve Remains Uncertain About Digital Dollars 

Unlike China, which has been bullish on CBDCs, the U.S. Federal Reserve remains far more uncertain. In mid-2021, Fed chair Jerome Powell stated that the Fed would begin conducting serious research on the impact of CBDCs on the global economy. Research projects regarding CBDCs are currently underway at the Federal Reserve Bank of Boston, and the Fed is also collaborating with a variety of other organizations on CBDC research, including the CBDC coalition at the Bank for International Settlements. In late 2021, Powell said that the U.S. is unlikely to issue a CBDC anytime soon and that the timeline for a digital dollar would likely be measured in years, not months. 

The Bahamas: The First Country with an Active CBDC Issuance Program

Surprisingly to some, the Bahamas is the first country to have a fully-fledged CBDC program. According to the Bahamian government, “Sand Dollar is the digital version of the Bahamian dollar (B$). Like regular Bahamian currency, the Sand Dollar is issued by the Central Bank of The Bahamas through authorized financial institutions (AFIs).” 

The Bahamas Sand Dollar has caught interest from institutions including Mastercard, which partnered with the company Island Pay to create a prepaid card that allows users to instantly convert the Sand Dollars to regular Bahamian to make payments both in the Bahamas and anywhere Mastercard is accepted worldwide. 

Russia’s CBDC Program is Perhaps the Largest Behind China’s 

Starting in 2020, Russia’s Central Bank said it was beginning to seriously explore creating a digital ruble. Similar to the CBDC plans of several other countries, the digital ruble would be stored in a specialized wallet. At the end of 2021, a prototype was tested, and is planned for testing in the first quarter of 2022. The government believes this will reduce transaction costs for both citizens and businesses, and has boldly claimed that the digital ruble will likely fully replace the traditional ruble within 10-30 years. In the near future, the digital ruble will also allow citizens and businesses to pay their taxes. The program has proposed a combination of both centralized and decentralized DLT technologies to protect the security and stability of the digital ruble, including the potential use of biometric citizen profiles to prevent unauthorized transactions. Private banks have raised significant concerns over the digital ruble project, as they believe it could seriously impact their profits and perhaps lead to negative impacts on the Russian financial industry and the economy as a whole. However, as far as large countries are concerned, Russia seems to be slightly behind China, but far ahead of the United States and the EU. 

The EU Continues to Investigate CBDC Implementation, Though Timelines Are Unclear 

July 14th, 2021 marked the European Union’s first step towards a digital euro. For the next 24 months, the project will be in an investigation phase, aiming to work on design and distribution. A major focus is safety, making sure that any illegal activities are safeguarded against. However, the European Union seems adamant about using a digital euro as a supplemental currency, not a replacement, to the physical euro. 

The investigation phase will include several additional components, the first of which focuses on user experience and a functional design aimed at making accessing the digital euro easy for consumers. Next, the investigation will include European co-legislatures, who will review and determine any changes needed to the legislative framework as the digital euro is implemented. Lastly, an analysis will be carried out regarding the potential impact of a digital euro on the European market. Key areas of interest include design options for privacy, security, and the potential impact across the overall economy. Potential users and distributors will be polled regarding their views on the implementation of the digital euro. 

Mexico Also Has Tentative Plans to Implement CBDCs 

Mexico is also planning to implement their own digital currency by 2024. The central bank of Mexico (Banxico) reported that a digital currency will advance financial inclusion within the country. Paper money will still be the primary payment option in Mexico for some time, however they do not plan to miss out on the technological advances that other countries are using. The governor of Banxico, Victoria Rodriguez Ceja, reported that the monetary authority will be analyzing the launch of the digital peso. However, Mexico’s government does not seem convinced. Mexico’s finance minister Arutro Herrera asserted that cryptocurrencies are not legal tender assets or currencies within Mexico’s current legal framework. Additionally, the Financial Intelligence Unit of Mexico alleged 12 crypto exchanges of non-compliance with reporting requirements. 

Sweden, Singapore, and Others Continue to Explore CBDCs

In 2017 Sweden’s Riksbank began implementing the use of a CBDC they called e-krona. The drop in cash payments used in retail shopping encouraged this development. The bank believes that DLT may be the foundation for the digital currency.

In addition, The Marshall Islands are launching their own CBDC called Marshallese Sovereign. This digital currency will be formed on the Algorand blockchain in order to increase financial inclusion. Users of the digital currency will be protected by strict verification processes required to use the platform. 

Other countries, including Singapore, have been proposing the use of CBDCs. The Monetary Authority of Singapore launched Project Ubin in 2016 to experiment with the use of DLT for clearing and settling payments and securities within an interbank network. South Korea, Canada, and Japan are all also among the many other countries proposing the implementation of CBDCs.

CBDCs for Banking the Unbanked and International Remittances 

One of the major potential uses for CBDCs is banking the world’s unbanked population. According to the World Bank, over 1.7 billion people worldwide currently do not have access to banking services. It can be particularly difficult for those in poverty to open bank accounts due to minimum opening requirements, as well as the significant documentation needed to open a bank account in many countries. By interfacing directly with government-backed wallets issued by central banks, or even low-fee private wallets, these unbanked individuals could gain unprecedented access to financial markets. 

CBDCs could also be helpful for remittances, in which foreign workers send money to family members back home. Currently, remittance fees are extremely high, and CBDCs could change this. Since crypto is already being increasingly used for remittances, CBDCs would be a natural extension of this trend. 

Traditional Crypto as Tender vs. CBDCs

In one interesting case, El Salvador has focused less on CBDCs and has opted to use cryptocurrencies like Bitcoin as legal tender. This is highly controversial, and while it could lead to economic growth and less reliance on the U.S. dollar, the high volatility of Bitcoin could make it very difficult to use, both as a form of daily payment and as a value-storage mechanism in a country’s currency reserves. 

In fact, these difficulties have already materialized, with the 200 Bitcoin El Salvador bought in 2021 worth significantly less as of early 2022. Bitcoin adoption also has little support throughout the country’s population, with less than 5% interested in adopting the currency in legal tender. The country’s official Bitcoin wallet, the Chivo wallet, has also been problematic, with some citizens reporting losing up to $16,000 in Bitcoin due to hacking. 

Instead of utilizing crypto as legal tender, some countries may be going down the route of using it as a reserve currency and stockpiling to convert to dollars in order to pay for government expenditures or international debts. 

Some experts believe that North Korea has already been doing this, as evidence suggests that government-backed Monero (XMR) mining is already occurring inside the “hermit kingdom,” which has been essentially walled off from international financial markets for the last several decades. Monero has the benefit of not requiring energy-intensive ASICs, which would be difficult to import due to the strong sanctions the international community has levied on the country. 

For sanctioned countries like North Korea, Venezuela, or Iran, creating their own CBDCs may not hold much value, but the use of other country’s CBDCs may be useful, particularly if these CBDCs have privacy restrictions that would allow them to use the currencies unchecked. 

Overall, CBDCs Are Still in Their Infancy, But May be the Future of Money 

As of the writing of this article, no major country has successfully implemented a CBDC, but that’s likely to change in the coming years. As previously mentioned, CBDC adoption speed will depend on a variety of factors, including the centralization or decentralization of these new currencies, as well as how they will interface with both the traditional banking and financial system as well as the quickly growing crypto and DeFi ecosystem. CBDCs have the potential to reduce the power of traditional banks, but could also be co-opted by traditional financial institutions, depending on how these currencies are implemented. 

As different countries adopt different CBDC issuance models, it will become clear which models work effectively, and which models do not. The countries that issue the most interoperable, effective, stable, and decentralized CBDCs, may end up controlling the future of money, while those that fail could be left behind. 


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