Why Central Banks Race to Issue Their Own Digital Currency

Is It Necessary That Central Banks Issue Their Own Digital Currency?

The continuously declining importance of cash as a central payment method -- especially for teenagers and young adults -- and the rising prevalence of cryptocurrencies are leading to a change in attitudes toward digital transactions and payment methods within society. To date, cryptocurrencies have been issued almost exclusively by private entities. Currently, however, there is also growing interest from individual countries and central banks to be a significant part of this development. Thus, the question arises whether it is necessary that central banks also recognize the technological progress and issue their own digital currencies. This post will look at the potential of digital currencies and whether central banks should follow the trend or what the consequences will be if they do not. Understanding this topic requires context on both the future of cash payments and how payment methods shape consumer behavior.

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The Rise of Private Digital Currencies

The public debate around digital currencies is not only about technological progress, but is also increasingly shaped by political interests. Cryptocurrencies, which are usually set up by private entities and are not (or can only be) regulated to a limited extent, have shown that digital transactions are no longer tied to the classic banking system. Digital currencies can in principle be created by anyone with the relevant technical skills and resources. This also opens up new opportunities for companies and other organizations. Token solutions in particular are worth highlighting at this point, even if they are not explicitly considered in the further course of this post. The best-known cryptocurrencies can be understood as a kind of driver in the development of digital currencies, as they were the first contact with such technology for many people and drew attention to the topic. However, in order for them to no longer be considered a purely financial product and speculative asset, but to be widely recognized and used as a means of payment, a certain stability of value is necessary. The debate around whether cash should remain a payment option adds important context to this transition.

Stablecoins and the Bridge Between Private and Public Currency

One significant development that has emerged in the private digital currency space is the rise of stablecoins -- digital tokens designed to maintain a fixed value relative to a reference asset, typically a fiat currency such as the US dollar. Projects like Tether (USDT), USD Coin (USDC), and the now-discontinued Diem project (formerly Libra, proposed by Meta) demonstrated both the demand for price-stable digital currencies and the regulatory concerns they provoke.

Stablecoins address the volatility problem that prevents Bitcoin and other cryptocurrencies from functioning as practical payment instruments. When a currency's value can fluctuate by ten or twenty percent in a single day, neither merchants nor consumers can rely on it for everyday transactions. By pegging their value to established currencies, stablecoins offer the transactional efficiency of blockchain technology with the price predictability that commerce requires.

However, stablecoins also introduce systemic risk. The assets backing these tokens are not always transparent, and a sudden loss of confidence could trigger a run comparable to a bank run. On top of that, a widely adopted stablecoin issued by a large technology company could effectively create a private monetary system operating outside the reach of central bank policy. It is precisely this scenario that has accelerated central bank interest in developing their own digital alternatives.

A widely adopted stablecoin issued by a large technology company could effectively create a private monetary system operating outside the reach of central bank policy.

Understanding Central Bank Digital Currencies

One approach to enabling digital currencies that function as a means of payment is so-called Central Bank Digital Currencies (CBDCs). This would involve central banks issuing a digital currency that is either made available centrally via the central bank itself or -- similar to what is currently the case with fiat money -- is accessible to individuals via an extensive network of banks. However, the arguments in favor of such a currency often relate to problems that would not only be solvable via CBDCs, but could also be avoided via other changes. Perhaps the most significant motive for such a central bank currency is increased competition among various institutions and organizations competing for customers' wealth with their financial and investment products. Engert & Fung (2017) considered different incentives for CBDCs and concluded that "while CBDCs are an interesting tool, they are not essential to overcome the challenges of the financial system." It should be noted, however, that their argument is based on a form of CBDC that is as close to cash as possible, and that this could have far-reaching limitations in terms of meaningfulness with respect to the overarching theme.

Wholesale versus Retail CBDCs

An important distinction exists between two fundamentally different CBDC models. Wholesale CBDCs are designed exclusively for use by financial institutions in interbank settlement and large-value transfers. They aim to make existing financial plumbing more efficient by reducing settlement times from days to seconds and eliminating certain counterparty risks. Several central banks, including the Bank of Canada and the Monetary Authority of Singapore, have conducted extensive pilots in this area.

Retail CBDCs, by contrast, are intended for use by the general public and represent a far more transformative proposition. A retail CBDC would allow any individual or business to hold a direct digital claim on the central bank, fundamentally altering the relationship between citizens and the monetary authority. This model raises deeper questions about privacy, financial intermediation, and the role of commercial banks in the economy.

The choice between these models -- or the decision to implement both -- has profound implications for the design, governance, and societal impact of any CBDC initiative. For investors and financial professionals, understanding this distinction is essential for anticipating how CBDCs will reshape the landscape of investment and speculation.

The Technical Possibilities and Promise of CBDCs

When looking at CBDCs without bias, the technical possibilities for such a currency seem endless. A wide variety of constructs exist as to how the requirements for a public currency could be met. A CBDC could, for example, represent the transition to a cashless economy by replacing cash as a new, central means of payment. Likewise, it could change the way individuals store their monetary assets. Unlike physical cash, a digital currency need not be tied to face value. Instead, such a currency could reflect real value or even yield interest payments. The increased stability that could result from the introduction of a CBDC also favors the behavior and decisions of individuals and organizations, as the prevailing uncertainty would be reduced. However, the new opportunities that would arise for central banks and their monetary policies may not even be the driving force behind the decision to initiate such a development. Bordo & Levin (2017) argue that a passive approach or inaction by the relevant institutions could be associated with significant risks: "Should cash indeed become obsolete, central banks may suffer a loss of control unless they have made provisions."

Programmable Money and Smart Contracts

One of the most discussed technical capabilities of a CBDC is programmability. In theory, a digital currency could be embedded with rules that govern how, when, and where it can be spent. For example, government stimulus payments could be programmed to expire after a certain period, ensuring that the funds are spent rather than saved, thereby maximizing their economic impact. Social welfare payments could be restricted to approved categories of spending, reducing the potential for misuse.

While these capabilities are technically feasible, they raise significant ethical and political questions. The ability to control how individuals spend their money represents an unprecedented level of governmental power over personal financial decisions. Critics argue that programmable money could become a tool of social control, particularly in authoritarian regimes. The design choices made during CBDC development will therefore reflect deeply held values about the relationship between the state and its citizens.

Global CBDC Development: Where Major Economies Stand

The pace of CBDC exploration varies significantly across the globe. China's digital yuan (e-CNY) represents the most advanced major-economy CBDC project, with extensive pilot programs conducted across multiple cities involving millions of participants. The People's Bank of China has tested the digital yuan in real-world scenarios including public transportation, retail purchases, and government salary payments.

The European Central Bank has been exploring a digital euro, focusing on privacy, offline functionality, and interoperability with existing payment systems. The Bank of England has published detailed consultation papers on a potential digital pound, while the Federal Reserve has taken a more cautious approach, emphasizing the need for extensive research before committing to a specific design.

Smaller nations have moved more quickly. The Bahamas launched the Sand Dollar in 2020, becoming one of the first countries with a live retail CBDC. Nigeria introduced the eNaira in 2021, and several Caribbean nations have implemented or piloted their own digital currencies.

This global landscape creates competitive dynamics. Countries that develop functional CBDCs early may establish standards that influence the broader ecosystem, while those that delay risk being left with infrastructure designed around foreign systems and protocols.

The Transition Challenge

Regardless of whether the introduction of a digital currency by central banks would be a positive development or not, it must be emphasized that this would be a long-term process. Developing and implementing a corresponding system involves significant resources and would be time-consuming, so a change would not be expected in the near future. One advantage, however, could be that CBDCs could build on existing infrastructure by allowing consumers to use existing mobile devices as hardware. This would also potentially reduce inhibitions, as many people already use their smartphone as a payment medium and the new form of payment would not be completely unknown. Whether such a currency would be accepted and used by users would certainly depend on the possible uses. As described above, there are a variety of different ways in which such a currency could be constructed and what characteristics it could have. It is likely that widespread acceptance within society will only exist if its use would bring explicit benefits. Otherwise, it would be more convenient to continue using the existing alternatives.

Financial Inclusion as a Driving Force

One of the most compelling arguments for retail CBDCs is their potential to advance financial inclusion. The World Bank estimates that approximately 1.4 billion adults worldwide remain unbanked, lacking access to basic financial services. In many developing nations, the barriers to traditional banking -- minimum balance requirements, physical distance from bank branches, documentation requirements -- exclude significant portions of the population from the formal financial system.

A well-designed CBDC accessible through a basic mobile phone could bypass many of these barriers. By providing a direct account with the central bank, individuals would no longer need to meet the requirements of commercial banks to participate in the digital economy. This could facilitate access to credit, enable more efficient receipt of government benefits, and reduce reliance on expensive informal financial services.

However, financial inclusion through CBDCs is not automatic. Digital literacy, internet connectivity, smartphone ownership, and trust in government institutions all influence whether a CBDC will actually reach the populations it aims to serve. Without deliberate attention to these prerequisites, a CBDC could inadvertently widen the divide between those who are digitally connected and those who are not.

Implications for Commercial Banks and Financial Intermediation

CBDCs would be a way for individuals to have direct access to central bank money. So far, this is only possible for selected banks and such a change could be a positive development for individuals as well as businesses and other organizations. So far, these still rely on banks as service providers to process digital transactions. If these intermediary entities were no longer integrated into the payment process, this could possibly lead to significantly lower transaction costs and also simplify the payment process. One challenge, however, would be deciding the extent to which CBDCs retain the anonymity of cash payments. It is conceivable that the approach of a fully anonymous digital payment method could also be seen as an incentive to process illegal transactions. Accordingly, it can be assumed that central banks are more likely not to take this route should they actually develop digital currencies. From the central banks' point of view, the attractiveness of such a currency probably lies more in the fact that it would continue to ensure monetary governance in a technologically evolving society. If they were to fail to consider the trend of cryptocurrencies and other digital currencies as part of their own activities now, they may find that they can only tap into the area through extensive regulation, thereby undermining existing innovation.

The Disintermediation Risk

Perhaps the most significant concern raised by commercial banks regarding CBDCs is the risk of disintermediation. If individuals can hold digital money directly with the central bank, they may choose to move deposits away from commercial banks, particularly during periods of financial stress. This could reduce the deposit base that banks rely on to fund lending activities, potentially constraining credit availability and raising borrowing costs across the economy.

Central banks are aware of this risk and have proposed several design features to mitigate it. These include imposing caps on the amount of CBDC an individual can hold, offering no interest on CBDC balances (making commercial bank deposits more attractive for savings), and implementing a tiered remuneration system that penalizes excessively large CBDC holdings. The two-tier distribution model, in which the central bank issues the currency but commercial banks manage the customer-facing infrastructure, represents a compromise that preserves the role of financial intermediaries while still providing the benefits of a public digital currency.

Privacy, Surveillance, and Civil Liberties

The question of privacy in CBDC design extends far beyond the narrow issue of anonymous transactions. A fully traceable digital currency would give governments unprecedented visibility into the financial activities of their citizens. Every purchase, transfer, and payment would be recorded in a centralized or semi-centralized ledger, creating a detailed profile of individual behavior.

For law enforcement and tax authorities, this transparency offers obvious advantages. Tracking illicit financial flows, enforcing tax compliance, and combating money laundering would all become significantly easier with a fully traceable payment system. However, the same infrastructure could be used to monitor political dissidents, suppress minority communities, or enforce arbitrary restrictions on personal spending.

The design spectrum ranges from full anonymity (impractical for regulatory reasons) to full traceability (incompatible with civil liberties in democratic societies). Most CBDC proposals settle somewhere in between, offering limited anonymity for small transactions while requiring identification for larger ones. The precise calibration of this balance will be one of the most consequential decisions in CBDC design, as it reflects fundamental choices about the kind of society a nation wishes to build.

Conclusion

On the one hand, the creation of a digital currency by central banks allows them to integrate new technical and innovative approaches into the financial system and, on the other hand, could be seen as a kind of hedge. Various cryptocurrencies have already proven in recent years that the technological requirements for digital currencies are in place. The broader implications for capital markets and financial infrastructure are significant. Central banks now have the responsibility to find an appropriate solution on how to best use the available technology within their own activities, otherwise they risk losing control. The introduction of CBDCs could also have positive implications for individuals and organizations if it can reduce transaction costs or simplify payment processing. Whether it is imperative that central banks launch digital currencies cannot be answered unequivocally, but it can be assumed that they will do so at some point.

The design decisions made in the coming years — regarding privacy, programmability, interoperability, and the role of commercial banks — will shape the financial infrastructure for generations.

The trajectory of CBDC development suggests that the question is shifting from "whether" to "how." The design decisions made in the coming years -- regarding privacy, programmability, interoperability, and the role of commercial banks -- will shape the financial infrastructure for generations. For individuals, staying informed about these developments is not merely an academic exercise but a practical necessity, as the choices being made today will ultimately determine how every person stores, transfers, and spends their money in the decades ahead.

Frequently Asked Questions

What is a central bank digital currency (CBDC) and how does it differ from cryptocurrency?

A CBDC is a digital currency issued and backed by a central bank, representing a direct claim on the monetary authority. Unlike cryptocurrencies such as Bitcoin, which are decentralized and often volatile, CBDCs are centralized, government-backed, and designed for price stability. They are not speculative instruments — they function as digital versions of existing fiat currencies, with the added benefits of programmability and instant settlement. Over 130 countries representing 98% of global GDP are currently exploring or piloting CBDCs.

What is the difference between wholesale and retail CBDCs?

Wholesale CBDCs are designed exclusively for financial institutions, improving interbank settlement by reducing times from days to seconds and eliminating certain counterparty risks. Retail CBDCs are for the general public and represent a far more transformative proposition — allowing any individual to hold a direct digital claim on the central bank, fundamentally altering the relationship between citizens and the monetary authority. Most countries are exploring both models, and the choice has profound implications for privacy, financial intermediation, and the role of commercial banks.

Could CBDCs replace physical cash entirely?

While technically possible, complete cash replacement raises significant concerns about social equity, privacy, and resilience. Not all populations have equal access to digital infrastructure, and physical cash remains the only payment method that functions during power outages, cyberattacks, and banking failures. A more likely scenario is that CBDCs coexist with cash for an extended period, with cash usage declining gradually as digital alternatives become more accessible and inclusive.

What are the privacy concerns around CBDCs?

A fully traceable digital currency would give governments unprecedented visibility into citizens' financial activities — every purchase, transfer, and donation recorded in a centralized ledger. While this aids law enforcement and tax compliance, the same infrastructure could monitor political dissidents or enforce arbitrary spending restrictions. Most proposals settle between full anonymity (impractical for regulatory reasons) and full traceability (incompatible with civil liberties), offering limited anonymity for small transactions while requiring identification for larger ones. This balance reflects fundamental choices about the kind of society a nation wishes to build.

How would CBDCs affect commercial banks and the broader financial system?

The most significant concern is disintermediation risk — if individuals can hold money directly with the central bank, they may move deposits away from commercial banks, reducing the deposit base banks rely on for lending. This could constrain credit availability and raise borrowing costs across the economy. Central banks are mitigating this through design features like holding caps, zero interest on CBDC balances, and two-tier distribution models where commercial banks manage customer-facing infrastructure while the central bank issues the currency. Understanding these dynamics requires attention to broader trends in financial literacy and education.