What is Central Bank Digital Currency (CBDC)? Everything You Need to Know

AtoZ Markets – What is a Central Bank Digital Currency (CBDC)? As decentralized cryptocurrencies like Bitcoin have become more popular, major central banks around the world are beginning to realize they need to jump on the bandwagon or let the evolution of money pass them by.

In this article, we'll explain what exactly is a central bank digital currency. There are a number of advantages to issuing CBDCs. But what are the risks? As you read on, you'll find satisfactory answers to these questions and more.

Table of contents

  1. What is Central Bank Digital Currency?
  2. Why is CBDC needed?
  3. What are CBDCs?
  4.  What is Wholesale or Commercial CBDC (W-CBDC)?
  5.  What are retail CBDCs?
  6.  What are Hybrid CBDCs?
  7.  What are intermediary CBDCs?
  8.  What are synthetic or indirect CBDCs (sCBDCs)?
  9.  How do central banks view CBDC?
  10. Which CBDCs do central banks study and test?


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What is central bank digital currency (CBDC)?

CBDC (Central Bank Digital Currency) is the digital currency of the central bank. It is an electronic obligation of the monetary regulator, denominated in the national unit of account and serving as a means of payment, measure, and conservation of value.

But how and why do central banks create digital currencies (CBDCs)?

Why is CBDC needed?

Central banks are already practicing virtual currency emission, a significant proportion of payments and transfers are made in non-cash form.

The differences between CBDC and the existing system are as follows:

  • CBDC aims to increase stability and competition in the financial arena amid banks' rivalry with tech companies and cryptocurrencies.
  • CBDC helps increase financial inclusion by offering a payment infrastructure with lower transfer costs. It also makes it easier for central banks to operate in a digital economy.
  • CBDC will expand the fiscal policy tools available to regulators - for example, avoid the "zero rate trap". CBDC's programmability and transparency will make it easier for regulators to control the monetary sector. More transparent data on payment flows will improve the quality of macroeconomic statistics.
  • CBDC encourages the use of local currency to pay for goods and services, which is especially important in countries prone to dollarization.
  • The commercial version of CBDC (for banks only) will reduce settlement risks, provide 24/7 access to liquidity for banks, and cut costs for cross-border transfers.

The motivation for CBDC research and development varies by jurisdiction.

In advanced economies, central banks see digital currency as a means of increasing security and resiliency, as well as the efficiency of domestic payments and achieving financial stability.

For central banks in emerging economies, achieving financial inclusion is important.

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What are CBDCs?

There is no single generally accepted classification of CBDC. The key parameters by which you can divide them into types are:

  • architecture;
  • infrastructure;
  • technology and conditions of access;
  • level of anonymity;
  • possibility of application for domestic and/or cross-border payments.


According to the architecture, researchers distinguish two main categories of CBDC:

  1. Wholesale (wholesale, they are commercial or direct);
  2. Retail (retail / general purpose).

The retail category includes three types of architectures:

  1. Hybrid;
  2. Intermediary;
  3. Indirect (synthetic).

What is Central Bank Digital Currency (CBDC)?

At the time of writing, four central banks are considering a direct model (the motive is increased financial inclusion); seven consider a hybrid or intermediary model (some of them alongside the direct model). However, most regulators have not yet decided on the architecture.

What is Wholesale or Commercial CBDC (W-CBDC)?

The bulk version of CBDC is a payment system operated by central banks. It is available only to a narrow circle of users (financial institutions that store funds in central bank accounts and professional market participants). Analogues of wholesale digital currencies are correspondent accounts and bank deposits with central banks.

In the case of calculating interest income, wholesale CBDCs can be viewed as interest-bearing liabilities of the central bank.

Advantages of wholesale digital currencies:

  • the ability to regulate the demand for money;
  • flexible monetary policy;
  • ensuring financial stability;
  • providing round-the-clock bank liquidity;
  • reduction of costs for cross-border transfers;
  • fixing transfers in a distributed ledger - this increases the efficiency of settlements, as well as reduces credit and settlement risks since the central bank acts as a source of funds and a guarantor for obligations;
  • reduction of counterparty risks.

Disadvantages of wholesale CBDC:

The scope of distribution is limited to interbank transactions, settlements on transfers, clearing operations, and international trade (where banks often act as guarantors of transactions).

Implementation perspective

The wholesale CBDC model is the most popular among central banks because it has the potential to speed up the operation of financial systems, increase their security, and reduce costs. In developed countries, retail payment and settlement systems are already quite efficient, operate almost in real-time, and are always available. Most citizens have access to banking services.

Wholesale CBDC technology will increase the efficiency of interaction between different areas. Direct linking of stock or foreign exchange platforms to cash platforms can improve the speed of transactions and eliminate settlement risk. The speed of transactions in the OTC markets and in the areas of syndicated lending, as well as settlements for international trade transactions, can significantly increase when establishing a connection with the instant settlement system based on wholesale CBDC.

Also, wholesale CBDCs can simplify cross-border payments infrastructure by significantly reducing the number of intermediaries. This will increase its efficiency and safety, reduce costs, and reduce liquidity and counterparty risks.

The introduction of distributed ledger technology will also make it possible to give wholesale CBDCs the characteristics of "smart", including targeted financing, limiting their use in time and space, and applying conditional interest rates. These features will allow central banks to leverage new monetary policy instruments such as personal lending rates.

Real-time monitoring and tracking options, as well as control over the money supply, will help banks and regulators in the fight against money laundering and in supervision.

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What are retail CBDCs?

Retail CBDCs are digital currencies available for widespread use by individuals and legal entities. Serve as a replacement for cash (or a supplement) and an alternative to bank deposits. Accrual of interest income, as a rule, is not provided.

Key features of retail CBDCs

While there are many variations on the retail digital currency model, most central banks highlight the following key characteristics:

  • Retail CBDC should be a new form of central bank money issued and controlled by the regulator. The retail digital currency supply is driven by monetary policy and controlled by the central bank.
  • CBDC should be included in the financial statements of the central bank.
  • Digital currency must be accepted as a means of payment by all citizens, companies, and government bodies.
  • CBDC is distributed by the central bank on a one-to-one basis with fiat currency and must be freely convertible into cash.
  • CBDCs must operate on an open infrastructure that will allow private companies to create new products and services.
  • The transaction cost should be less than in existing systems.

Implementation perspective

The retail CBDC concept is relatively popular among emerging economies' central banks, where financial institutions are seeking to lead the dynamic fintech industry, promote financial inclusion by accelerating the movement towards a cashless society, and reduce the cost of issuing money and processing banknote processing costs.

Central banks in developed countries are not very enthusiastic about retail CBDCs. Regulators are unwilling to create competition between central bank funds and the private sector, considering the potential benefits of using retail digital currencies to be limited.

In their opinion, introducing retail CDBCs is too bold (or premature).


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What are Hybrid CBDCs?

Hybrid digital currencies are a cross between direct (wholesale) and indirect (synthetic) CBDCs. Payment processing is handled by intermediaries, but the digital currency itself is a direct payment request to the central bank. The latter is responsible for a distributed ledger with all transactions and manages a backup technical infrastructure that allows the payment system to be restarted in the event of a failure.

One of the key elements of the hybrid CBDC architecture is the regulatory framework that underpins currency rights, separating them from the balance sheets of the payment service provider (PSP). If the supplier is unable to meet its obligations, then the assets held in the CBDC are not considered part of the PSP's assets available to lenders.

The legal framework gives the central bank the ability to transfer a retail customer's contract with an unworkable PSP to a fully functional supplier.

Another key element is the technical ability to ensure the transfer of assets. The bank is obliged to support the payment process in a situation where the intermediary is experiencing technical difficulties. Therefore, the financial institution needs the ability to restore the balance of a retail client. Therefore, the bank retains a copy of the retail customer's CBDC assets, which allows assets to be moved from one PSP to another in the event of a technical failure.


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Pros and cons of hybrid CBDC

As an intermediate solution, this model may have better stress tolerance than indirect (synthetic) CBDCs, but more complex in infrastructure management from the point of view of the central bank.

Hybrid CBDCs are somewhat easier to manage than direct (bulk) ones. Since the central bank does not interact directly with retail users, it can focus on a limited set of key processes, such as the settlement of payments. At the same time, resellers can manage other services, including confirmation of instant payments.

Hybrid CBDCs enhance central bank reserve storage capabilities and improve interoperability between different payment systems.

What are intermediary CBDCs?

The architecture of intermediary digital currencies resembles that of hybrid CBDCs. In this case, the monetary regulator controls the wholesale register, not the central register of all retail transactions. Intermediary CBDCs represent a direct payment claim against the central bank, while payments are made by intermediaries.

The Bank for International Settlements (BIS) notes an increase in the number of central banks that are leaning towards hybrid and intermediary CBDC models. Only a few jurisdictions are considering “direct” projects, in which the regulator takes over all user payments.

What are synthetic or indirect CBDCs (sCBDCs)?

Along with the above three general-purpose CBDC architectures, there is another approach. It is based on a model for the indirect provision of retail digital currencies through financial intermediaries.

The sCBDC model is also known as “two-tier” CBDC because it resembles the existing two-tier banking system.

Issuing intermediaries secure all of the regulator's obligations to retail customers (in the form of indirect CBDCs) through assets in actual CBDCs (or other funds) deposited with the central bank. Intermediaries control communications with retail customers, online payments and messages to other intermediaries, and bulk payment instructions to the central bank.

Central banks protect the assets and rights of intermediate clients (issuing companies), monitor the ledger of transactions, and manage the backup technical infrastructure.

The sCBDCs issued by intermediary companies are backed by central bank reserves.

sCBDCs demand increased access to central bank reserves for financial institutions, fintech startups, and large technology companies. Back-up collateral allows sCBDC providers to guarantee repayment at par.

Pros and cons of sCBDC

sCBDCs are cheaper and less risky compared to direct-produced and more manageable counterparts. They also enable the private sector to innovate and engage with customers more effectively, and central banks to build trust with users.

The downside is that society can view sCBDC as a product released under the brand of a central bank, not fully realizing that the regulator has limited responsibility for it.

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How do central banks view CBDC?

According to experts, the development of CBDC is one of the most important trends in the monetary sphere, which will radically change the world of money in the next decade.

As of January 2020, more than 80% of central banks were involved in CBDC research and development, according to the BIS.

A report released by BIS in April 2020 indicates that the Covid-19 pandemic has only accelerated CBDC development. According to the document, China, Sweden, and Canada are leading in the development of CBDC.

Related: BIS Report Says COVID-19 Pandemic Amplified Calls For CBDCs

Compared to 2019, there was an increase in the number of speeches in which representatives of central banks touched upon various aspects of the CBDC.

If in 2017-2018 public statements by managers and board members of central banks about digital currencies were predominantly negative, especially with respect to retail CBDCs, then at the end of 2018 the rhetoric began to change. Currently, representatives of central banks assess CBDC rather positively.

The number of central banks willing to issue CBDCs in the next six years doubled in 2019:

“Central banks, representing one-fifth of the world's population, have indicated they are likely to issue CBDCs in the near future,” the BIS said in a report.

The study authors clarify:

“As of mid-July 2020, 36 central banks have published papers looking at retail or wholesale CBDCs. At least three countries (Uruguay, Ecuador and Ukraine) have completed pilot retail CBDC projects. Six more retail CBDCs are currently being piloted in Sweden, South Korea, the Eastern Caribbean Monetary Union, the Bahamas, the PRC and Cambodia. ”

Read also: The Bahamas Launches Its CBDC Dubbed "Sand Dollar"

What CBDCs do central banks study and test?


A growing number of banks are considering promising digital currencies with a hybrid or intermediary architecture. In this context, CBDC is a direct payment request to the central bank, but the private sector controls interactions with customers.

Only a few jurisdictions are considering models in which the central bank plays a significant operational role in payments to customers.

Central banks are more likely to choose direct or hybrid/intermediary architectures in jurisdictions with a relatively high standard of living, broad public access to banking services, and effective governance.

In less developed countries, central banks generally do not specify the architecture they choose.

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Infrastructure (technical concept) CBDC

The infrastructure can be based on either a traditional centralized database or a distributed ledger (DLT).

Many banks are considering various technology options. However, the current approbation of the CBDC concept is based primarily on DLT rather than traditional technology infrastructure.

Central banks experimenting with DLT use, as a rule, permissioned systems, in which operators have the right to decide who to admit to the network.

Account-based access technology

Account-based CBDCs are tied to identity information. Combining the qualities of cash as an inclusive and crisis-resistant means of payment with the characteristics of anonymity can be challenging.

This is the most popular concept - five central banks are looking at it.


The access mechanism based on digital tokens makes it possible to implement various value-based payment options - for example, to issue prepaid CBDC banknotes. The latter can be exchanged both physically and digitally.

However, this carries the risk of criminal activity and counterfeiting. In addition, access under such a scheme is difficult for people without access to banking services and forced to use only cash.

Three central banks are looking at this concept.

Can be used for domestic and/or cross-border payments

CBDCs can be used for domestic settlements or for cross-border payments. Accordingly, the digital currency model can provide retail and wholesale relationships and access options for residents or non-residents. The token-based internal CBDC will be open to everyone, including non-residents.

Most projects tend to be used internally. By contrast, the ECB, the central banks of France, Spain, the Netherlands, and the Eastern Caribbean Central Bank are focusing on the cross-border use of digital currencies.


The introduction of CBDC would involve a structural reform of the monetary system. In a society where digital technology is becoming the norm, it is key that a public form of money remains available. Central bank digital currency could play this role.

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