Understanding CBDCs
What they are, why they matter, and how they could affect us all
You’ve probably heard of Central Bank Digital Currencies (CBDCs) by now – they’ve been making headlines as central banks worldwide explore new ways to digitise money. But do we really understand what CBDCs are, or what they could mean for our daily lives? Every year, I talk to future blockchain developers at Medietet Institute in Sweden, diving into digital assets with a particular focus on CBDCs. I make sure they understand not only the technical aspects but also the possible social and financial impacts these digital currencies could have. One question came up during the lecture, that might be on your mind too: Will commercial banks disappear if central banks launch digital currencies? My answer leaned towards “no,” with good reasons, which I’ll get into shortly. But first, let’s dive into what CBDCs are, what they aim to achieve, and why they’ve become such a hot topic.
So, what exactly are CBDCs?
CBDCs are essentially digital versions of a country’s national currency, but with one important difference: they’re issued directly by the country’s central bank. This isn’t just like using your debit card or a mobile payment app. Those payments are promises to pay – bits and pieces of data that represent money moving from one account to another. But with a CBDC, the digital currency is the money. It’s like carrying digital cash in your phone or wallet, backed directly by the central bank.
Now, what’s in it for the government? Here’s a look:
Reducing reliance on cash: Cash use is dropping fast, in many countries, like the UK and Sweden. CBDCs could serve as a digital alternative for people who still want the security of cash but in a digital form.
Increasing financial inclusion: CBDCs could be a regulated, secure payment option available to everyone, even those without traditional bank accounts.
Improving payment security and efficiency: CBDCs could reduce dependency on private payment providers and ensure that payments are secure, fast, and transparent.
Monetary policy leverage: CBDCs could give central banks more direct tools for economic management, potentially even allowing “helicopter money” (direct payments to citizens in times of crisis) or experimenting with negative interest rates to stimulate spending.
Different types of CBDCs
CBDCs aren’t one-size-fits-all. Here’s a brief breakdown:
Retail vs. Wholesale: Wholesale CBDCs are for banks and financial institutions for big transfers. Retail CBDCs, however, would be for everyday use, like how we use cash.
Direct vs. Indirect Models: With a direct model, the central bank manages all user accounts. In an indirect model, they’d partner with commercial banks to handle user transactions and accounts.
The indirect model, where commercial banks serve as third-party intermediaries, is more likely to take shape. Why? Well, besides saving central banks from setting up costly infrastructure, banks already have established customer bases and a history of managing accounts efficiently. It’s also a way to keep banks in business, providing them with a role that doesn’t destabilise the banking sector by pulling all deposits into centralised government accounts.
Sweden’s “e-krona” is one of the most prominent CBDC projects. The Riksbank started exploring this idea in 2017 as cash use dwindled, running several pilot projects to see if an e-krona could realistically complement physical cash. Their findings? A blockchain-based e-krona is possible, but there are scalability issues and questions around how it would work offline.
Where things can go wrong
Now, here’s where it gets interesting – and maybe a bit concerning. Let’s talk about some potential pitfalls of CBDCs and why we should pay attention to these issues.
Privacy and surveillance
With a CBDC, every transaction could potentially be monitored by the central bank. Think about it: right now, cash transactions are anonymous. You buy a coffee with cash, and no one has to know where you spent that money. With a CBDC, especially a direct one, every digital “coffee” transaction could be tracked. This raises serious privacy concerns. If we’re not careful, CBDCs could open the door to financial surveillance. Imagine a future where governments have full visibility into our spending habits, not just as a matter of fraud prevention but for outright control. It’s the kind of thing that could stifle personal freedom, with potentially every purchase recorded and, perhaps, scrutinised.
Cybersecurity risks
Another big issue is security. By nature, digital currencies are vulnerable to cyberattacks. And with something as centralised as a CBDC, the stakes are high. If someone hacks into a central bank’s CBDC system, they could disrupt the entire financial system. Cyberattacks could lead to theft, data breaches, and economic instability. In a worst-case scenario, imagine a large-scale outage where people can’t access their digital wallets, pay bills, or buy essentials because of a system failure. When our entire financial infrastructure depends on one digital system, the risks become far more pronounced than with traditional cash.
Centralisation and control
Here’s a core concern for many of us who believe in decentralisation: CBDCs centralise control in the hands of the central bank. The bank becomes the issuer, regulator, and sometimes even the “keeper” of everyone’s digital wallets. That level of control can be a slippery slope. This kind of centralisation raises the question: Who has the ultimate say over your money? Will central banks be tempted to freeze accounts, set spending limits, money expiration dates, or even dictate what people can buy based on policy changes? With centralised digital control, these interventions become a lot easier, and that’s a scenario we should be mindful of.
Negative interest rates and wealth erosion
One overlooked concern with CBDCs is how they might make it easier for central banks to impose policies like negative interest rates. With physical cash, people have the option to hold their money outside of banks if interest rates go negative. But with CBDCs, a central bank could theoretically set negative interest rates on digital wallets, making it costly to hold onto money. What does this mean in practical terms? Imagine a world where your digital balance slowly decreases just by holding onto it. Such measures could push people to spend rather than save, eroding wealth over time and discouraging financial stability for individuals.
The challenge of public trust
Finally, there’s the question of trust. If CBDCs are seen as tools for surveillance or control, will people even want to use them? Building public trust in CBDCs requires transparency, safeguards, and a clear understanding of how data will be used (or, ideally, not used). If people suspect that their every transaction is under scrutiny, they might avoid CBDCs altogether, which could limit their effectiveness as a national currency option.
Long-term Implications for Society
CBDCs may seem like a simple upgrade to digital finance, but they represent a profound change in how we view and use money. Different countries are taking different approaches to these Central Bank Digital Currencies (CBDCs). China's already diving in headfirst with their digital yuan, while Europe's being more careful, taking their time to study the impacts. It's like some countries are rushing to build a new financial highway while others are still carefully drawing up the blueprints.
Now, there's some good that could come from this. People who've never had a bank account might finally get access to basic financial services. Think about the local street vendor who can't get a traditional bank account – they might be able to use a simple digital wallet on their phone. But consider this: what about folks who don't have smartphones or reliable internet? In 2023, 55% of people in the EU aged 16 to 74 had at least basic overall digital skills. There were significant disparities across the EU, with rates ranging from 83% in the Netherlands to 28% in Romania. We could end up creating an even bigger gap between the digital haves and have-nots.
Think about this: while most of us take our bank accounts for granted, there are people in our communities who are basically locked out of the financial system through no fault of their own. Take homeless folks who can't even open a basic account because they don't have a fixed address, or refugees who fled their homes with nothing but the clothes on their backs and now can't meet strict ID requirements. And here's something that might surprise you – more than half of all adults who can't access banking services worldwide are women. That's millions of people, many of them mothers and breadwinners, trying to manage their money without even the most basic financial tools we use every day. Are CBDCs going to make life easier for vulnerable groups or continue keeping them excluded from the financial system?
The impact on our privacy is what really keeps me up at night. Imagine every coffee you buy, every donation you make, every euro you send to a family member – all of it potentially tracked and monitored. Sure, they say it's for preventing crime and tax evasion, but do we want to live in a world where every financial move we make is watched? Some people are working on building in privacy protections, like making smaller transactions anonymous, but we need to push hard for these safeguards.
Here's what we need to remember, this isn't just a tech upgrade to our money – it's a fundamental change in how our financial system works and how much freedom we have with our own money. We need to speak up now, while these systems are still being designed. Ask questions like: Who will protect our privacy? What happens if the system goes down? How do we make sure this technology helps everyone, not just the digitally savvy?
We need to talk about this with our friends, family, and elected representatives. Because once these systems are in place, it'll be much harder to change them. The future of money is being shaped right now, and we all deserve a say in how it works.
Until next time, let’s keep the conversation going and stay open to where this digital future might lead us.