What is CBDC (Central Bank Digital Currency)?

When was the last time you paid for something with cold, hard cash? While physical currency is still widely used all around the world, people in some countries have been using it a lot less lately—especially during the COVID-19 pandemic, with its cash shortages and hygiene concerns. As people shift away from cash, many are increasingly turning to digital financial transactions. Globally, banks and financial institutions process far more transactions digitally than they do in physical branches.

A variety of recent digital disruptions, including the emergence of cryptocurrencies and blockchain technology, have made waves in the financial-services sector. Digital currencies are part of that story, and central banks have started to take note.

Central bank digital currencies (CBDCs) are the digital form of a government-issued currency that isn’t pegged to a physical commodity. They are issued by central banks, whose role is to support financial services for a nation’s government and its commercial-banking system, set monetary policy, and issue currency. Examples of central banks include the US Federal Reserve System, the Bank of Japan, the People’s Bank of China (PBOC), and Germany’s Deutsche Bundesbank.

CBDCs are similar to—but not the same as—stablecoins. Stablecoins are a specific type of private, stabilized cryptocurrency pegged to another currency, commodity, or financial instrument with the goal of maintaining a relatively stable value over time. Unlike cryptocurrencies, which are decentralized, CBDCs are state issued and operated.

Learn more about McKinsey’s Financial Services Practice.

There’s no one type of CBDC; a wide variety of approaches are being piloted in various countries. One type of CBDC is an account-based model, such as DCash, which is being implemented in the Eastern Caribbean. With DCash, consumers hold deposit accounts directly with the central bank. At the opposite end of the spectrum is China’s e-CNY, a CBDC pilot that relies on private-sector banks to distribute and maintain digital-currency accounts for their customers. China showcased e-CNY during the 2022 Olympic Games in Beijing. Visitors and athletes could use the currency to make purchases within the Olympic Village.

Another model is the one under consideration by the European Central Bank in which licensed financial institutions each operate a permissioned node of the blockchain network as a conduit for the distribution of a digital euro. A final model, popular with “cryptophiles” but not yet fully trialed by central banks, is where fiat currency (currency that is government issued but not backed by a commodity) would be issued as anonymous fungible tokens to protect users’ privacy.

At present, 87 countries—representing more than 90 percent of global GDP—are exploring CBDCs. Here’s a closer look:

Four trends have likely spurred central banks’ interest in CBDCs:

There are potential benefits to establishing CBDCs, but they aren’t without risk. Read on to learn more.

Advocates of digital finance believe that new digital tools, among them CBDCs, can address many issues related to efficiency, security, and access:

Learn more about McKinsey’s Financial Services Practice.

While central banks are enthusiastically exploring the potential of CBDC, there are some challenges to be considered as well. When money becomes digital, it also becomes traceable and therefore taxable. McKinsey analysts anticipate this to become a hurdle to voluntary adoption. Another issue is a lack, so far, of technological stability. In January 2022, the digital version of Eastern Caribbean DCash went offline for two months because of technological issues.

There are also concerns that the business case for CBDCs is weak. For one thing, it may take more effort for central banks to develop infrastructure for digital currencies than can be justified by the relatively meager reward. Also, CBDCs may not confer the increased speed as predicted: many developed countries now activate instant payments using legacy (nonblockchain) infrastructure. Central banks in some nations, such as Canada and Singapore, have come to the conclusion that there isn’t currently a strong case for digital currency.

Private cryptocurrency is banned in China, but the country has still been dabbling in digital currency. In fact, China’s central bank, PBOC, has created the most advanced market application of CBDC to date. China’s CBDC pilot of e-CNY relies on private-sector banks to distribute and maintain these accounts for their customers.

In late 2019, PBOC began testing e-CNY through app- and wallet-based payments for government services, shopping, transportation, and other consumer lifestyle use cases. The pilot initially launched in four cities, then quickly expanded to five more. As of May 2022, 4.5 million merchant wallets and 260 million transactions worth more than 83 billion renminbi had been performed through the e-CNY pilot.

An early look at lessons from China’s use of CBDC found the following potential benefits:

Learn more about McKinsey’s Financial Services Practice.

It’s still too early to predict what the future holds for CBDCs. But despite the uncertainty, central banks can consider the following five questions:

But as we’ve seen, central banks aren’t the only organizations invested in the game. Here’s how other stakeholders can prepare for the arrival of CBDCs:

While much is still unknown about the future of CBDCs, a fuller picture of their benefits and disadvantages will emerge with time. One thing is clear: CBDCs have the potential to significantly affect the world.

For a more in-depth exploration of these topics, see McKinsey’s insights on financial services. Learn more about McKinsey’s Financial Services Practice—and check out finance-related job opportunities if you’re interested in working at McKinsey.

Articles referenced

Talk to us