21 Mar, 23

What are CBDCs and How do they Work?

what are cbdcs and how to they work banner
Finn Judell

The emergence of cryptocurrencies like Bitcoin and Ethereum has resulted in consumers around the world having an increasing interest in the world of blockchain – ushering a movement towards a more decentralised era in global financial infrastructure. Meanwhile, governments are taking notes as central banks look towards developing their own digital currencies, commonly known as Central Bank Digital Currencies (CBDCs).

The core function of a CBDC is to enable more transparent, secure, and accessible monetary infrastructure through the use of blockchain technology. However, not all CBDCs utilise blockchains. Today, over 90% of the world’s central banks are undergoing research into the adoption of CBDCs. In this report, we will examine the motivations for the adoption of CBDCs, how they work, the technical and operational challenges of centrally controlled digital currencies, as well as the potential advantages and disadvantages.

The Difference Between Digital Money and CBDCs

Presently, almost all banking and payment infrastructure is digital. However, these digital numbers are really just credits and debits between central banks, commercial banks and payment processors. The underlying infrastructure is actually maintained by legacy banking infrastructure, controlled by central banks. 

Central banks only control two kinds of money, physical cash and legal reserves that are held by central banks on behalf of retail banks. In the case of physical money, central banks work with a state’s treasury to print physical money, in some cases, physical money can be burnt but in most cases, this is just to replace old, worn-out money with new money. In a virtual sense, central banks control the money supply by purchasing government bonds from commercial banks and institutions. These government bonds are paid with central bank-issued debt; this results in commercial banks and institutions having more money to lend out to businesses and individuals, stimulating the economy. Once commercial banks decide to repay these debts, the money is figuratively deleted from existence – removing it from the economy’s circulating supply. If a central bank wants to reduce the amount of money in circulation, it will adjust the interest rate of the money it lent out to commercial banks, incentivising debt holders to pay back their loans and disincentivising businesses and individuals to take out new loans.

CBDCs offer a third option for central banks to control the monetary supply and regulate financial infrastructure. This option would, in theory, operate in a similar way to the virtual money already circulating within the economy, with a few key differences: CBDCs have the potential to integrate programmability, and transparency. Programmability in money allows authorities to have greater control over how the money is spent as well as automate key monetary functions within the economy. Added transparency would allow central bankers to audit the public’s spending, giving authorities the ability to prevent fraud and money laundering. This allows monetary policy to be more easily tracked providing quantifiable data on every dollar held within the CBDC system.

What are CBDCs?

Inspired by the uprising of Bitcoin over the last decade, the term CBDC is broadly used in reference to a cryptocurrency that is issued and backed by a state – not an individual, organisation or corporation. Over the last decade, central banks have been undergoing diligent research into issuing their own digital currencies. However, CBDCs function in a fundamentally different way from other types of digital currencies, like Bitcoin and Ethereum, which are fully decentralised and are not issued or backed by a central authority.

Wholesale CBDCs

Wholesale CBDCs are used to facilitate payments between central banks and retail banks or other financial institutions. This type of CBDC offers a more transparent, efficient, accessible and more easily regulated solution, as opposed to legacy systems. While wholesale CBDCs are important, they do not directly affect the way that members of the public transact on an everyday basis. Instead, this type of financial infrastructure has the potential to drastically change the underlying infrastructure of the global financial system.

Retail CBDCs

Retail CBDCs can be used by corporations and members of the public in a similar way to bank notes or credit/debit card systems. For decades, regulators have considered ways to phase out cash from society, due to its role in money laundering and tax avoidance. Retail CBDCs provide a way for regulators to replace cash with a digital form of money. While this concept is not new to regulators, it is understood that implementing a retail CBDC would require a significant amount of technical infrastructure and public education to ensure successful adoption without sacrificing financial inclusion. This has led to a delay in the adoption of retail CBDCs.

It was not until the emergence of Facebook’s digital currency, Diem (previously Libra) that regulators decided to be proactive in their approach toward retail CBDCs. The project was eventually abandoned and sold to Silvergate following scrutiny from regulators. Reasoning behind the scrutiny is said that regulators feared that a corporate entity having control over its own native currency would make it too economically powerful. Retail CBDCs have faced significant concerns from the public regarding privacy and sovereignty, as they have the potential to accumulate a large amount of sensitive payment and user data. While this is a valid concern, it has thus far not stopped regulators from exploring the potential of retail-focused digital currencies.

How CBDCs Work

Cryptocurrencies use blockchain technology to maintain a consistent ledger of transactions, allowing for fully permissionless transactions. In contrast, most central bank digital currencies require some form of centralisation and control, meaning that the underlying technology used for CBDCs will not likely be fully decentralised and permissionless. With that said, there is currently no consensus on the underlying architecture of CBDC on a global scale. Currently, countries from all over the world are taking different approaches to CBDCs and are trialling different technologies that facilitate digital currency. On the 11th of July, the Bank for International Settlements (BIS) published a report highlighting the importance of global interoperability between CBDC designs. In the report, they emphasised the need for international cooperation and standardisation may be necessary to overcome key challenges and facilitate interoperability between CBDC systems.

How CBDCs Compare to Stablecoins

Stablecoins are digital currencies that are designed to maintain a stable value and are often pegged to a fiat currency. They are usually issued by businesses, foundations, or corporations, not governments or central banks. The goal of a stablecoin is to provide a more stable and reliable store of value compared to other cryptocurrencies that are volatile and susceptible to price fluctuations. Recent controversy has put stablecoins under heavy scrutiny following the Terra Luna crash of 2022, which caused a catastrophic collapse in the cryptocurrency market. On one hand, stablecoins were created to help cryptocurrency investors manage risk. On the other hand, the entities that issue these stablecoins operate in a largely unregulated environment, making them susceptible to fraud and malpractice. To this day, stablecoins are mostly unregulated in most jurisdictions, placing regulators in a precarious predicament in regard to what to do next. The advent of stablecoins has likely contributed to the accelerated development of CBDCs due to the potential risks that stablecoins pose to retail users in the event of the underlying company’s bankruptcy. CBDCs, on the other hand, are immune to bankruptcy due to their association with the central bank, which has the ability to print more money rather than face financial insolvency.

There are several different types of stablecoins, including those pegged to a specific fiat currency, those that are backed by a basket of assets and algorithmic stablecoins. Algorithmic stablecoins are designed to maintain their value through the use of mathematical formulas and smart contracts that automatically adjust the supply in response to market demand. While there have been several efforts to create algorithmic stablecoins, such as Terra Luna, Ampleforth, Magic Internet Money, and Empty Set Dollar, many of these have faced challenges, including smart contract exploits, governance issues, and regulatory uncertainty.

The emergence of stablecoins poses a significant challenge to traditional banking systems, as their cost-efficient business models pose a threat to the costly infrastructure that banks must maintain in order to secure various forms of money, such as cash, coins, and precious metals. Unlike banks, stablecoin issuers do not incur significant expenses for security and instead rely on users to cover these costs through transaction fees. Additionally, while banks must invest heavily in legal and compliance professionals to remain compliant with the law, stablecoin issuers are able to keep their costs low by accepting fiat currency from trusted counterparties and purchasing fixed-income securities. 

Adoption of Central Bank Digital Currencies

Countries all over the world are undergoing research into how to best adopt CBDCs. Information regarding the development and deployment of CBDCs can be monitored using the CBDC tracker. However, the development of CBDCs has been slow in many countries due to a variety of factors, including regulatory concerns and the need to carefully consider the potential impacts on the financial system and monetary policies. In addition to this, most jurisdictions have not clearly laid out legislation regarding cryptocurrencies and stablecoins, making it difficult for central banks to begin rolling out a digital currency of their own. At the same time, the potential benefits of CBDCs have caused regulators to move quickly to regulate the cryptocurrency ecosystem as a whole. Countries such as China, Nigeria, the Bahamas, Jamaica and various eastern Caribbean islands have already adopted CBDCs with mixed results.

Source: IMF as of June 2022

Caribbean Islands

The Caribbean islands have been the first to publicly launch CBDCs. Three separate CBDCs have been launched in the Caribbean region: The Bahamas’ Sand Dollar, the Eastern Caribbean Central Bank DCash and the Jamaican Jam-Dex. Additionally, Haiti’s Digital Gourde is under development according to the Atlantic Council CBDC tracker. The currencies are optional for members of the public to use and can opt for cash or regular central banking digital monies instead. 

The first to launch was the Carribian Sand Dollar in 2020. The technology was built in by NZIA. The technology backing the currency itself is called NZIA Cortex DLT which can be accessed digitally via smartphones (iOS and Android) and via physical prepaid cards. The Sand Dollar is not seeing significant adoption yet, with the CBDC making up for 0.01% of the currency in circulation.

The Eastern Caribbean Central Bank introduced its CBDC ‘Dcash’ on the 31st of March 2021 for four of its eight members: Antigua and Barbuda, Grenada, Saint Kitts and Nevis and Saint Lucia; with the remaining ECCB member countries incrementally following suit shortly after the initial launch. The technology was built in collaboration with Barbados-based fintech Bitt, who developed the technology that connects to Hyperledger Fabric, which is used as the underlying transaction network. On January 14th 2022, Dcash suffered an outage that lasted for two months, leaving users of the digital currency unable to transact. A key criticism of the CBDC is that if the network goes offline, the entire country’s citizens cannot use their own money. Although Dcash systems are now back online, the outage has caused public sentiment regarding digital currency to dwindle. There is no public data in reference to the adoption rate of Dcash.

Jamaica’s Jam-Dex was the most recently launched CBDC, being issued for use by the public on July 11, 2022. The Bank of Jamaica appointed the CBDC technology provider eCurrency, which utilises a technology called DSC3. As part of the lunch, the first 100,000 customers were issued an incentive bonus of $2.5k in Jam-Dex which has a 1:1 backing to the Jamaican Dollar. According to this source, as of July 26 2022, over 120,000 users and over 2300 merchants have signed up to use the CBDC.


Despite the country’s harsh regulatory stance on cryptocurrencies, the People’s Bank of China (PBoC) is one of the primary leaders in the CBDC space. China has pioneered consistent research and development on CBDC technologies since 2014. The reasoning behind China taking a first mover advantage on the matter may be due to the success of fintech payment providers in the country such as Alipay and WeChat Pay. In response to the success of fintech payment providers, the PBoC has been quick to compete in regaining market dominance within the payments sector. The Chinese bank launched its digital yuan (or e-CNY) pilot program in select cities throughout 2020 and launched the digital currency publicly in April 2022 integrating into popular fintech payment providers WeChat and Alipay the following month. While currently the CBDC is designed to coexist with cash and other forms of electronic payment, the country’s central bank has been aiming to eventually replace cash with the digital yuan. 

China’s CBDC does not operate atop any kind of blockchain technology. A common misconception is that the digital yuan is built atop the Blockchain-based Service Network (BSN). In fact, due to China’s harsh stance on cryptocurrencies, the BSN is built to be a ‘currency-free’ blockchain and is intended for the development of blockchain-based applications only.


The Central Bank of Nigeria rolled out its CBDC ‘eNaira’ to the public on the 25th of October 2021. The country is using the same digital currency technology provider as the Eastern Caribbean Central Bank, Bitt – which remains connected to Hyperledger Fabric as the chosen underlying transaction network. Although studies show that up to between 27% and 50% of Nigerians hold or trade cryptocurrencies, only 0.5% of Nigerians have confessed to using the eNaira. On December 6, the Central Bank of Nigeria announced a cap on cash withdrawals. Withdrawals of digital currency cannot exceed ₦100k (US$ 225) for individuals and ₦500k (US$ 1125) for businesses. ATM withdrawals were capped at ₦20k (US$ 45) per day. Any withdrawals above these limits attract processing fees of up to 10%.


The Digital Finance CRC (DFCRC) and the Reserve Bank of Australia (RBA) are currently working together to develop a pilot for Digital Finance Innovation in Australia. The goal of this pilot is to find specific business models and use cases, economic benefits and operational, technological or regulatory issues that may arise upon the deployment of the RBA’s eAUD currency in Australia. The project was initiated in September 2022 and aims to be concluded by roughly June 2023. The key objective of the pilot is to gain a clearer understanding of CBDCs and how they could be integrated into Australian Society. Zerocap is involved with this eAUD pilot by designing and implementing use cases.

In late 2020 the Reserve Bank of Australia, Commonwealth Bank of Australia (CBA), Perpetual and National Australia Bank (NAB) participated in Project Atom. The objective of the project was to develop a functional proof of concept to demonstrate how a wholesale CBDC could be issued and used for the settlement of a tokenised asset on an enterprise-grade version of the Ethereum blockchain. Although Australian research into CBDCs is prevalent and ongoing, CBA stated that the deployment of a CBDC in Australia is still “years away”.

United States of America

The Biden Administration recently signed an executive order directing US government agencies to prioritise the development of policies to regulate digital assets and examine the requirements and feasibility of launching a digital version of the US dollar. Until a more comprehensive policy framework for digital assets is developed, few pilots and use cases relating to a US-based CBDC will emerge.


The European Commission plans to propose legislation for a digital euro in 2023. The proposed legislation would allow the European Central Bank (ECB) to issue and manage a digital version of the euro, which could be used for peer-to-peer transactions and as a store of value. The digital euro would be available to all EU citizens and businesses, and could potentially be used in conjunction with physical cash or as a standalone currency. The proposal will be reviewed by the European Parliament and the European Council and may be amended or approved as necessary. 


In August 2022, the central bank of the United Kingdom, the Bank of England, announced that it will begin running a CBDC pilot project called ‘Project New Era’ in collaboration with the Digital FMI Consortium which is made up of financial institutions such as commercial banks, payment providers, telecommunications platforms, Fintechs and blockchain-related companies. The Digital FMI consortium will provide recommendations to the Bank of England in regard to developing a digital currency ecosystem in the UK, including regulated stablecoins and retail CBDCs. The project will encourage closer public-private collaboration in order to address key challenges and open questioning relating to stablecoin regulation and CBDC development. 

The Pros and Cons of CBDCs

The implementation of CBDCs has the potential to bring a plethora of benefits to the financial system. However, despite these potential benefits, the technology has also been met with scepticism and criticism from the public, as researchers and individuals have highlighted the various risks associated with the technology. 


In a CBDC-enabled society, enforcing financial law becomes much easier due to the fact that CBDCs are programmable and easily traceable. CBDCs have the potential to protect the state against fraudulent practices from its citizens such as tax avoidance and money laundering. A state that is protected from financial malpractice through CBDCs will eventuate in increased government revenue as well as greater fairness within monetary systems. Additionally, CBDCs have the potential to increase transparency in this process by allowing the public to see how the central bank is altering the supply of money. This can help the public verify inflation rates and increase accountability for central bankers, creating a system that is less vulnerable to malpractice.


Prior to the invention of CBDCs, commercial banks have been essential in a healthy financial system. They act as a trusted third party to assess credit risk, as the monetary gain is prioritised over political influence. The notion of transferring this risk to the central bank poses potential dangers due to the potential conflicts of interest that can arise between politics and the financial system. Additionally, CBDCs introduce privacy concerns for their users, allowing the central bank and governments to track individuals’ transactions. The technology exposes members of the public to potential exploitation which may be fueled by a citizen’s race, religion, immigration status or even social credit score. In practice, the introduction of such a monetary policy could allow nations to develop classist systems that stray far away from free market ideals that promote equal opportunity. 


While CBDCs are still in the early stages of development, there is no doubt that the technology has already disrupted and continues to disrupt the global financial system at scale. Powerful governments around the world are experimenting with technology. Many have the aspiration to not only have digital currencies operate in tandem with current financial infrastructure, but also have CBDCs eventually replace commercial banking and physical cash as a whole. Governments are attracted to this technology due to its many state-focused benefits that boil down to giving governments more control and visibility over the economy. Nonetheless, although these perks may advantage members of the public in many ways, a lack of trust in the government has caused portions of the populace to be worried about the sacrifice of additional personal freedoms. 


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What are Central Bank Digital Currencies (CBDCs)?

Central Bank Digital Currencies (CBDCs) are digital currencies issued and backed by a state’s central bank. They are designed to enable more transparent, secure, and accessible monetary infrastructure, often through the use of blockchain technology. However, not all CBDCs utilize blockchains. They are fundamentally different from other types of digital currencies like Bitcoin and Ethereum, which are fully decentralized and not issued or backed by a central authority.

What is the difference between Digital Money and CBDCs?

While most banking and payment infrastructure is digital, these digital numbers are credits and debits between central banks, commercial banks, and payment processors, maintained by legacy banking infrastructure. CBDCs offer a third option for central banks to control the monetary supply and regulate financial infrastructure. They have the potential to integrate programmability and transparency, allowing authorities to have greater control over how the money is spent and to prevent fraud and money laundering.

What are the types of CBDCs?

There are two types of CBDCs: Wholesale and Retail. Wholesale CBDCs facilitate payments between central banks and retail banks or other financial institutions, offering a more transparent, efficient, and regulated solution. Retail CBDCs can be used by corporations and members of the public in a similar way to banknotes or credit/debit card systems, providing a way for regulators to replace cash with a digital form of money.

How do CBDCs compare to Stablecoins?

Stablecoins are digital currencies designed to maintain a stable value, often pegged to a fiat currency, and are usually issued by businesses, foundations, or corporations, not governments or central banks. CBDCs, on the other hand, are immune to bankruptcy due to their association with the central bank, which has the ability to print more money rather than face financial insolvency.

What are the pros and cons of CBDCs?

CBDCs can enforce financial law more easily due to their programmability and traceability, protecting the state against fraudulent practices like tax avoidance and money laundering. However, they introduce privacy concerns for users, allowing the central bank and governments to track individuals’ transactions. The technology exposes members of the public to potential exploitation, which may be fueled by a citizen’s race, religion, immigration status, or even social credit score.

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