From the barter system to the use of cowries and seashells to coins and paper notes, practicality and convenience have fueled the evolution of legal tender. It is for these same reasons that we have financial institutions, cheques and credit cards today. Imagine if we still had to carry cash and coins around to transact every day. This might not be so inconvenient for little grocery shopping, but imagine having to cover heavy business expenses running in millions in cash; that would be so insecure and impractical.

In the age of technology, where it seems like everything is moving from paper and other physical forms to our smartphones, Central Bank Digital Currency (CBDC) is only the next practical and convenient stage of the evolution of legal tender.

What is a Central Bank Digital Currency (CBDC)?

A CBDC is simply a digital form of a country’s currency issued by the Central Bank. Similar to cash, the central bank would issue digital currency to allow everyday transactions.

Fun fact: the vast number (80%) of Central Banks are exploring the option of CBDCs. And about 10 countries around the world have already launched a CBDC.

Why CBDCs?

Two key factors pushed Central Banks down this route. 2Cs: Cryptocurrencies and COVID. Cryptocurrencies have shown that consumers are willing to transition from legal tender that has physical form to purely digital currency that has no physical equivalent anywhere. The blockchain technology behind cryptocurrencies showed a tested way to go about issuing and using digital currency.

Many central banks also worry that the widespread use of cryptocurrencies could weaken their control of the financial system and their ability to implement monetary policy.

If you can’t beat them, join them.

Right now, Central Banks can respond to changes in the economy with monetary policies. If things are sluggish like the way things were when the world was on lockdown, they can lower interest rates or print more money. If things are overheating, inflation is rising; they can raise rates and make rules about how much money banks can keep in reserve. But all of these cease to be effective if people are no longer predominantly using currencies that Central Banks control.

Another enabling factor was the payment of stimulus cheques. During the pandemic, some governments found it difficult to find a way to send stimulus cheques to all citizens. With a CBDC, this would have been a lot easier.

How CBDCs work

CBDCs would operate just like the money we see when we check our bank accounts online. Instead of printing physical currency, the central bank would use digital coins or notes held in a digital wallet accessible from a smartphone. Governments could also decide whether they want citizens to open accounts with the Central Banks or operate digital currency through existing commercial banks.

In Nigeria, the government went the existing commercial bank route. Many governments in Europe and Canada are considering the option of citizens opening bank accounts directly with the Central Bank, which may be due to  the difficulty they faced with disbursing stimulus cheques during last year’s lockdown. CBDCs would use blockchain technology to monitor supply and who owns what while users’ data could be held by the Central Banks or an external party. Among the world powers, China is way ahead in the race to get a CBDC. They have been testing their CBDC, the Digital Currency Electronic Payment (DCEP), for a while now with tens of thousands of people.

China’s DCEP works very similarly to the country’s top payment processors, AliPay and WeChatPay. For China, their CBDC could be a means of taking back control over a financial system challenged by rapidly growing Fintech companies.

The DCEP would work in 2 simple steps:

1. Users download the wallet app

2. They scan a QR code which the app generates (like the way we scan our debit/credit cards) to pay for stuff at a terminal to complete transactions

Could a CBDC compete with any cryptocurrency?

While it is true that CBDCs can be based on blockchain or not, decentralized or centralized, I imagine that we will quickly find that most CBDCs would lean towards the centralized form. After all, they are issued by the CENTRAL Bank and not the decentral bank. China’s DCEP and Nigeria’s eNaira, for example, are not based on blockchain.  And that is where it loses the race against crypto. Because the key reason why people move to crypto is not just for the digital form it takes but also for its transparent, decentralized nature, and I don’t think central banks can truly give that.

Does this mean CBDCs are dead on arrival?

Maybe we had it all wrong. Maybe digital currencies aren’t coming to compete or offer an alternative to crypto. Maybe they are coming to compete directly with digital payments platforms like PayPal, Visa, Mastercard.

It makes its failure to compete with cryptocurrencies less of a problem when you think of it like that. That is, it doesn’t have to be transparent (open). It doesn’t have to be decentralized, permissionless and everything else crypto offers. It just has to be the Central Bank taking over digital payments. And maybe the Central Banks don’t even realize this yet.

After all, they are called central bank digital currencies (CBDCs) and not central bank cryptocurrencies. 

Think of CBDCs more as a step towards a truly cashless society than as a step towards a decentralized society.

A great illustration of how this is true is Sweden which has one of the lowest usage rates of cash. The Swedish CBDC, the E-krona, had its pilot program as far back as 2019 before the key factors that pushed many Central Banks to consider CBDCs happened.

Some Potential Risks CBDCs Pose Or Face

The first risk is the risk with any new technology built on the internet:

If we solely rely on digital currencies and there is a massive power outage (higher risk in some countries more than others) or a hack, it could jeopardize the entire system. If there are no backups and the internet goes down, then what happens to digital currencies held? To mitigate this risk, most central banks say CBDCs would be implemented alongside physical forms of currency. In times of economic uncertainty, people run to their banks to withdraw their money to hold in cash.

There are also concerns that CBDCs could cause bank runs where there is economic instability. In times of economic uncertainty, people may be more inclined to pull their money from commercial banks to place it in CBDCs as this is a more convenient option than keeping all their money in cash as they would have done in the past. This can exacerbate the financial crisis. Since they are essentially displacing payment processors, it might raise privacy issues if the central bank can monitor every transaction citizens make. Because in the status quo, you can make payments using your bank, PayPal, switch and several other payment processors where no single platform has all your purchasing data, but if the central bank replaces all those processors in your daily use, they can get all that data. Central Banks need to think about where all that data will be stored and protected or if that data needs to be collected at all

There are also issues of preventing CBDCs from being used in money laundering, financing terrorism etc.

Use Cases For CBDCs

CBDCs can be used for every form of payment and transaction we currently do with cash or money in your bank account. A bigger use case that has a lot of people excited is CBDCs potential to make cross border payments faster, cheaper and easier. CBDCs could potentially half the costs of cross-border payments and reduce transactions’ completion from up to 5 days to less than a minute.


 In 1 word, Interoperability.  That is, currencies can directly be exchanged with each other instead of going through the long process of settlement. Since there’s no need for physical currency to exchange hands, money can move as easily as it is to send an email. Countries like Hong Kong are already trialling this, using digital currency to facilitate cross border payments with Thailand.

People also say CBDCs can improve financial inclusion like the M-Pesa did in Kenya. The M-Pesa made it such that anyone with a sim enabled phone can have a mobile account that allows them to send and receive money.

It could also be cheaper to issue new CBDCs than it is to print paper money and coins. The incremental cost of printing $1 trillion for example is likely to be higher than the cost of issuing the same amount in digital dollars.

Fun fact: Eastern Caribbean was the first currency union central bank to issue digital cash. Barbados is 1 of the countries in the Eastern Caribbean. Probably that’s why Nigeria employed a Barbadian company, Bitt, to build the eNaira. Maybe experience?

Final Thoughts

A lot of countries are still researching CBDCs. In August 2020, the Federal Reserve Bank of Boston announced a multi-year partnership with MIT to research CBDCs. The research project will explore new and existing technologies to build and test a hypothetical digital currency platform. They released their 1st prototype this summer as open-source code to see how best to go about it.

The concept of CBDC is still young. So we can expect refinement of this idea as time goes on.

Would you use a CBDC?