Published January 25, 2023 | Version 1.0
Working paper Open

An insight into Central Bank Digital Currency

  • 1. University of Bath



This is a literature review survey paper designed to be a synthesis of existing knowledge and as an introduction to idea of a central bank digital currency for those new to the concept. The digital payments landscape has evolved in recent years, and the intensity of research into central bank digital currencies (CBDCs) has massively increased. This paper outlines the likely impacts of a CBDC on the economy, with a focus on financial stability and the banking system. It also gives an insight into the design choices and the extent to which they satisfy crucial central bank policy goals. It is intended to be read primarily by those associated with implementing a CBDC, namely policymakers and central banks. A well-designed retail CBDC could benefit the economy by improving payment efficiency and satisfying policy goals such as financial inclusion. It could also protect monetary sovereignty against the recent surge of currency competition, chiefly from cryptocurrencies and stablecoins. The principal risk associated with a CBDC is the potential to cause bank disintermediation and financial instability. The level of disintermediation that a CBDC would cause largely depends on the design choices, which significantly influence the economic impact of the digital currency and how widely it is used by the general public.


Non-Technical Summary

In recent years, the intensity of research into central bank digital currencies (CBDCs) has massively increased. Central bank digital currency is a digital representation of the sovereign currency produced by a centralised monetary authority such as a central bank. This paper focuses on the design choices and likely impact surrounding retail CBDC, the form of CBDC which would have the most substantial impact on the financial system. A retail CBDC is the primary form of this digital currency that most policymakers are considering implementing worldwide.

Introducing a retail CBDC may improve many factors, including financial stability, monetary policy implementation, financial inclusion, domestic and cross-border payments efficiency, and payments safety and robustness. The primary reason for introducing a CBDC varies across different countries, many of which want to provide an alternative form of widely available central bank money in economies where the use of cash is dwindling.

Many central banks also fear the rise of cryptocurrencies and stablecoins, which provide cash alternatives and could compromise the ubiquity of public money, reducing monetary sovereignty. An established retail CBDC is widely considered a disrupting force against the recent explosion in cryptocurrency growth. It would be backed by central bank reserves and could help to cement central banks’ monetary sovereignty. 

The design choices for CBDC determine its likely impact on the financial system. CBDC must be designed as an attractive form of payment to ensure that it is accepted and used within the economy. However, many fear that CBDC could substitute commercial bank deposits on a large scale and cause disintermediation of the banking sector. This would depend on the design of the operating model; the central bank would have total control over the entire process under a single-tiered CBDC, whereas an intermediated CBDC would involve outsourcing some tasks to financial intermediaries. These intermediaries would include commercial banks and non-bank financial institutions and would likely obtain revenue by charging payment fees. From these fees, commercial banks would be able to retain most of their earnings even if they face a drop in traditional bank deposits. However, the amount of revenue commercial banks and other intermediaries would be allowed to earn largely depends on the extent to which bank disintermediation would cause severe financial instability. There is a growing consideration that commercial banks are no longer ‘too big to fail’ in the UK, for example, meaning the central bank would not be responsible for keeping them afloat and could allow bank disintermediation to occur.

Another crucial design choice that central banks must make is to introduce a remunerated or non-interest-bearing CBDC. A remunerated CBDC would improve monetary policy transmission and could be increased or lowered to improve or reduce its attractiveness to the general public. A remunerated CBDC also gives central banks the opportunity to implement negative interest rates, eliminating the liquidity trap.

Central banks must also decide which type of ledger system to run CBDC on. A centralised ledger system would involve opening an account directly with the central bank (or with an intermediary) and would facilitate more, quicker transactions than alternatives. The other option is to use distributed ledger technology (DLT), for example, blockchain, which is the underlying system for Bitcoin. Although this system is decentralised and difficult to hack, it is very energy-intensive and faces issues such as slow transaction speeds.

There is somewhat of a trade-off between privacy and security in designing a CBDC. The network must comply with AML, CFT and KYC regulations, requiring financial institutions to verify the identity of their users. However, much of the general public value transactional anonymity, as offered by cash. Central banks must also decide whether to collect (or allow intermediaries to collect) transaction data or allow transactional privacy.

Some countries have already implemented CBDCs, and many others have introduced, or are planning to introduce, pilot schemes. Other international projects, such as the mCBDC Bridge project, aim to facilitate and speed up cross-border transactions, a key element of CBDC. Central banks worldwide must cooperate on CBDC design to ensure interoperability on issues including cross-border payments. If not, dollarisation could occur, or private currencies could become prevalent and threaten monetary sovereignty worldwide.

Policymakers must be aware of the likely impact of each design choice and ensure that CBDC promotes innovation within the payments sphere. They must also be flexible in introducing and adjusting regulations as the digital currency industry changes. Trials and surveys around CBDC design choices must also continue for policymakers to discover the likely impact on the economy and the response of the general public.


An insight into Central Bank Digital Currency_FINAL.pdf

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