What is a CBDC (Central Bank Digital Currency)? A Clear, Professional Overview of Its Differences from Cryptocurrencies

What Is CBDC (Central Bank Digital Currency)?

CBDC (Central Bank Digital Currency) refers to legal tender in digitized form issued by national central banks. Legal tender is currency designated by law, such as the Japanese yen or the US dollar. Because central banks issue CBDCs as their liabilities, the state guarantees their value, making them far less susceptible to the dramatic price swings typical of crypto assets.

CBDCs represent a new kind of electronic money, distinct from cash or bank deposits. Traditional cash exists as physical bills and coins, while CBDCs exist solely in digital form and are transacted via smartphones or computers. Bank deposits are liabilities of private financial institutions; CBDCs are direct liabilities of central banks, providing greater reliability and security.

In recent years, countries like China, Sweden, and the Bahamas have actively pursued CBDC initiatives. China has rolled out large-scale pilot programs for the digital yuan, which is already used in commercial transactions in select cities. Sweden is advancing its "e-krona" project to accelerate the shift to a cashless society. The Bahamas was the first country to officially launch a nationwide CBDC, the "Sand Dollar."

In Japan, the Bank of Japan is conducting phased studies into the practical viability of CBDCs. Because there are numerous issues to consider—including the impact on private banks, the existing financial system, and privacy protection—many central banks remain cautious but continue research and development toward possible future adoption.

How CBDC (Central Bank Digital Currency) Differs from Crypto Assets

CBDCs and crypto assets both exist in digital form, but their core attributes are fundamentally different. Here, we break down the main differences from three critical perspectives.

CBDC vs. Crypto Assets #1: Issuer and Legal Status

CBDCs are digital versions of legal tender issued by central banks—government entities. They have the same legal status as physical cash, with their value backed by the full faith and credit of the state. Because CBDCs are legal tender, they are required by law to be accepted for all obligations, including debt payments and taxes.

CBDCs are less prone to sharp price fluctuations driven by supply and demand, since the state guarantees their value. One CBDC always equals one unit of legal tender. While they are subject to inflation or deflation, they do not experience the short-term speculative volatility seen in crypto assets.

By contrast, crypto assets are digital currencies created by private organizations, individuals, or decentralized communities. Major examples like Bitcoin and Ethereum operate without central administrators, using blockchain technology for decentralized management. Crypto assets do not have legal tender status; whether to accept them as a payment method is up to individuals or businesses.

Crypto assets are highly volatile because market supply and demand set their prices. For instance, Bitcoin can fluctuate by more than 10% in a single day. This makes them attractive as investment vehicles but challenging to use for day-to-day payments.

CBDC vs. Crypto Assets #2: Technical Architecture

CBDCs are typically developed using Distributed Ledger Technology (DLT). DLT allows multiple network participants to manage and share a single ledger, making data tampering difficult and providing high transparency and trust.

Blockchain is the leading form of DLT, recording transactions in blocks linked like a chain to enhance tamper resistance. CBDC designs commonly use blockchain or similar DLTs, usually as permissioned (private) networks overseen by central banks.

Crypto assets also rely on DLT for issuance and management. However, for major crypto assets like Bitcoin and Ethereum, participants reach consensus without a central authority, requiring specialized rules known as consensus algorithms.

Consensus algorithms include Proof of Work (PoW) and Proof of Stake (PoS). PoW—used by Bitcoin—verifies transactions through complex computations. PoS, used in Ethereum 2.0, selects validators based on the amount of crypto assets they hold, making it more energy efficient.

For CBDCs, the central bank acts as the administrator, so such complex consensus protocols are not necessary. Instead, only nodes approved by the central bank verify transactions on a permissioned network, enabling fast and efficient settlement.

CBDC vs. Crypto Assets #3: Intended Uses and Impact

CBDCs are designed for public purposes: streamlining payment systems, reducing costs, adapting to digital environments, and preventing money laundering. Central banks aim to issue CBDCs to maintain monetary sovereignty while supporting the growth of the digital economy.

CBDCs can also promote financial inclusion. Even people without bank accounts can make payments or transfers using CBDCs if they have a smartphone, improving access to financial services. For cross-border remittances, CBDCs can lower costs and speed up processing.

CBDCs may also play a key role in preserving monetary sovereignty and financial stability. If private digital currencies and stablecoins become widespread, central banks could lose monetary policy effectiveness. By introducing CBDCs, they can retain control over currency issuance and management in the digital era.

In contrast, crypto assets are used for private or commercial purposes, such as permissionless transactions, investment, and technological innovation. Their main use is as investment vehicles, with trading and speculation based on price swings.

Crypto assets can also serve needs such as international transfers and micropayments. Traditional international bank transfers incur high fees, but crypto assets can make them faster and cheaper. Assets like Ethereum, which support smart contracts, enable automated transactions and decentralized applications (DApps), driving new business models.

Key Advantages of CBDC (Central Bank Digital Currency)

CBDCs offer several significant benefits. Here are three of the most important advantages, explained in detail.

CBDC Benefit #1: Cost Reduction

Issuing and managing physical cash—coins and bills—has required enormous costs in recent years. Manufacturing currency calls for specialized printing technology and materials and advanced security features. Collecting and disposing of old notes and coins also adds to the expense.

Additionally, circulating cash requires infrastructure and personnel: ATM deployment and maintenance, armored transport, and cash management in banks and stores. Ultimately, these costs are borne by society at large.

CBDCs can drastically cut these cash-related expenses. As digital currency, CBDCs don’t need to be manufactured or transported and are managed electronically, keeping operating costs low.

What’s more, transaction fees can be minimized. Private-sector e-money or credit cards have typically imposed merchant fees of 2–5% for system use—a significant burden, especially for small businesses.

As a public good, CBDCs are likely to be operated by central banks on a not-for-profit basis, so fees could be set at zero or at very low levels. This eases the cost burden on merchants and makes payments more convenient for consumers.

CBDC Benefit #2: High Transparency and Lower Fraud Risk

Because all CBDC transactions are digitally recorded, CBDCs are effective in curbing cash-based fraud. The biggest drawback of cash is its anonymity, which makes it difficult to track illegal activities like money laundering and tax evasion.

Physical cash is nearly impossible to trace, making it ideal for criminal organizations and tax evaders. International anti-money laundering measures have stepped up in recent years, and financial institutions must perform strict Know Your Customer (KYC) checks, but cash transactions remain hard to monitor.

With CBDCs, every transaction is logged in a digital ledger, so records can be tracked as needed. This makes it easier to detect illicit fund flows and helps deter crimes like money laundering and tax evasion.

Central bank backing also makes CBDCs highly reliable. E-money and crypto assets issued by private companies can fluctuate in value based on issuer health or market conditions, or even lose all value.

For example, there have been cases where users lost assets when major crypto exchanges collapsed. CBDCs, however, are legal tender with state-backed value, ensuring excellent stability and liquidity. Users can hold and use CBDCs with confidence for everyday payments.

CBDC Benefit #3: Greater Payment System Efficiency

CBDCs can dramatically improve payment system efficiency. Financial transactions—such as tax payments and transfers—can be completed instantly and digitally, greatly accelerating processing. Traditional bank transfers are limited by business hours and can take several days if weekends or holidays intervene, but CBDCs enable real-time payments 24/7, 365 days a year.

For instance, special COVID-19 stimulus payments sometimes took weeks or months to reach recipients. With CBDCs, governments could disburse benefits quickly and efficiently by sending funds directly to digital wallets, slashing administrative costs and delays.

CBDCs also enable rapid response in emergencies and disasters. When major disasters strike, cash shortages or ATM outages are real risks. Cash transport to disaster zones takes time and money, delaying relief efforts.

With CBDCs, as long as there’s internet access, digital payments remain possible, supporting rapid aid and commerce in affected areas. Offline-capable CBDC designs are also in development, allowing certain transactions even if communications networks are down.

Challenges and Disadvantages of CBDC (Central Bank Digital Currency)

CBDCs carry important challenges as well as benefits. Here are the main concerns related to CBDC adoption.

CBDC Drawback #1: Loss of Transaction Anonymity

While digital records help prevent fraud, they also mean less transaction anonymity. There are concerns that individual privacy could be compromised, since central banks or related agencies could observe transaction flows.

As digital technology has advanced, personal privacy has become a critical issue. If governments or central banks monitor CBDC transaction data, they could infer details about individuals’ spending, assets, or relationships.

For example, authorities might analyze spending patterns to change tax policies or target specific goods and services for taxation. If companies access consumer data, it could be used for pricing and marketing strategies.

In authoritarian regimes, there’s also a risk that CBDCs could be misused as tools for surveillance. Governments could monitor the funds of dissidents and restrict CBDC usage, stifling free speech and political activity.

To address these concerns, it’s vital to implement privacy safeguards in CBDC design. For example, maintaining anonymity for small transactions while tracking only large or suspicious transactions provides a balanced approach.

CBDC Drawback #2: High Disaster and Security Risks

CBDCs are entirely digital, so large-scale disasters or cyberattacks could shut down the entire payment system. Earthquakes, typhoons, or floods could damage power or communications infrastructure, temporarily halting CBDC transactions.

Cyberattacks are also a major concern. Attackers could infiltrate central bank systems or CBDC networks, tampering with data or fraudulently creating currency. A successful attack could disrupt a nation’s currency system and severely impact the economy.

CBDC adoption requires robust offline capabilities and ironclad security. Ideas include storing a set amount of CBDC on smart cards or mobile devices for offline payments using NFC, for example.

Cash, by contrast, works without electricity or communications infrastructure—a major advantage in disasters. CBDCs can’t fully replicate this, so maintaining some cash in circulation remains important for risk management.

CBDC Drawback #3: Erosion of Private Banks’ Intermediation Role

If CBDCs become widespread, citizens may no longer need to keep funds in private banks, leading to shrinking deposits. Private banks use deposits to make loans to businesses and individuals, which is vital for the economy.

With CBDCs, people can hold digital currency directly from the central bank, reducing reliance on private banks. In times of financial stress, a “digital run” could occur, with depositors moving funds from banks into CBDCs.

This would make it harder for banks to fund loans, reduce business lending, and potentially slow economic growth. If banks’ revenues fall, their operations could come under pressure, threatening the stability of the entire financial system.

To address this, central banks are considering CBDC holding limits, not paying interest, or even applying negative interest rates to prevent excessive outflows from banks. They are also exploring “two-tier” structures, where private banks act as intermediaries for CBDC distribution, with central and private banks cooperating in CBDC operation.

Japan’s CBDC (Central Bank Digital Currency) Initiatives

In October 2020, the Bank of Japan announced its basic policy and pilot plans for CBDCs. Since April 2021, it has been conducting phased proof-of-concept trials to test the technical feasibility of CBDCs.

The Bank of Japan is running CBDC experiments in three phases. Phase 1 was a proof-of-concept to confirm basic functions—issuance, circulation, redemption—and system performance. Phase 2 tested more advanced features, such as offline payments, holding limits, and transaction history management, to identify technical issues before real-world use.

Phase 3 envisions pilot programs with private businesses and general consumers. These would evaluate real-world usability and issues, informing decisions on full-scale adoption.

Japan’s main goals for CBDC include:

• Reducing costs for cash transactions and payment processing: Cash usage remains high in Japan, imposing heavy manufacturing and management costs. CBDC adoption could cut these costs and build a more efficient payment system.

• Strengthening crime prevention, such as anti-money laundering and tax evasion: CBDC transaction records make illicit fund flows easier to detect, helping combat financial crime.

• Building payment systems for a digital society: As cashless payments rise, CBDCs can provide public digital payment infrastructure and foster healthy competition with private digital currencies.

• Streamlining cross-border payments and remittances: If CBDCs become interoperable globally, international payments can be made faster and at lower cost, supporting trade and tourism growth.

In summary, Japan is steadily advancing CBDC research and development and considering future issuance from multiple angles. Unlike cash or e-money, CBDCs are state-guaranteed digital currencies, with the potential to become a new foundation for financial infrastructure. As CBDCs promise a more efficient and secure payment environment, Japan’s CBDC efforts are drawing increasing attention.

Summary: Key Differences Between CBDC (Central Bank Digital Currency) and Crypto Assets

CBDCs and crypto assets have both attracted attention as digital currencies, but their characteristics and roles are distinctly different. This article has explored the differences in terms of issuer, technical architecture, and intended use.

CBDCs are digital legal tender issued by governments, with the same legal status as cash and state-backed value. Their main goals are improving payment system efficiency, reducing costs, adapting to digital environments, and preventing money laundering and tax evasion for the public good.

CBDCs also face challenges, such as reduced financial intermediation by private banks, the risk of digital bank runs, privacy concerns, and vulnerabilities to cyberattacks or disaster. Central banks are taking a cautious approach through careful design and pilot testing.

Crypto assets are decentralized digital currencies, mainly used as investment products. While they’re highly volatile and actively traded for speculation, they also enable innovative uses like international transfers and smart contracts.

CBDCs serve as public infrastructure—the digital alternative to cash—while crypto assets drive private-sector financial innovation. Understanding and using the unique features of each is essential for thriving in the digital economy.

FAQ

What is a CBDC? How is it different from crypto assets?

A CBDC is a digital form of legal tender issued and managed by a central bank. Crypto assets run on decentralized blockchain technology, with no central administrator. CBDCs are recognized as legal tender; crypto assets are speculative investments.

What are the benefits of CBDCs? How do they help ordinary people?

CBDCs reduce transaction costs, can be used without bank accounts, help prevent tax evasion and money laundering, and provide stable value. Because they’re backed by the government, there’s no risk of issuer bankruptcy, making them safe to use.

What are the main differences between CBDCs and crypto assets like Bitcoin or Ethereum?

CBDCs are legal tender issued and managed by central banks and backed by government credit. Crypto assets are privately issued and operate on decentralized blockchain networks. CBDCs focus on stability and regulation; crypto assets emphasize decentralization and flexibility.

What’s the status of CBDC development worldwide? How is Japan progressing?

CBDC development is active globally, with emerging markets generally moving faster than developed economies. Japan is advancing pilot trials and aims for full-scale rollout by 2026.

Are CBDCs really secure? What about privacy?

CBDCs are highly secure thanks to advanced protections, but transaction records do raise privacy issues. Using wallets for small amounts and hybrid management with digital IDs can help balance security and privacy.

How will CBDCs change our everyday lives?

CBDCs will enable contactless, instant payments and reduce cash usage. Economic efficiency will rise, and access to financial services will broaden.

Will CBDCs replace the current banking system?

No—CBDCs won’t fully replace the banking system but will complement it. CBDCs are digital money issued by central banks, but private banks will continue to provide credit creation and financial intermediation. The main role of CBDCs is to offer safe retail payment options and support monetary and payment system stability in a digital society.

How are CBDCs different from existing digital payments like credit cards or e-money?

CBDCs are legal tender issued by central banks, usable anywhere, with no risk of issuer default and zero usage fees. E-money is issued by private firms, is accepted only at specific merchants, carries default risk, and may incur fees.