What is CBDC (Central Bank Digital Currency)? An Easy-to-Understand Comparison with Cryptocurrency

What Is a CBDC (Central Bank Digital Currency)?

A Central Bank Digital Currency (CBDC) is a digital form of legal tender issued by a country’s central bank. Legal tender is currency defined by law, such as the Japanese yen, US dollar, or euro. Because CBDCs are issued as central bank liabilities, their value is guaranteed by the state, making them highly stable and less prone to price fluctuations.

CBDCs represent a new type of electronic money, distinct from traditional cash and bank deposits. While cash exists as physical notes and coins, CBDCs exist entirely in digital form. Unlike bank deposits, which are managed by private banks, CBDCs are issued and managed directly by central banks—a fundamental distinction.

Globally, China, Sweden, and the Bahamas are among the countries actively advancing CBDC initiatives. China is conducting large-scale pilot tests of the digital yuan. Sweden is developing the “e-krona” project. The Bahamas has officially launched the “Sand Dollar,” now in practical use.

The Bank of Japan is also assessing the feasibility of a CBDC. However, CBDC adoption involves many considerations, including impacts on private banks and the existing financial system, privacy protection, and technical challenges. Consequently, most central banks are pursuing research and development in a cautious, phased approach.

How Do CBDCs (Central Bank Digital Currencies) Differ from Crypto Assets?

Although both CBDCs and crypto assets are digital currencies, their characteristics and purposes differ significantly. Here are three key differences.

Difference 1: Issuer and Legal Status

CBDCs are digital forms of legal tender issued by a central bank, a government institution. As legal tender, CBDCs have “legal tender status,” meaning they are accepted for all economic activities, such as debt settlement or purchasing goods and services.

Because the state guarantees CBDC value, these currencies are highly stable and rarely experience significant price swings. For example, if one CBDC equals one yen, its value remains steady under government oversight.

By contrast, crypto assets (virtual currencies) are unique digital currencies issued by private organizations, individuals, or decentralized networks—Bitcoin and Ethereum are prime examples. Crypto assets lack legal tender status, so their acceptance as payment depends on the discretion of individuals or merchants.

Crypto asset prices are determined by market supply and demand and can be extremely volatile. Their high price volatility means they are often used as investment assets, but this instability is a risk for payment purposes.

Difference 2: Technical Infrastructure

Both CBDCs and crypto assets frequently use Distributed Ledger Technology (DLT), but their implementation and management differ greatly.

DLT allows network participants to collectively manage and share a transaction ledger. Blockchain, the most widely known DLT, is the foundation of most crypto assets.

For CBDCs, central banks generally retain control over ledger management, centrally approving and recording transactions. This structure enables fast, efficient transactions and simplifies monitoring and regulating illicit activity. Some CBDCs adopt blockchain technology as a “permissioned blockchain” controlled by the central bank.

In contrast, crypto assets require “consensus algorithms” to achieve agreement among network participants without a central authority. There are various consensus mechanisms, including Proof of Work (PoW) and Proof of Stake (PoS).

Proof of Work, used by Bitcoin, requires miners to solve complex mathematical problems to validate transactions. Proof of Stake, as used by Ethereum, grants validation rights based on the amount of crypto assets held.

In summary, CBDCs are centrally administered by central banks, while crypto assets are managed in a decentralized fashion by participants.

Difference 3: Purpose and Expected Benefits

CBDCs and crypto assets also differ in their intended use and anticipated effects.

CBDCs are expected to provide public benefits, including streamlining payment systems, reducing costs, adapting to digital environments, and combating money laundering. For example, CBDCs can lower cash production and management costs, promote digital payment adoption, and enhance overall convenience in society.

CBDCs may also reinforce currency sovereignty and financial stability. By digitizing their national currencies, governments can maintain competitiveness against foreign and private digital currencies, ensuring financial system stability.

Crypto assets, on the other hand, are valued for enabling free transactions, investment opportunities, and innovation without central intermediaries. They can meet needs unmet by conventional finance, such as cross-border remittances and financial inclusion for the unbanked.

Crypto assets are also primarily investment vehicles for individual profit and are particularly useful for specific applications, such as speeding up international remittances or enabling micropayments.

In summary, CBDCs focus on public interest and financial system stability, while crypto assets emphasize individual freedom and innovative financial services.

Benefits of CBDCs (Central Bank Digital Currencies)

CBDCs have the potential to deliver many benefits to society. Here are three major advantages.

Benefit 1: Cost Reduction

Issuing physical coins and notes is costly. Production requires special paper, metals, printing, and anti-counterfeiting technology—all of which are expensive. Collecting and disposing of old notes and coins also adds to the cost.

Cash circulation requires infrastructure such as registers, ATMs, armored transport, and security systems, which entail ongoing maintenance costs. CBDCs can significantly reduce these physical expenses.

Transaction fees can also be kept lower. Private-sector e-money and credit cards typically charge merchants transaction fees of 2–5%, a burden especially for small businesses.

CBDCs, as public infrastructure, could offer free or extremely low transaction fees, easing burdens for businesses and increasing consumer convenience. If small payments can be made without worrying about fees, digital payment adoption will accelerate.

Benefit 2: Greater Transparency and Fraud Prevention

All CBDC transactions can be digitally recorded, making fraud involving cash less likely. Traditional cash is difficult to trace, which is why it is often used for money laundering, tax evasion, or other crimes.

CBDC transaction histories are traceable, helping authorities prevent and quickly investigate illicit activity. For example, large or suspicious transactions can be rapidly inspected. This enables more effective crime prevention and early detection.

The central bank’s guarantee of currency value also enhances trust. E-money or crypto assets from private companies can lose value if the issuer fails or due to market forces. For example, holders can lose stored value if an e-money issuer goes bankrupt.

In contrast, CBDCs are legal tender with stable value and liquidity, backed by the state, so users can transact confidently. This strengthens trust in the overall financial system.

Benefit 3: Enhanced Payment System Efficiency

CBDCs can greatly improve payment system efficiency, enabling instant digital tax payments and remittances, much faster than traditional bank transfers. Bank transfers are restricted by business hours and days, so weekend or nighttime payments are delayed. With CBDCs, real-time transactions are possible 24/7.

Government disbursements, such as stimulus payments, can also be distributed quickly via CBDCs. For example, during the COVID-19 pandemic, cash payments sometimes took weeks or months to process. CBDCs would allow for instant crediting to recipients’ digital wallets, making emergency support more effective.

CBDCs also enable rapid response during disasters or emergencies. Physical cash can become scarce or inaccessible if banks or ATMs are down, and transporting cash to disaster zones is difficult.

With CBDCs, digital payments can be made without moving physical cash. As long as there’s internet access, payments and remittances can be processed—even in disaster areas. However, developing offline features to ensure continuity during outages remains crucial.

CBDCs could also streamline international remittances. Traditional cross-border payments involve several banks, resulting in delays and high costs. If interoperable CBDCs become widespread, international transfers could be instant and low-cost, supporting global economic growth.

Drawbacks of CBDCs (Central Bank Digital Currencies)

While expectations are high for CBDCs, there are also significant disadvantages and challenges. Here are three major drawbacks.

Drawback 1: Loss of Transaction Anonymity

Although digital transaction records help prevent fraud, CBDCs eliminate cash’s anonymity. Concerns have been raised about privacy, as governments and central banks could monitor transaction flows.

For example, information about individual spending, assets, and counterparties could be collected and analyzed by authorities. This data might be used for tax policy, pricing, or credit scoring.

There are also fears that governments could restrict transactions for political reasons. If authorities oppose certain political activities, they could technically monitor or limit related transactions, raising major issues of individual freedom and human rights.

Cash traditionally offers some anonymity, helping protect privacy. Balancing privacy and fraud prevention is a central challenge in CBDC design.

Some countries are considering “tiered anonymity,” where small transactions remain anonymous but large ones require identity verification. Such mechanisms aim to balance privacy with fraud prevention.

Drawback 2: Disaster-Related Risks

CBDCs are entirely digital, so disasters that disrupt networks could render them unusable. Natural disasters such as earthquakes, typhoons, or floods may damage communications infrastructure, making payments impossible.

Cyberattacks are another risk. If CBDC systems are targeted by major attacks, the entire financial system could be paralyzed. State-level attacks and sophisticated hackers are especially concerning.

Robust offline payment functionality and strong security measures are needed. For example, some countries are developing offline payment features that temporarily store CBDC balances on smartphones or IC cards for use without internet access.

Enhancing redundancy through backup systems and distributed servers is also important. Regular cybersecurity audits and advanced encryption are essential for ongoing protection.

Physical cash, on the other hand, doesn’t depend on electricity or communications and can be used in emergencies. Since CBDCs can’t fully replace these advantages, “hybrid” systems that retain some cash are being considered as realistic solutions.

Drawback 3: Reduced Role for Private Banks

If CBDCs become widespread, deposits at private banks could shrink, reducing available lending capital. This poses a significant risk for the entire financial system.

Traditionally, private banks collect deposits and make loans to businesses and individuals, driving economic growth. But CBDCs would allow users to hold digital currency directly with the central bank, reducing the need for private bank deposits.

If CBDCs are perceived as safer, more convenient, or interest-bearing, people may shift funds away from bank deposits. Private bank deposit balances—and their lending capacity—could fall sharply.

This undermines banks’ profitability, which depends on the margin between deposit and lending rates. Declining deposits could destabilize banks and threaten financial system stability.

There’s also concern that loans to small businesses and individuals could decrease, especially for those with lower credit ratings, potentially slowing economic activity.

To mitigate these issues, many central banks are considering holding limits and not paying interest on CBDCs. Models where private banks distribute CBDCs (“two-tier” systems) are also being explored to preserve the role of intermediaries.

Japan’s CBDC (Central Bank Digital Currency) Initiatives

In the early 2020s, the Bank of Japan released its “Policy on Central Bank Digital Currency Initiatives.” Since then, the Bank has begun pilot experiments and is gradually advancing research and development.

Japan’s central bank is conducting phased experiments, with the first phase focused on verifying basic functions and performance—including issuance, circulation, redemption, transaction speed, and system durability.

The second phase is testing more advanced features such as offline payments, holding limits, and interest mechanisms. Research is also underway into collaboration with private companies and interoperability with existing payment systems.

The Bank of Japan is gathering perspectives from private industry and academia to inform CBDC design and operations. International cooperation is also a priority, with active information sharing and joint research with other central banks and organizations.

Japan expects several benefits from CBDC research and development.

First, there is the potential to reduce costs and fees associated with cash transactions. Japan’s high cash usage leads to substantial production and management expenses. CBDCs could cut these costs and improve overall efficiency.

Second, CBDCs offer enhanced crime prevention against money laundering and tax evasion. Greater transaction transparency facilitates detection and prevention of illicit activity.

CBDCs also support building payment systems suited to a digital society. As cashless payment adoption increases, CBDCs can serve as public infrastructure and reinforce the digital economy’s foundation.

Additionally, international payments and remittances could become much smoother. If multiple countries introduce interoperable CBDCs, cross-border transaction costs and settlement times could be greatly reduced.

In summary, Japan is steadily advancing CBDC research and development, considering potential future issuance. Unlike cash or e-money, CBDCs are digital currencies guaranteed by the state. As CBDCs offer various benefits, domestic developments continue to attract attention. However, privacy protection and impacts on the financial system remain key challenges, and implementation is likely to require careful deliberation and time.

FAQ

What Is a CBDC (Central Bank Digital Currency)? How Is It Different from Regular Digital Payments?

A CBDC is a digital form of legal tender issued by the central bank. Unlike conventional digital payment services, a CBDC is an official currency directly managed and issued by the government, offering guaranteed value and credit. In contrast, ordinary digital payments are simply intermediary services provided by private companies, while CBDCs offer greater security and legal authority.

What Are the Fundamental Differences Between CBDCs and Cryptocurrencies Like Bitcoin and Ethereum?

CBDCs are government-issued digital currencies, strictly for payment purposes, subject to regulation, and maintain stable value. Cryptocurrencies like Bitcoin are decentralized, unregulated, used for both speculation and payments, and are highly volatile.

Why Are Central Banks Around the World Developing CBDCs? What Advantages Do CBDCs Offer?

Central banks are developing CBDCs to respond to the growth of digital payments. Benefits include greater payment efficiency, lower transaction costs, government-backed security, and the preservation of the central bank’s leading role in the financial system.

Will CBDCs Replace Cash and Electronic Payments?

CBDCs are intended to supplement existing payment systems, not completely replace cash or electronic payments. Multiple payment options are expected to coexist.

Are CBDCs Safe? What About Privacy?

CBDCs are fundamentally secure due to encryption technology, but privacy risks do exist. Central banks can monitor transactions, so balancing data protection and transparency is essential. Regulatory enhancements are underway to address these issues.

Is China’s Digital Yuan (e-CNY) a CBDC? What Is Its Current Status?

Yes, the e-CNY is a CBDC. It is currently in a pilot phase and being introduced in stages. Pilot programs in several cities support both retail and corporate payments, and further adoption is expected.

How Can Ordinary People Use CBDCs? Do They Need a Special Account?

Ordinary users do not need a special account to use CBDCs. Usage is similar to digital cash. CBDCs are issued by the central bank and can be accessed directly via digital wallets, making them as convenient as cash.

How Will CBDCs Affect the Financial System and the Economy?

CBDCs can improve payment efficiency, reduce transaction costs, and enhance financial stability. However, they also pose risks such as reduced financial intermediation and privacy concerns. Careful, incremental implementation and thoughtful design will be essential for harmonizing CBDCs with the existing system.