What Is a CBDC (Central Bank Digital Currency)? An In-Depth Comparison with Cryptocurrency

What Is a CBDC (Central Bank Digital Currency)?

Many people associate the term "digital currency" with major cryptocurrencies. However, in recent years, another type of digital currency has emerged as a focal point—quite different from cryptocurrencies. This is the CBDC (Central Bank Digital Currency).

A CBDC is a digital version of legal tender issued by a country's central bank. Legal tender is money designated by law as official currency, such as the yen or the dollar. Because CBDCs are issued as central bank liabilities, their value is guaranteed by the state, resulting in minimal price volatility.

CBDCs possess the same compulsory acceptance as cash and are expected to enhance payment system efficiency, reduce operational costs, and support anti-crime initiatives. Unlike cash or bank deposits, CBDCs represent a new form of electronic money and are anticipated to become a key payment method in a digital society.

Countries like China, Sweden, and the Bahamas have actively pursued CBDC adoption, conducting pilot programs and launching official implementations to drive financial system innovation. Japan is also investigating the practical use of CBDCs.

However, introducing CBDCs raises a range of issues—including potential impacts on commercial banks and existing financial infrastructure, privacy protection, and technical challenges. As a result, most central banks are moving forward cautiously with phased research and development.

CBDCs vs. Cryptocurrencies: Issuer and Legal Status

The biggest differences between CBDCs and cryptocurrencies are their issuing authority and legal status. Understanding these factors highlights the fundamental nature of each.

CBDCs are digital legal tender issued by central banks, which function as state institutions. As legal tender, CBDCs enjoy the same mandatory acceptance as cash, meaning merchants and service providers are legally required to accept CBDC payments.

Importantly, because CBDCs are guaranteed by the state, they are far less susceptible to price swings. One CBDC unit always equals one unit of its underlying currency. Although exchange rates may change, the core value of the currency remains stable—a crucial factor for everyday payments.

By contrast, cryptocurrencies are digital currencies issued by private organizations or individuals. Cryptocurrencies lack legal tender status, and acceptance is up to each individual or business. Refusing payment in cryptocurrency does not create any legal issues.

Cryptocurrency prices also fluctuate rapidly based on supply and demand, resulting in high volatility. Prices can soar or plummet in short timeframes. While this attracts investors, it makes cryptocurrencies unreliable for daily transactions.

CBDCs vs. Cryptocurrencies: Technical Architecture

Both CBDCs and cryptocurrencies leverage digital technology, but their technical frameworks differ significantly.

CBDCs are often built on Distributed Ledger Technology (DLT). Distributed Ledger Technology allows network participants to manage and share the same ledger, providing transparency and resistance to tampering. Blockchain is a leading example of DLT, and many CBDC projects are considering its use.

Because central banks oversee CBDCs, most implementations adopt a hybrid model that incorporates centralized elements, rather than being fully decentralized. This delivers faster transaction approvals and improved system stability.

Cryptocurrencies also utilize distributed ledger technology for issuance and management. Their defining feature is that participants reach consensus independently, without central authorities. This requires consensus algorithms.

Consensus algorithms include models such as Proof of Work (PoW) and Proof of Stake (PoS). Proof of Work relies on computational power to validate transactions—highly secure, but energy-intensive. Proof of Stake assigns validation rights based on token holdings, delivering greater energy efficiency.

In essence, CBDCs seek efficient systems managed by central banks, while cryptocurrencies pursue fully decentralized, autonomous networks—reflecting distinct technological philosophies.

CBDCs vs. Cryptocurrencies: Use Cases and Anticipated Impact

CBDCs and cryptocurrencies differ substantially in their intended use and expected effects.

CBDCs are public-purpose digital currencies. Their primary goals include streamlining payment systems, reducing costs, adapting to digital environments, and preventing money laundering. CBDCs operate as national financial infrastructure, aiming to enhance convenience for all citizens.

CBDCs may also help maintain currency sovereignty and support financial stability. As societies become more digital, issuing a national digital currency can help preserve monetary sovereignty and stabilize the financial system. CBDCs are also expected to accelerate the adoption of cashless payments and improve economic efficiency.

Cryptocurrencies, in contrast, offer benefits such as independent transactions, investment opportunities, and innovation without reliance on central authorities. They are primarily financial assets for individual profit, making their investment function predominant.

Cryptocurrencies also show promise for international transfers and micropayments. Traditional banks can be slow and expensive for cross-border payments, but cryptocurrencies may offer solutions. They're also well-suited for small transactions, such as online content purchases.

In summary, CBDCs serve as public financial infrastructure, whereas cryptocurrencies primarily enable individual economic freedom.

CBDC Advantages: Lower Costs

Issuing coins and banknotes incurs significant costs—from production and disposal to installing and maintaining registers and ATMs, and securing cash transportation. CBDCs could dramatically reduce these physical expenses.

CBDCs eliminate costs for printing or minting, collecting and disposing of worn currency, and developing anti-counterfeiting technologies. Security and insurance costs for storing and transporting cash may also decrease.

Additionally, payment processing fees could be reduced. Private electronic money systems typically charge merchants 2–5% per transaction. As a public resource, CBDCs could offer free or minimal transaction fees.

This is especially advantageous for small businesses. Lower payment fees improve profitability and can result in lower prices for consumers. Minimal fees will also support broader CBDC adoption.

CBDC Advantages: Greater Transparency and Fraud Prevention

CBDCs can record every transaction, making cash-based fraud much harder to perpetrate. The anonymity of cash makes it difficult to track illicit acts like money laundering or tax evasion, which criminal organizations and tax evaders can exploit.

With CBDCs, every transaction is digitally documented and traceable. This facilitates the detection and prevention of money laundering and tax evasion. Tax authorities and law enforcement can analyze transaction records to track illegal fund flows.

Transparency must go hand in hand with privacy protection. Routine transaction data should not be excessively monitored, so privacy-focused design is crucial. Many CBDC projects are considering mechanisms that preserve anonymity for small payments while requiring identity verification for large ones.

Central bank guarantees also bolster user trust. Privately issued electronic money and cryptocurrencies can fluctuate in value depending on issuer credibility and market dynamics, but CBDCs—being legal tender—offer superior stability and liquidity. CBDC users can rely on a fixed value, supporting widespread adoption as a payment method.

CBDC Advantages: Faster, More Efficient Payment Systems

CBDCs streamline payment systems and enable rapid digital payments for taxes and transfers. While traditional banking systems may take days for transfers, CBDCs allow near-instant transactions.

For example, emergency government benefits could be delivered quickly using CBDCs. Conventional methods might take weeks or months from application to payment, but CBDCs enable immediate transfers to digital wallets upon approval. This is especially effective for emergency relief.

CBDCs also facilitate quick responses during disasters or emergencies. Cash can be scarce or difficult to transport in affected regions, and ATMs or armored vehicles may be inaccessible.

With CBDCs, payments and transfers can be executed digitally, bypassing physical barriers. As long as digital devices are available, even disaster areas can process payments, accelerating recovery efforts.

CBDCs are also expected to boost cross-border payment efficiency. If multiple countries introduce interoperable CBDCs, international remittance costs and processing times could fall sharply—an important benefit for global economic growth.

CBDC Drawbacks: Privacy Issues

CBDCs record all transactions, which helps prevent fraud but erodes the anonymity that cash provides. Central banks and governments can track transaction flows, raising concerns about privacy.

Governments or businesses could analyze personal spending and asset data for purposes such as tax policy, pricing, or marketing. Information on purchases and income could be analyzed or used without the individual's knowledge.

To address these concerns, many CBDC projects are developing privacy protection mechanisms. These may include tiered systems that preserve anonymity for small transactions but require identity verification for large ones, or cryptographic techniques that protect transaction details while enabling fraud detection.

Balancing privacy and fraud prevention is one of the most crucial CBDC design challenges. Excessive surveillance risks violating individual freedoms, while total anonymity can foster criminal activity. Achieving a suitable balance requires broad social consensus.

CBDC Drawbacks: Technical Risks and System Dependence

CBDCs are digital, so disasters or network disruptions could cause system outages. Major blackouts or communication failures can temporarily halt CBDC-based payments.

Cyberattacks are another concern. If a CBDC system is compromised, widespread payment failures or asset losses can occur. As national financial infrastructure, CBDCs are prime targets for cybercriminals and terrorists, demanding robust security measures.

Offline transaction solutions and strong security foundations are essential. Technologies like smart cards or dedicated devices could enable limited offline transactions. Multi-layered security frameworks and quantum encryption are also under consideration.

Cash isn't dependent on electricity or connectivity, so it's usable during disasters. As CBDCs proliferate, cash's advantages may be lost, making emergency backup systems essential.

CBDC Drawbacks: Impact on Financial Systems

If CBDCs become common, commercial bank deposits could drop, reducing funds for loans. Commercial banks lend from deposits, acting as financial intermediaries, but CBDCs allow direct access to digital currency from central banks—diminishing the role of commercial banks.

If people move funds from bank deposits to CBDCs, bank balances shrink, limiting lending for businesses and mortgages. This cuts into commercial banks' revenue streams and could threaten overall financial stability.

Financial crises could see mass digital withdrawals from banks to CBDCs—so-called "digital bank runs." Traditional bank runs are limited by branch access, but digital bank runs allow instantaneous, large-scale transfers, accelerating system instability.

To counter these risks, many central banks are considering measures such as capping CBDC holdings or designing CBDCs without interest—minimizing their impact on commercial banks. By positioning CBDCs as a cash alternative instead of a major asset vehicle, stability can be maintained.

Japan's Approach to CBDCs

In recent years, the Bank of Japan has advanced CBDC research and development. It conducts staged pilot programs to evaluate technical feasibility and potential impacts on the financial system.

The Bank of Japan's research proceeds in phases. The first stage tested basic functions and performance—such as issuance, transfer, and redemption.

The second stage verifies more advanced functions, including offline payments and system resilience under transaction surges. Collaboration with private businesses and interoperability with existing payment systems are also under study.

Japan's potential CBDC benefits include:

• Reducing the costs of cash transactions and payment fees
• Strengthening measures against money laundering and tax evasion
• Building payment systems suited to a digital society
• Facilitating smoother international payments and transfers

With an aging population, Japan must build efficient social systems using digital technology, and CBDCs could play a vital role in this transformation.

However, the Bank of Japan takes a cautious stance on CBDC issuance, considering impacts on commercial banks, privacy protection, and technical issues. The Bank states: "We have no current plans to issue a CBDC, but it is essential to prepare thoroughly to ensure the overall stability and efficiency of payment systems and to respond effectively to future changes."

Japan will continue to monitor domestic and global CBDC trends, pursuing research and development to identify the most suitable approach.

FAQ

What is a CBDC (Central Bank Digital Currency), and how does it differ from traditional legal tender?

A CBDC is a digital legal tender issued by the central bank. Unlike traditional currency, it is a direct digital liability of the central bank and serves as a digital version of cash, accessible 24/7.

What are the key differences between CBDCs and cryptocurrencies like Bitcoin?

CBDCs are state-backed digital currencies issued and managed by central banks. Cryptocurrencies such as Bitcoin are decentralized and do not rely on central authorities. CBDCs offer stable value, while Bitcoin is highly volatile and typically speculative.

What benefits do CBDCs offer to the public?

CBDCs provide a secure, highly convenient digital payment option available anytime, anywhere. As government-backed currency, they carry no credit risk and enable instant settlement. They also improve access to financial services and support a wide range of everyday and online transactions.

What privacy and security risks could arise with CBDC adoption?

CBDCs face security risks such as cyberattacks and data breaches. Privacy concerns include potential government monitoring or excessive personal data collection. These risks can be greatly reduced through advanced encryption, data minimization, and robust data protection regulations.

Which countries are developing or implementing CBDCs?

Over 130 countries—including China, Switzerland, the United States, the United Kingdom, and Japan—are advancing CBDC development or implementation. China's digital yuan is already in pilot use, and other nations are actively researching CBDCs.

How could CBDC implementation affect financial systems and daily life?

CBDCs will streamline and accelerate payments, expand financial access, and increase economic transparency. Individuals will find asset management easier, and central banks will be able to execute policy directly.