With the explosion of the cryptocurrency market and the prospects of a privately issued digital currency gaining traction globally, central banks around the world are scrambling to issue digital versions of their own currencies.

As many as 86% of central banks are currently researching the potential for issuing a central bank digital currency (CBDC), according to a 2021 study published by the Bank for International Settlements. Some 60% are already experimenting with the technology and a further 14% are deploying pilot programs.

“A lot of this is driven by what’s going on in the crypto world,” says Frances Coppola, an independent economist, blogger, and author. “Governments first really started to think about central bank digital currencies after Facebook proposed to set up a global digital currency. They clearly saw it as a threat to their existing payment systems and thought, ‘we’ve got to respond to this’.”

Facebook project stalled

Since then, Facebook’s crypto project has stalled. What had been proposed as a global currency that would be backed by a basket of reserve assets, first known as Libra and later renamed Diem, was watered down to a US-only coin amid intense regulatory scrutiny after many of its initial partners quit the project. That launch never happened and, in January 2022, Diem was said to be winding down and exploring a sale of its assets. Facebook’s parent company Meta is now eyeing the potential for a virtual currency that can be used in the metaverse – a long way off its original plan, says Coppola.

“Now the bandwagon seems to have started for central bank digital currencies, everybody’s looking at them. But the threat now is not from the cryptocurrency world so much as from other central banks,” she says. “If one major central bank adopts a digital currency, others worry they will lose out, so now they are all competing with each other.”

The stage of development – and the approaches being taken – vary across the world. China has already launched a pilot for its digital currency, the e-CNY, which has been rolled out in 10 provinces and was adopted at Olympic venues in Beijing and Zhangjiakou during this year’s Winter Olympics. China is also working with the Bank for International Settlements (BIS), the Hong Kong Monetary Authority, the Bank of Thailand, and the UAE’s central bank on the mBRIDGE project, a proposal to develop an interoperable wholesale CBDC for cross-border transactions.

Part of China’s motivation to issue a CBDC is the huge adoption of digital payments in the country through Alipay and We Chat Pay, says Ashley Ebersole, a partner at Bryan Cave Leighton Paisner.

“The Chinese government is one that has traditionally wanted greater information on these types of transactions and so, from their perspective, it likely makes sense to develop a government-sponsored option.”

Ashley Ebersole, partner, Bryan Cave Leighton Paisner

“The Chinese government is one that has traditionally wanted greater information on these types of transactions and so, from their perspective, it likely makes sense to develop a government-sponsored option that could take some of the volume that is currently going to the private providers,” he says.

In the US, Joe Biden issued an Executive Order in March calling for a sweeping government-wide review of digital assets, which also included urgently researching the potential for issuing a CBDC. Separately, the Boston Federal Reserve is already working with the Massachusetts Institute of Technology on Project Hamilton, which is testing the technical aspects of creating a CBDC system that would operate at scale, says Ebersole.

A number of countries in developing markets are also exploring the potential for adopting digital currencies. In 2021 El Salvador passed a law to make Bitcoin legal tender in the country, while Nigeria issued its own digital currency, the e-Naira, in part to boost financial inclusion. Other central banks in Africa are also considering issuing digital currencies, including Ghana, Egypt, South Africa, and Madagascar, says Anthony Oduwole, Chief Technology Officer and co-founder of Nigerian fintech Verto.

The challenges of CBDCs

While many emerging market economies hope that issuing CBDCs will help to improve access to financial services, there could be challenges in countries with limited internet and smartphone penetration, says Oduwole.

“If someone is on a farm somewhere in, say, Madagascar and doesn’t have a smartphone, you can’t financially include them even with a CBDC, so the problem that needs solving first is getting them access to better technology,” he says.

While the broader growth in crypto markets is underpinning central bank interest in digital currencies, none of the CBDCs being proposed are similar to existing cryptocurrencies such as Bitcoin.

“Bitcoin is open, permissionless, and decentralized, meaning virtually anybody who’s interested can spin up the software and begin to interact with the network,” says Matt Kohen, co-chair of Carlton Fields’ digital currency practice. “So far, central bank digital currencies have not been discussed as being open and permissionless.”

“Every government has different motivations, but the ability to surveil and control currency better than with paper money, that’s perhaps an unstated goal of many sovereigns out there.”

Matt Kohen, co-chair, Carlton Fields’ digital currency practice

While CBDCs could help to improve inefficiencies in existing payment systems, the ability for governments to monitor what people are doing with their money is likely to be a strong incentive for issuing digital currencies.

“Every government has different motivations, but the ability to surveil and control currency better than with paper money, that’s perhaps an unstated goal of many sovereigns out there,” says Kohen.

Those snooping powers could be used to tackle money laundering or prevent the financing of illicit activities, but it could also enable authoritarian governments to stifle dissent or otherwise deny people access to finance.

“That means that, for users of CBDCs, there’s going to be certain benefits in some areas and trade-offs in others, and privacy and surveillance-related concerns are going to be a major drawback,” says Kohen.

The benefits of CBDCs

The benefits for consumers will likely be felt most in countries that don’t already have the ability to execute fast, digital payments. While that includes many developing economies, it also includes the US, which has notoriously clunky payments rails compared to other developed countries like the UK and other parts of Europe.

“A lot of the drivers for cryptocurrency and now for central bank digital currencies have actually come from America, which is considerably behind the curve as far as advanced countries go in digital payments,” says Coppola.

One reason consumers might be interested in adopting CBDCs is because a claim on the central bank is the safest and, in theory, comes with an unlimited guarantee, says Coppola. Most deposit insurance schemes, by contrast, have a limit – €100,000 in the EU and £85,000 in the UK.

“The counter to that is that central banks have been looking at imposing limits on the amount of money you can hold in a central bank deposit account if they had such a thing,” she says. “Some of the proposed limits have been really low because there appears to be a dreadful worry that CBDCs would disintermediate banks.”

Companies, however, could be enticed into using CBDCs if they remove friction and risk from cross-border payments, helping them to export into new markets.

“If a CBDC is operational to an extent that it is accepted in multiple jurisdictions, or at least can be paired against another CBDC, that would be a good advantage because if you can remove the FX risk from cross-border transactions, it becomes much more scalable to build your business around it,” says Oduwole.

Just how motivated people will be to use CBDCs over their traditional fiat currency or crypto alternatives such as Bitcoin will likely hinge on people’s trust in their governments.

“If people are highly suspicious that their government is trying to get eyeballs on their financial transactions, and that places them at risk, you would probably get less adoption,” says Ebersole.

Ultimately, some people might not have a say in whether a government adopts a CBDC.

“Governments have the luxury where they can just flip the switch and folks are forced to comply,” says Kohen. “They can just say, ‘If you don’t adopt this, you’re cut off from the financial system’.”