Too embarrassed to ask: what is a central bank digital currency?

Governments around the world are considering creating their own digital currencies. But what are they and how do they compare to cryptocurrencies such as bitcoin?

Cryptocurrencies such as bitcoin and ethereum have divided investor opinion. Some people think that they represent the future of money and a huge technological advance. Others think that the whole thing is a scam, a bubble, or just hopelessly idealistic. 

But one thing is clear: governments are increasingly keen on the possibilities that might arise from issuing fully-digital currencies themselves. Hence the growing interest in central bank digital currencies, or CBDCs for short. 

A CBDC is simply a government-backed digital currency. A digital pound – or “Britcoin”, as it’s been nicknamed – would be similar to the paper pound, in that the central bank would control its issuance. 

This is perhaps the most important difference between CBDCs and cryptocurrencies. Cryptocurrencies are decentralised. The whole point of bitcoin is that it represents a form of money that cannot be created at will by a government or a central bank. Instead it derives its value from a network of freely-participating individuals. 

There are some benefits to CBDCs. In theory they should cut down on transaction costs. And in developing markets in particular, they should make it easier for everyone to get a bank account. 

However, there are also some serious disadvantages. Bitcoin is anonymous, but transactions made using CBDCs would be easily tracked by the authorities. This gives rise to privacy concerns.

CBDCs might also replace cash altogether. That would make it easier for central banks to impose policies – such as negative interest rates – that effectively operate as a tax on savers. So the next time the economy is deemed to require monetary stimulus, the central bank could effectively force people to go out and spend their money.  

This might sound like something from a dystopian science-fiction novel, but most governments around the world are now working on CBDCs. The Bahamas already has the “sand dollar” which was launched last year. Among major economies, trials of a digital yuan are well advanced in China. And in the UK, the Bank of England and the Treasury are now looking into the idea of “Britcoin”. 

So even if cryptocurrencies aren’t the future of money, there’s a good chance that they’ve helped to bring forward the end of cash.

To find out more about the monetary system and central banks in general, subscribe to MoneyWeek magazine.

Recommended

Whether it’s cryptocurrencies or investment trusts, make sure you know what you’re investing in
Investment strategy

Whether it’s cryptocurrencies or investment trusts, make sure you know what you’re investing in

Many people scoff at cryptocurrency speculators pouring money into an asset they may barely understand. But the same could be said of investors in man…
26 Jan 2022
How to invest in energy and metals as tech stocks crash
Commodities

How to invest in energy and metals as tech stocks crash

It’s been a terrible week for stockmarkets. But not everything is crashing – “real” assets such as metals and energy are holding up well and should ha…
26 Jan 2022
Shareholder capitalism: the world’s most powerful asset manager wants you to have your say
ESG investing

Shareholder capitalism: the world’s most powerful asset manager wants you to have your say

Under shareholder capitalism, the owners of the companies the big fund managers invest in are us – yet our voice is rarely heard. Now one asset manage…
26 Jan 2022
Julian Brigden: markets are at a huge inflexion point
Investment strategy

Julian Brigden: markets are at a huge inflexion point

Merryn talks to Julian Brigden of Macro Intelligence 2 Partners about the unwinding of the US stockmarket's super-bubble, and the risks and opportunit…
25 Jan 2022

Most Popular

Shareholder capitalism: why we must return power to listed companies’ ultimate owners
Investment strategy

Shareholder capitalism: why we must return power to listed companies’ ultimate owners

Under our system of shareholder capitalism it's not fund managers, it‘s the individual investors – the company's ultimate owners – who should be telli…
24 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022
Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022