St. Louis Fed
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St. Louis Fed

Central Bank Digital Currencies: Back to the Future

By Amalia Estenssoro


  • Monetary authorities are researching central bank digital currencies (CBDCs), which could make payment and settlement systems more efficient.
  • Once issued, CBDCs will be a third type of central bank liability, along with cash and reserves.
  • China is an example of a country where the central bank has taken the lead in testing a CBDC that could be available as early as next year.
Getty Images/KeremYucel

In the digital age, monetary authorities are researching CBDC as a new form of money that can greatly increase the efficiency of future payment and settlement systems in domestic and international financial markets.

A CBDC is defined as another form of public money. Together with cash and bank reserves, when issued in the future, a CBDC will become the third type of central bank liability.¹ A brief recounting of how new technologies have brought about different forms of sovereign money — from metal-based to fiat — and their interactions with private money precursor technologies, such as promissory notes, can shed light on current innovations taking place in some jurisdictions, such as China’s digital payment flurry.

The Evolution of Money over Time

Among the most ancient money technologies, coins were introduced in the fifth and sixth centuries B.C. Their intrinsic value was linked to different precious metals used in their production. Empires throughout history projected power by not debasing their sovereign coins — or public money — with lesser materials.

Another long-standing money technology is promissory notes, used in early dynastic China, Carthage and Rome. These were known as private money to facilitate trade. However, it took the 13th century travels of Marco Polo to bring the bank note concept to Europe, and only by the 17th century in Sweden did this new private money technology become widely acceptable as a means of payment when issued by a chartered bank.

However, the privately issued bank note innovation led to the failure of the issuing bank in Sweden and the creation of the first central bank.²

Also in the 17th century, a public bank first issued wholesale deposits backed by coins. This technology eventually developed properties of public fiat money, transforming the Bank of Amsterdam into the first proto-central bank performing the public policy role of a liquidity provider and lender of last resort.

The issuance of wholesale deposits led to the failure of the Bank of Amsterdam, which lacked fiscal backing.³ Yet this experiment of a deposit liability backed by safe assets and convertible to cash 1:1 on demand resembles today’s rigid stablecoin technology. In this context, digital private currency innovations are no different from innovations in the 17th century, and a new form of public money, CBDC, could turn out to be a significant and more efficient monetary innovation than digital private money.

Public vs. Private Money

Public and private money evolved significantly in the 20th century. Public money was freed from any link to an intrinsic value based on precious metals,⁴ while notes and coins set the unit of account for fiat money, which has legal tender status. This allowed cash to discharge any type of legal debt.

Wholesale public money (or reserves, the safest high-quality digital asset exclusively held by depository institutions) is not considered legal tender due to its restrictive use. Likewise, private money has evolved as bank notes gave way to deposits — or bank money — as a widely acceptable medium of exchange, given banks’ regulation and supervision, as well as their deposit insurance.⁵

The coexistence of public and private money has led to two-tier payment system rails, which use bank payment tools for retail transactions and reserves for interbank wholesale settlements. This is a continuum of private and public money that oils economic activity. The share of each type of money depends on historical preferences and regulations in each jurisdiction. There are important elements to preserve, such as central bank public goods — finality of payment and monetary stability — and the innovations frequently introduced by the private sector within this well-established, regulated and safe dual system as it continues adapting to the digital age.

CBDC Technology Design Choices, Trade-offs

This brief retrospective shows how private innovation leads to public innovation, which brings us to CBDC and its technological capabilities.⁶

Depending on its design, a CBDC could be a substitute for cash for the first time in history and could directly compete with bank deposits, though central banks worldwide are adamant these are not their intentions.

Each feature, or technological detail, has important, implicit trade-offs that require specific policy decisions. For instance, a CBDC can be designed as an account-based, centralized ledger resembling a bank account — with crime prevention features — or as a token-based, anonymous transactional tool. The degree of privacy designed into a CBDC, which will vary according to jurisdiction, will determine the wider acceptability of a CBDC as a means of payment.

A CBDC can also be wholesale or retail, with the latter adding immediate settlement capabilities for retail payments. Therefore, policymakers can choose to expand real-time gross settlement bank rails in the current two-tier payment systems — making a wholesale CBDC almost redundant — or move directly into an alternative two-tier system running on retail CBDC payment rails using distributed ledger technology, most likely permissioned to banks and other intermediaries.

Current CBDC research focuses on retail CBDC as a preferred medium of exchange to be used in the future by private wallet apps such as Apple Pay and Google Pay. The alternative, wider transactional acceptability of unregulated stablecoins could concentrate financial risk in nonregulated, nonbank tech companies, and ultimately affect monetary and financial stability if there is a run on them.

The new technology behind private wallet apps is a convenient, peer-to-peer, user-friendly tool. Digital payments create digital balances, carried in electronic form and recorded in an intermediary tech company’s balance sheet, as opposed to a bank’s. Nonetheless, digital transactions today almost always settle in the two-tier (bank) payment rails that deliver finality of payment on the central bank books.

The reluctance to dismantle jurisdiction-specific two-tier bank payment systems rests on the need to minimize fraud and crime and to promote financial stability in the economy at large. This is the case despite the new technology capability that could, in theory, bypass banks and central banks, if widely accepted by the public. Such a development most likely would lead to bank-type regulation being applied to tech innovators.

Fast Payment System vs. CBDC

Central banks have taken full advantage of new technology efficiency gains in the past, and digital payments innovation can lower transaction costs, reach unbanked populations and unleash important global economic gains. The digitalization of money — and the pace of innovation — will be a function of each jurisdiction’s legacy systems and their capacity to adapt.

Central banks have a role to play as catalysts for change by choosing one or a combination of options:

  • Making existing payment systems faster and more efficient data transmitters
  • Giving nonbank technology innovators access to wholesale public money
  • Or even creating a new central bank liability in the form of a retail CBDC

Different central banks will choose differently.

So far in the U.S., digital progress is gradually being introduced in the payment system as nonbank digital companies acquire bank charters or partner with existing banks to provide digital payment capabilities to end users. In 2023, the Federal Reserve is slated to launch FedNow, a retail instant payment system that will allow more dynamic digital service competition in the marketplace, while updating the existing two-tier bank payment system for 24/7 clearing and settlement.

Updated real-time payment systems are the obvious steppingstone before any major advanced economy’s central bank decides to issue a CBDC, because central banks have yet to fully understand the monetary and credit implications of digital money.

Payment Digitalization in China

This gradual approach contrasts with China’s digital explosion, where the accumulation of digital private balances occurred unobstructed by the central bank until widespread usage posed potential systemic risk to China’s financial sector.

Chinese private mobile payments began back in 2004, when the Alipay wallet app was introduced at Taobao e-commerce websites owned by Alibaba. By 2012, total nonbank wallet apps handled $20.6 billion in transactions. By 2019, total Chinese mobile transactions amounted to $35 trillion for more than 1.2 billion users, mostly in mainland China. Other financial services, such as a money market mutual fund, were offered to consumers by digital platforms and one, Yu’e Bao, soon became the largest in the world, depleting bank deposits.

By 2017, Chinese regulators began demanding that wallet balances — private digital liabilities of tech companies — be deposited at the central bank. Since 2019, end users’ account balances have attained 100% reserve backing and are fully regulated. Also, new directives enacted in January are already putting limits on digital platforms’ overall market share, particularly their credit creation ability in the Chinese economy.

The Chinese central bank, however, wants to go further and launch its own CBDC by 2022–23. Since 2020, Chinese authorities have been live-testing in several mainland cities the Digital Currency Electronic Payment (DCEP), or e-CNY (digital yuan), a retail-hybrid CBDC.⁷ This public infrastructure in the form of CBDC for the first time will allow the Chinese banking system to compete with digital platforms that benefited from “first mover advantage” networking gains in the financial sector while they were unregulated.⁸

Systemic risk will also be curtailed by reducing digital concentration and convertibility risks on digital tech platform balance sheets. Of course, the e-CNY will have to compete with tech companies and private banks to attract customers’ balances, but public money has always been preferred to private money. Therefore, the risk is that the CBDC ends up hampering the role of credit intermediaries in the economy, particularly at times of stress. That is why Chinese authorities are planning to limit the CBDC balances individuals can hold.

CBDCs Only Beginning to Be Understood

There is also the international dimension to CBDCs, as most countries perceive the new technology as a future avenue for a better cross-border payment system. Some see it as an opportunity to stimulate international transactions in their own currencies, while others see substitution risk to their sovereign currencies. However, Federal Reserve Chairman Jerome Powell has made clear that the U.S. has no intention of rushing into a CBDC launch, because there are many aspects to consider, not least the role of the dollar as the global reserve currency.

In October 2020, seven of the world’s most powerful central banks and the Bank for International Settlements in Switzerland published their first report on CBDC. In it, they stated their common motivation for exploring a new digital means of payment for a more diverse and inclusive domestic payment system, while aspiring to future global “interoperability” among sovereign CBDCs.

Therefore, the major central banks’ concerns are about stability and sovereignty — in the domestic and international arenas — and much research remains to understand how CBDCs will address these. However, the decision to launch a CBDC will likely be made based on each jurisdiction’s unique considerations, especially the potential for disturbing the equilibrium in demand for cash, bank deposits and credit creation in the economy.


  1. Cash is a central bank liability that pays no interest. Reserves are balances that banks keep at the central bank. While they are assets of individual banks, reserves are a liability for the central bank, which pays interest on them as a policy lever in the current floor system.
  2. In 1656, a royal charter was bestowed on the first Swedish bank, Stockholms Banco, which issued and guaranteed bank notes convertible into copper “tablets” on demand. However, overissuance led to the bank’s eventual failure. By 1668, private bank notes were outlawed, and the Bank of the Estates of the Realm, Sveriges Riksbank, was established as the first central bank.
  3. In 1609, the Bank of Amsterdam, owned by the city of Amsterdam, was created as a public bank. Its wholesale deposits were backed by silver and gold coins and convertible on demand. After 170 years and following the severe economic shock of the 1780–84 Anglo-Dutch War, the bank suffered runs and collapsed in 1820 because of lack of full fiscal backing by the sovereign, giving way to a modern central bank, De Nederlandsche Bank.
  4. The last vestige of any gold link was recreated with the Bretton Woods dollar-gold peg, a system that guided global exchange rates from 1958 to 1971. Its demise started the “freely floating” fiat money era and consolidated the dollar as the main reserve currency.
  5. Because bank deposits are not fully backed by reserves, the fractional reserve system allows banks to issue credit in the economy, which could lead to bank failures. Regulation and insurance were put in place to maintain the public confidence that bank deposits will always be convertible to cash 1:1 on demand, up to a statutory limit (in the U.S., the Federal Deposit Insurance Corp. guarantees up to $250,000 per account).
  6. CBDC technology brings finality of payment to settle transactions and is able to embed code with programmable functionality.
  7. A hybrid CBDC is managed through the banking system that deals with the end-user accounts, but their balances are a liability of the central bank (public money) instead of a liability of the bank (private money).
  8. Alipay has 54% of the mobile payment market share in China, while TenPay (a combination of WeChat Pay and QQ Wallet) has 39%. Combined, they represent 93% of the Chinese mobile market.

Amalia Estenssoro is a senior economist at the Federal Reserve Bank of St. Louis.

Originally published at



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