What central banks do, how money actually moves, and why CBDCs could reshape the financial system.
Before understanding CBDCs, you need to understand the institution that would issue them. Central banks are often described as "printing money" or "setting interest rates," but their actual role is more specific and more consequential than either phrase suggests.
A central bank is the sole institution authorized to issue a nation's base money: the foundational layer of currency on which everything else rests. In the United States, that institution is the Federal Reserve System (the Fed). The European Central Bank (ECB) serves the eurozone. The People's Bank of China (PBOC) serves China. Every major economy has one.
1. Monetary policy. The Fed's primary mandate is to promote maximum employment and stable prices (low, predictable inflation). It does this mainly by setting the federal funds rate, the interest rate at which banks lend reserves to each other overnight. When the Fed raises this rate, borrowing becomes more expensive throughout the economy, which slows spending and reduces inflationary pressure. When it lowers the rate, borrowing becomes cheaper, encouraging spending and investment. This single rate cascades through the entire financial system: mortgage rates, corporate bond yields, auto loan pricing, and savings account returns all move in response.
2. Financial system stability. The Fed acts as a lender of last resort. When banks face sudden withdrawals and cannot borrow from each other, the Fed lends to them directly through the "discount window," preventing bank runs from cascading into systemic collapse. This function was critical during the 2008 financial crisis and again during the March 2020 COVID liquidity crunch.
3. Payment system operation. The Fed operates the infrastructure through which banks settle payments with each other. When you send a wire transfer, the money moves between banks through Fed-operated systems (Fedwire for large-value transfers, FedNow for real-time retail payments launched in 2023, and the ACH network for batch processing). The Fed is not just a regulator of the payment system; it is the payment system at the foundational layer.
The money in your bank account is not what most people think it is. Understanding this is essential for understanding why CBDCs matter.
Modern economies run on a two-layer system. The base layer is central bank money: physical cash (bills and coins) and digital reserves held by banks at the Fed. Only banks and certain financial institutions can hold digital central bank money. You and I can hold the physical version (cash), but we have no direct access to the Fed's digital ledger.
The second layer is commercial bank money: the deposits in your checking and savings accounts. When you "deposit" $1,000 at Chase, you are exchanging central bank money (cash) for a claim on Chase. Chase now owes you $1,000. Your account balance is not money stored in a vault; it is an IOU from the bank. Chase takes your deposit, keeps a fraction in reserve, and lends the rest to other borrowers. This is fractional reserve banking.
This system works because of deposit insurance (FDIC covers up to $250,000) and central bank backstops (the lender-of-last-resort function). These guarantees make commercial bank money feel identical to central bank money for everyday users. When you pay for coffee with your debit card, you do not think "I am transferring a claim on my bank to a claim on the coffee shop's bank." But that is exactly what happens.
When you Venmo a friend $50, the money moves through a surprisingly long chain:
Each step involves intermediaries, each intermediary charges fees or earns float, and the process can take one to three business days for final settlement (even if the Venmo app shows "instant"). This is the infrastructure that CBDCs could bypass or restructure.
A central bank digital currency is a digital form of a nation's fiat currency, issued and backed directly by the central bank. It is not cryptocurrency. It is not a stablecoin. It is not a digital version of your bank deposit. It is digital cash: a direct claim on the central bank, held by the public in electronic form.
Think of it this way. Today, you can hold central bank money in exactly one form: physical cash. Cash is anonymous, works offline, has no transaction fees, and requires no bank account. But it is increasingly impractical for the way people actually pay for things. A CBDC would give cash a digital equivalent: central bank money you hold electronically, transfer instantly, and use for everyday payments.
| Often Confused With | How It Differs |
|---|---|
| Cryptocurrency (Bitcoin, Ethereum) | Crypto is decentralized and not issued by any government. A CBDC is centralized and issued by the central bank. Crypto's value fluctuates against fiat; a CBDC is fiat. |
| Stablecoins (USDC, USDT) | Stablecoins are private tokens pegged to a currency, backed by reserves held by a company. A CBDC is the currency itself, backed by the sovereign issuer. No peg needed because there is nothing to peg to. |
| Bank deposits | Your bank balance is a claim on your bank (commercial bank money). A CBDC is a claim on the central bank. Different counterparty, different risk profile. |
| Payment apps (Venmo, Zelle) | Payment apps move commercial bank money through intermediaries. A CBDC could settle directly on central bank infrastructure, without intermediaries. |
If Venmo and Zelle already let you send money digitally, why would a central bank need to create its own digital currency? Three reasons.
First, the cost of payments. Credit card interchange fees average 2% to 3% per transaction. Merchants pass these costs on to consumers through higher prices. Consumers who use rewards credit cards recoup some of that cost through points and cashback, but consumers who pay with cash or debit cards do not. Research from the Journal of Banking & Finance shows that this system is regressive: the lowest-income consumers effectively subsidize the rewards programs of the highest-income consumers. A CBDC with zero transaction fees would eliminate this cost structure entirely. India has already demonstrated this is possible without a CBDC: the Unified Payments Interface (UPI), a government-backed real-time payment system, processes over 640 million transactions per day at zero cost to users and now accounts for 85% of India's payment volume.
Second, financial inclusion. Approximately 5.6 million US households are unbanked (no bank account at all), according to a 2023 FDIC survey. Existing digital payment systems require a bank account or credit card. A CBDC could provide a digital payment option to people outside the banking system.
Third, payment system resilience. Today's payment infrastructure depends on a small number of private networks (Visa, Mastercard, ACH). A CBDC would give the central bank a direct, public payment rail that does not depend on private intermediaries.
Fourth, monetary policy transmission. If the central bank could pay interest directly on CBDC holdings or program conditional transfers (stimulus payments that expire if unspent, for example), it would have new tools for implementing monetary policy that bypass the commercial banking system entirely.
Saying "launch a CBDC" is like saying "build a house." The details determine everything. Two CBDCs with different design choices can have radically different effects on the financial system. The four most consequential design dimensions are explored below.
This is the most fundamental design choice. It determines whether ordinary people interact with the CBDC at all.
Available to the general public: individuals, businesses, anyone. This is the version that would compete with commercial bank deposits and payment apps. It is also the version that raises the hardest questions about financial stability, privacy, and bank disintermediation.
Real example: China's digital yuan (e-CNY) is a retail CBDC. Over 325 million individual wallets have been created.
High public impactRestricted to financial institutions: banks, payment processors, clearinghouses. This is an upgrade to the existing interbank settlement system (think: a better version of Fedwire). It does not change how ordinary people interact with money. It changes how banks settle with each other.
Real example: Project mBridge (BIS + central banks of China, Thailand, UAE, Saudi Arabia) tests cross-border wholesale CBDC settlement.
Backend infrastructureThis dimension determines whether using a CBDC feels more like using a bank account or more like using cash.
The central bank (or an intermediary) maintains accounts linked to verified identities. Every transaction is recorded against a known account holder. Similar to how your bank account works today, but held at (or guaranteed by) the central bank.
Trade-off: Full transaction visibility enables AML/KYC compliance but sacrifices the anonymity of cash. Every payment is traceable.
Privacy concerns AML/KYC built inValue is stored in digital tokens that can be transferred between wallets without verifying the holder's identity. Closer to how physical cash works: whoever holds the token owns the value. Could potentially work offline.
Trade-off: Preserves cash-like privacy but makes anti-money laundering enforcement much harder. Most central banks have rejected pure token-based designs for this reason.
Cash-like privacy AML challengesEven if the central bank issues the currency, it does not necessarily want to manage 330 million customer accounts. This dimension determines the role of private-sector intermediaries.
The central bank operates the CBDC system end-to-end: issues the currency, maintains accounts or wallets, processes transactions, handles customer service. No private intermediaries.
Trade-off: Maximum control and simplicity, but the central bank would need to build consumer-facing technology infrastructure it has never operated. The Fed has no experience running a consumer payments app.
Central bank as tech companyThe central bank issues the currency and maintains the core ledger, but private companies (banks, fintechs, or new entrants) operate the wallets, apps, and customer interfaces. This is the model the Fed's 2022 discussion paper recommended.
Trade-off: Preserves the private sector's role and avoids massive central bank IT buildout, but introduces the same intermediary layer that CBDCs were partly designed to bypass.
Leverages existing infrastructureThis single design choice has more consequences for the banking system than all the others combined.
The CBDC functions like digital cash: it holds value but does not grow. This is what the Fed's 2022 discussion paper recommended. It limits the CBDC's attractiveness as a savings vehicle and reduces the risk that deposits flee from commercial banks to CBDC wallets.
Real example: The European Central Bank's proposed digital euro would be non-interest-bearing, with a holding limit of approximately €3,000.
Limits bank disintermediationThe CBDC pays interest on balances, potentially at a rate set directly by the central bank. This makes the CBDC a direct competitor to bank savings accounts and gives the central bank a powerful new monetary policy tool: it can transmit rate changes directly to the public without waiting for banks to adjust deposit rates.
Real example: China announced in late 2025 that digital yuan holdings would begin earning interest in January 2026, making it the first major CBDC to offer this feature.
Threatens bank deposits Direct monetary policy toolCBDCs are a global phenomenon, not an American one. As of early 2026, 137 countries representing 98% of global GDP are exploring CBDCs in some form, according to the Atlantic Council's CBDC Tracker. Three countries have launched retail CBDCs. Several major economies are in advanced pilots or preparation phases. One (the United States) has prohibited development for now. No two countries are making the same design choices, which means understanding CBDCs requires looking at what is actually being built, what problems each country is trying to solve, and what trade-offs different designs create.
CBDCs are not just domestic payment systems. They are potential tools for reshaping international finance. China's digital yuan is being tested for cross-border settlement through Project mBridge (a collaboration with the BIS and central banks of Thailand, the UAE, and Saudi Arabia). If countries can settle trade directly in digital yuan without converting to dollars first, it reduces dependence on the US-dominated SWIFT network and dollar-denominated correspondent banking.
This connects directly to the de-dollarization dynamics you will study in Unit 8. The question is not just whether the US builds a CBDC; it is whether the absence of a US CBDC accelerates the adoption of alternatives.
Every fintech company you studied in Unit 6 exists in the space between the central bank and the end user. They are intermediaries: they make payments faster, deposits more accessible, lending more efficient, or infrastructure more interoperable. A CBDC redesigns that space. Depending on its design, a CBDC could eliminate the need for some of these intermediaries, create new infrastructure that others can build on, or prove irrelevant to categories it does not touch.
| CBDC Design Feature | Most Affected Fintech Category | Mechanism |
|---|---|---|
| Zero-fee P2P and merchant payments | Payment processors (Stripe, Block, Toast) | Merchants gain a costless alternative to card interchange fees (typically 1.5%–3.5% per transaction) |
| Interest-bearing balances | Neobanks (Chime, Revolut), deposit-taking fintechs (SoFi) | CBDC competes directly with savings products; zero counterparty risk may attract risk-averse depositors |
| Open API infrastructure | Infrastructure providers (Plaid, Marqeta) | New programmable payment rails could create demand for connectivity services, or could replace proprietary infrastructure |
| Real-time settlement | BNPL providers (Affirm), payment processors | Instant settlement reduces float revenue and changes the economics of short-term credit products |
| Third-party wallet providers | Neobanks, payment apps | If fintechs can serve as CBDC wallet providers, they gain a new distribution role; if restricted to banks, they lose ground |