Written by Giulia Lob, edited by Paolo Stohlmann


With 112 countries considering the use of digital currencies, of which 77 are in the R&D phase, and with 19 of the G20 countries being in the advanced stage of Central Bank Digital Currencies (CBDCs), to date 11 countries have fully launched a digital currency – with China’s pilot leading the race and reaching 260 million users after being tested in a wide variety of day-to-day scenarios. Looking at current events, Russia’s invasion of Ukraine and the G7 sanction responses has resulted in a renewed interest in wholesale CBDCs. There are currently 12 cross-border wholesale CBDCs.

In this article, I will provide a brief introduction of the main concepts and actors in the financial landscape before delving into the adoption of Digital Currencies (DCs) and exploring the advantages that they offer and the challenges that they face.

Digital Currencies and the payment system

As digital transactions continue to grow and as people increasingly favour contactless credit and debit cards to the use of cash (with 80% of the money in circulation being private money), many banks across the globe explore the possibility of issuing a digital government-issued digital currency (that is not pegged to a physical commodity) to shape a safer and more efficient payment system. But how exactly would they fit into the payment system? To answer this question, we must first understand the purpose and the composition of a financial system.

An effective and efficient financial system allows for funds to circulate: from economic units with a surplus of funds (savers) to economic units with a net deficit of funds (borrowers), thereby allowing people to convert public savings to investments and pushing the economy forward. The investments allow people to acquire or build new assets  (i.e. buildings, machinery, infrastructure and inventories of goods), leading to a healthy and booming economy which favours high living standards and low unemployment rates.

Currently, the financial system can be split into three segments – “financial assets and instruments”, “institutions”, and “markets”. 

  • Financial instruments are contracts made between parties (which give rise to a financial asset of one entity and a financial liability/equity instrument of the other entity). They can be created, modified, traded or settled on the market (or with the help of intermediaries). Examples of such are assets (e.g. banknotes, IOUs (such as loans which are informal agreements made by the CBs to pay back a debt)…), bonds(formal debt arrangements), equity (shares) or more “exotic” instruments such as derivatives (options and future contracts).
  • Financial institutions (establishments) and markets (arrangements) facilitate the exchange of assets. Financial institutions such as commercial banks, investment dealers and insurance companies collect funds from investors and place them in financial assets, take out loans and exchange currencies. They operate in financial markets and trade financial instruments. 
  • Financial markets allow for the purchase or sale and trade of assets (stocks, bonds, bill of exchange). Examples are the New York Stock Exchange and Forex markets.

Modern systems of transmission rely on electronic money, born out of the second wave of digitalisation in response to the need for faster transactions and lower costs of distribution. Examples can be seen in debit cards (which enable consumers to purchase goods and services by transferring funds from their bank account to that of the merchant) and electronic cash (e-cash) which allows consumers to perform internet transactions, for example through service providers such as PayPal. In Europe, these forms of systems of transmission are regulated by the 2001 E-Money Directive. However, the current European environment has also seen forms of unregulated digital currencies creep in, namely crypto-coins and crypto-tokens. These currencies seek to offer an alternative to the role of institutions through using technology to record and verify transactions.

To date, digital currencies powered by blockchain have carved out a new category for financial instruments and are traded on digital currency markets. Making heavy use of distributed-ledger technologies to record transactions (in the place of a traditional, centralised system), cryptocurrencies have gained considerable traction in many countries (because of political, economic, and social reasons). Famous examples are Bitcoin and Stablecoin (the latter seeks to reduce the volatility by linking the coins to the value of a dollar), though both do not fare well in terms of volatility. 

When compared to other methods of transmission, the increased use and normalisation of payments through the web has meant that cryptocurrencies have garnered much hype and generated interesting debates on the need, use, and scale of adoption of digital currencies. Examples are scrapping cash all-together in favour of a government-backed digital currency (Giles, 2015), or creating a single currency for Latin America  (Käufer, 2022). Although the number of advantages they offer are dependent on perception, scholars and users tend to agree that cryptocurrencies benefit from three main advantages: they provide financial inclusion (allowing the unbanked to hold an account), allow for faster transactions, and lower the cost of transactions. Indeed, the fact that they rely on blockchain technology (which benefits from smart contracts, automated tracking and policy enforcement) eliminates the need for third parties to verify transactions. This can lead to faster and cheaper money transfers and settlements (especially cross-border), with settlements which can occur at minimal costs and take minutes to complete (instead of days). Lack of regulation and open access to the internet also means that these systems do not set strict entry requirements as do banks, leading to greater financial inclusivity.

Although digital currencies have generated significant interest in the media and beyond, their adoption is still too weak for them to be recognised as money, which must satisfy the following three properties:

  •  Act as a store of value (in other words, the value of money should be approximately constant).
  •  Act as a unit of account (in other words, money allows for comparisons to be made between different items of value).
  • Act as a means of exchange (which implies that the asset (money) must be widely adopted by the public and used in transactions).

Financial analysts are quick to point out that cryptocurrencies do not fulfil these three basic conditions of money, as they heavily fluctuate in value (thereby not fulfilling condition #1) and lack clarity (because of the lack of regulation) and are therefore accepted by very few merchants (thereby not fulfilling condition #3). Although some big-tech companies in financial technology (FinTech), such as Meta, have tried to secure markets with their cryptocurrency, the lack of regulation and the fact that cryptocurrencies rely solely on code to verify transactions (and no institution is backing them up) has meant that they have not garnered the appropriate trust fundamental to any sound financial system. 

Indeed, cryptocurrencies remain rather volatile, and they have been flagged as environmentally unfriendly due to the high energy consumption which is needed to mine them. Adding to the current political landscape, the increasing level of distrust and uncertainty that citizens have in governments (as seen by the increasing popularity of anti-establishment politics) coupled with the increasing strength and nature of cyber-threats, the widespread adoption of CBDCs could still prove to be unrealistic. Coupled with the unfavourable anti-establishment waves which can be seen throughout Europe and the U.S., a successful cyber-attack (i.e. data leakage, frauds) could cause economic agents to quickly stop using CBDCs, eventually leading to a confidence crisis. 

As cyberthreats are becoming increasingly complex and varied, hybrid and state-funded attacks are starting to appear alongside disinformation campaigns. In Europe, the EU is being quite active on this front, bringing in a host of new regulations to fight against the latest wave of cyberthreats. Examples of the advancements in legislation are the Digital Service Act which introduces requirements to ensure a safe and accountable online environment, DORA, which introduces requirements regarding security measures financial entities should take, and NIS2, which provides legal measures to strengthen the post-breach response by essential service. To counter these threats, CBs along with governments should fight against disinformation campaigns and include new regulations along with including resilience and safety, investing in robust IT operational capabilities, threat intelligence, and clear and comprehensive regulations.

Research in Europe has shown that for digital currencies to be accepted by the public, they should be designed to be widely accessible (i.e. on any technological device), financially inclusive, and user-friendly. If digital currencies are backed through a legal tender (e.g. by a central bank), merchants would have more trust in the currencies and monetary policy would aid in ensuring that CBDCs act as a store of value.

Regarding institutions, central banks are responsible for creating public money (banknotes), overseeing and managing other banks (lending at a rate), and above all for maintaining the stability of a currency (helping banks and governments alike). More specifically, a central bank’s objective is to:

  • Guard the value of money, promote stable prices, maximum employment and moderate long-term interest rates.
  • Promote stability in the financial system by promoting safety and soundness of the financial institutions and by minimising or containing systemic risk through active monitoring and engagement domestically and abroad.
  • Foster payment safely and efficiently, facilitating the currency’s transaction.

As central banks are responsible for ensuring monetary stability and economic activity, many economists argue that CBs must be active in promoting innovation and efficiency if they are to maintain a role in managing and controlling the payment system infrastructure. Importantly, failing to promote a healthy economy would imply that the CB “fails to ensure the monetary stability and economic activity in the years to come”, thereby failing to fulfil its role (Report no.1, BIS 2020). Adding this responsibility to those of central banks (by e.g. issuing of CBDCs) would imply that they must provide new functions to the public and incorporate more direct front-end services. If the use of CBDCs as money is rejected by the public, the stability of the institutions could be undermined. CBs must therefore take a cautious and prudent view when adopting CBDCs, allocating resources to carefully craft digital currencies and tailor them to their audience.  

If central banks partner with commercial banks (which offer products and services such as savings and checking accounts, loans and debit cards and issuing money to the public, make transactions with the general public), commercial banks could provide the front-end services to users (thereby directly providing services to customers, collecting user-input, and reducing CBs’ load in designing and distributing CBDCs). This would allow central banks to monitor transaction flows more efficiently than with physical cash and commercial bank money, with Sandner (2020) noting that illegal activities (ranging from terrorism to money laundering and tax evasion activities) could be identified with greater ease by using such a system.

Acting as a win-win situation for governments, financial institutions, and commercial banks alike, CBDCs could potentially “increase economic inclusion, foster innovation and reduce financial crimes” and “increase the efficiency of the financial system in terms of cost and management”. Indeed, a 2020 study conducted by the Bank of England (2020) found that the reduction in transaction costs incurred by issuing 30% of the GDP in CBDCs could raise GDP by 3% (considering the gains from the subsequent increase in innovation).


In this paper, I have discussed the fundamental role of central banks in providing economic stability, along with key players such as commercial banks and FinTech organisations.

After pointing out the unparalleled innovative advantages that digital currencies can bring, I highlighted the risks of unregulated transactions – thereby introducing the need for central bank-backed digital currencies. In the next paper, I will explore the key drivers for CBDC’s adoption alongside the complex task which lies ahead to ensure a successful implementation of CBDCs.


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