When people or businesses make a payment, they place their trust in two critical elements: the money itself and the transaction system that processes it. These foundational components are often taken for granted, yet they form the bedrock of every thriving economy. Billions of daily transactions rely on this system and the institutions that stand behind it.
Digital innovations are rapidly transforming the nature of money and payments. Cryptocurrencies and decentralized finance (DeFi) are built upon the premise of decentralization, aiming to replace traditional financial intermediaries—like banks, brokers, and custodians—with technological solutions. The rapid growth of crypto assets has captured public attention, showcasing the power of new capabilities such as programmability, composability, and tokenization.
However, recent developments in the crypto space have exposed critical limitations. These are not minor flaws but structural deficiencies that prevent cryptocurrencies from meeting the requirements of a monetary system that fully serves society. That is why the future monetary system should harness the technological innovations introduced by crypto—but anchor them in the trust provided by central banks.
In short, any legitimate transaction achievable with crypto can be executed more effectively using central bank money. Central bank digital currencies (CBDCs), along with other public infrastructure, can form the basis of a rich and innovative monetary ecosystem designed with the public interest in mind.
The Structural Flaws of Cryptocurrencies
A monetary system that serves society must be safe, stable, and accountable. It should be efficient, inclusive, and resilient to changing needs. Users must retain control over their data, and the system must guard against fraud and misuse. It must also support cross-border openness to facilitate global economic integration.
While today’s traditional monetary system is largely safe and stable, there is still room for improvement. Cryptocurrencies and DeFi aim to replicate traditional money, payments, and financial services using permissionless distributed ledger technology like blockchain. Though these technologies offer adaptability and cross-border potential, crypto assets suffer from critical shortcomings.
First, crypto assets lack a reliable nominal anchor. The system depends on volatile cryptocurrencies and so-called “stablecoins,” which attempt to peg their value to sovereign currencies like the US dollar. However, stablecoins are not truly stable, as illustrated by the collapse of TerraUSD in May 2022 and ongoing concerns around the reserves backing Tether. In essence, stablecoins seek to “borrow” credibility from central bank-issued money—implying that if central bank money didn’t exist, it would need to be invented.
Second, the decentralized nature of crypto assets leads to fragmentation. Money is a social convention rooted in network effects: the more people use a particular form of money, the more valuable it becomes to others. These effects rely on a trusted institution—the central bank—which ensures stability, safety, and finality of transactions.
In contrast, decentralized systems depend on anonymous validators who are incentivized through fees and rents. This can cause network congestion, limit scalability, and lead to fragmentation. For example, as the Ethereum network approaches its transaction limits, fees rise exponentially, prompting users to migrate to other blockchains. Such inherent limitations inhibit broad adoption.
These structural flaws mean that crypto assets are neither stable nor efficient. Operating largely outside the regulatory perimeter, participants in this ecosystem are not held accountable to the public. Frequent incidents of fraud, theft, and scams have rightly raised concerns about market integrity.
While crypto assets have demonstrated new technological possibilities, their most useful components must be built on a more solid foundation. By adopting these innovations and anchoring them in trust, central bank money can support a rich, scalable, and public-interest-oriented monetary ecosystem.
A Tree and Forest Vision of the Monetary System
Central banks are uniquely positioned to provide this foundation of trust. Their role as issuers of sovereign currency, providers of payment finality, and guardians of system integrity makes them the solid trunk of the monetary tree. From this trunk, branches—banks and private service providers—can extend, competing to offer innovative services to households and businesses.
At a global level, the monetary system can be envisioned as a healthy forest. At the canopy, branches from different trees intertwine, enabling cross-border economic integration.
How can this vision be realized? New public infrastructure is needed at the wholesale, retail, and international levels.
Wholesale Central Bank Digital Currencies
Wholesale CBDCs—digital central bank money accessible only to banks and trusted institutions—can incorporate new capabilities like programmability, composability, and tokenization. These features can fuel innovation that benefits end users.
For instance, in a real estate transaction, a programmable wholesale CBDC could ensure that tokenized payment and tokenized transfer of ownership occur simultaneously in a single atomic transaction. Central banks around the world are already experimenting with these and other use cases.
Retail CBDCs and Fast Payment Systems
Retail CBDCs would function as digital cash for households and businesses, serviced by private intermediaries. Similarly, fast payment systems operated by central banks provide a public platform that ensures full interoperability between services.
Both retail CBDCs and fast payment systems promise lower transaction costs and greater financial inclusion. Brazil’s Pix system, for example, was adopted by two-thirds of the adult population within just one year. Merchant fees average just 0.2% of the transaction value—one-tenth the cost of credit card payments. Many central banks are now designing inclusive CBDCs to better serve the unbanked.
Cross-Border Connectivity
At the international level, central banks can interlink their wholesale CBDCs to allow banks and payment providers to transact directly using multiple currencies. This can be achieved through permitted distributed ledger technology limited to trusted participants.
Work led by the Bank for International Settlements Innovation Hub, in collaboration with 10 central banks, shows that such arrangements can enable faster, cheaper, and more transparent cross-border payments. This could help reduce remittance costs for migrants, scale cross-border e-commerce, and support complex global supply chains.
Digital technology holds great promise for the monetary system. By building on the foundation of trust provided by central bank money, the private sector can leverage the best of new technology to create a rich and diverse monetary ecosystem. Ultimately, user needs must guide private innovation, just as the public interest must guide central banks.
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Frequently Asked Questions
What is a central bank digital currency (CBDC)?
A CBDC is a digital form of central bank money that can be designed for use by the general public (retail CBDC) or restricted to financial institutions (wholesale CBDC). It aims to combine the efficiency of digital transactions with the safety and stability of sovereign currency.
How do CBDCs differ from cryptocurrencies?
Unlike most cryptocurrencies, CBDCs are centralized, regulated, and backed by a trusted authority—the central bank. They are designed to complement rather than replace existing forms of money, offering stability and legal certainty that crypto assets typically lack.
Can CBDCs improve financial inclusion?
Yes. By providing a low-cost, accessible, and secure digital payment option, retail CBDCs can help bring unbanked and underbanked populations into the formal financial system, especially when combined with digital identity solutions.
Are CBDCs programmable?
Wholesale CBDCs can be programmable, enabling automation of complex transactions—like conditional payments or delivery-versus-payment settlements—while retail CBDCs may include limited programmability features to support smart contracts or policy implementation.
What are the risks of CBDCs?
Potential risks include privacy concerns, operational cybersecurity challenges, and the possible disintermediation of commercial banks. These risks require careful design, clear regulation, and ongoing stakeholder coordination.
How are central banks collaborating on cross-border CBDC projects?
Through initiatives like the BIS Innovation Hub, central banks are experimenting with common platforms and international standards to enable interoperability between different CBDC systems. The goal is to make cross-border payments faster, cheaper, and more transparent.