What is Central Bank Digital Currency and How Does it Work?

Welcome to the first post in our series on Central Bank Digital Currency (CBDC). In this post, Art Stewart, Global Head of Sales & Marketing at IDEX Biometrics, talks about how a central bank digital currency works.

A central bank digital currency (CBDC) is an electronic form of cash that can be exchanged much like you exchange traditional “money”. Of course, we exchange “money” electronically on a daily basis, whether via bank transfer, digital wallets or card payments, but there is a difference.

Most digital payments are essentially checks – instructions for a bank to pay “real” money from your account. As such, multiple actors are involved to enact the transactions, clearing payments and administering millions of individual accounts. A CBDC on the other hand, has evolved from decentralized digital currencies like bitcoin and Ethereum and is more like cash itself in cutting out the middle-men – it seemingly travels directly from person to person or from customer to vendor like a coin.

Both cryptocurrencies and CBDC are dependent on networked electronic resources to create, track and validate transactions. In the case of most cryptos, such as Bitcoin, those resources are distributed and anonymized. In the case of CBDC, a central database ultimately controlled by a central bank issues the currency and provides every “e-dollar” or “e-yuan” with a unique serial number to identify it. Usually, central banks will also peg the electronic currency to their existing national currency. Since national currencies today are fiat, CBDCs are alternatively called digital fiat currencies.

Which Countries are Developing CBDC?

Early CBDC experiments took place in Finland in the 1990s and Venezuela in 2018, but a long list of national governments and central banks are now rushing to develop digital forms of existing currencies in order to remain relevant with the emergence of private stablecoin alternatives.

The United States is considering a digital dollar, following a hearing by the Senate Banking Committee in the summer of 2020.

In October 2020, a group of seven central banks including the US Federal Reserve, the Bank of Japan, the European Central Bank, BIS (Bank for International Settlements), the Swiss National Bank, Bank of Canada, Sveriges Riksbank in Sweden, and the Bank of England, indicated an intention to assess the feasibility of implementing publicly available CBDCs.

Other significant countries are considering or beginning to implement CBDCs including China and Russia as well as a host of smaller nations including South Africa, Uruguay, Barbados, Switzerland, Thailand and Iran. Clearly, the motivation for CBDCs is compelling.

Why do we need CBDC?

The two main motivations are the challenge presented to national currencies by cryptocurrencies, and the uncertainty about future currency stability in the world in general as the US dollar loses its exclusive position as the peg for other currencies and for conducting international trade.

The public explanations are usually more guarded. Centralized oversight of the movement of currency could potentially put an end to a lot of tax evasion and fraud. Identifiable digital currency is also hard to steal, and a currency that can move without sorting banks and clearing houses involves far lower costs, especially for corporations that conduct thousands of transactions per day. Some countries also see it as a means to inject capital into particular social or geographic areas.

A biometric fingerprint sensor overcomes many practical objections

Many people are understandably concerned about the security of electronic currencies: bitcoins have been stolen in vast numbers. Although providing each “e-coin” with a unique serial number should prevent counterfeiting, it provides no automatic guarantee that the person performing a transaction is the authorized owner. Digital currency cards also essentially embody a stored value, much like a prepaid debit card.  If the card is lost or stolen, there is nothing that prevents the thief from using the stored value.

Securing digital wallets on mobile phones with a biometric fingerprint sensor is already the norm, but until recently there was no biometric fingerprint sensor for card payments.

That has all changed with the recent introduction of biometric payment cards. A digital currency card with a biometric fingerprint sensor securely ties the card to its rightful owner.  Central banks need a solution that both keeps up with the emergence of crypto currency platforms and include strong, yet highly convenient user protection. IDEX Biometrics’ TrustedBio™ biometric payment card family of products are uniquely positioned to enable this large and emerging market, offering the highest possible levels of integration, security and biometric performance.