Digital Payment Systems & CBDCs: From Electronic Rails to Central Bank Digital Currency

Published: March 17, 2026

Article by Ryan O'Connell, CFA, FRM

A central bank digital currency (CBDC) represents one of the most consequential proposals in modern payments. The way people pay for goods and services has evolved continuously — from commodity money to government-issued fiat currency, from paper checks to electronic transfers, and now to the prospect of digital money issued directly by central banks. Understanding CBDCs requires understanding the digital payment landscape that makes them necessary, the private-sector alternatives they respond to, and the trade-offs they involve for banking and monetary policy.

What Is a Central Bank Digital Currency (CBDC)?

A CBDC is a digital form of central bank money — a direct liability of the central bank itself, denominated in the national currency unit. This distinction is critical because it places CBDCs in a fundamentally different category from other forms of digital money.

CBDCs come in two broad forms. Retail CBDCs are designed for use by the general public for everyday transactions — the digital equivalent of cash. Wholesale CBDCs are restricted to financial institutions for interbank settlement, potentially replacing or supplementing existing real-time gross settlement systems like Fedwire.

CBDC design involves three key axes. First, account-based vs token-based: account-based CBDCs verify the identity of the account holder (like a bank account), while token-based CBDCs verify the validity of the token itself (like cash). Second, direct vs intermediated vs hybrid: in a direct model, the central bank manages all accounts; in an intermediated (two-tier) model, commercial banks distribute and manage CBDC wallets; hybrid models split responsibilities between the two. Third, interest-bearing vs non-interest-bearing: whether CBDCs pay interest has profound implications for bank deposit competition.

Why Central Banks Are Exploring CBDCs

The motivations for exploring CBDCs vary by country, but several forces are driving interest globally.

Declining cash usage is reducing the public’s direct access to central bank money. In the United States, cash accounted for just 18% of in-store payments in 2022, according to the Federal Reserve’s Diary of Consumer Payment Choice. In Sweden, only 10% of respondents used cash for their most recent in-store purchase (Riksbank, 2024). As cash disappears from daily commerce, the public’s only link to risk-free central bank money weakens. For a detailed discussion of how central banks operate and their role in the financial system, see our article on the Federal Reserve System.

Financial inclusion remains a pressing global challenge. The World Bank’s Global Findex Database (2021) estimated that 1.4 billion adults worldwide lacked access to a bank account. Mobile-based CBDCs could potentially reach populations that traditional banking infrastructure cannot serve.

Private stablecoins have demonstrated demand for digital dollars, but without the safety guarantees of central bank money. As discussed in our analysis of the shadow banking system, private money creation outside the regulated banking perimeter creates systemic risks. CBDCs represent the public-sector response to this challenge.

As of early 2026, 137 countries and currency unions — representing 98% of global GDP — were actively researching, developing, or piloting CBDCs, according to the Atlantic Council’s CBDC Tracker. In January 2025, the United States issued an executive order on digital financial technology, which explicitly prohibited federal agencies from establishing, issuing, or promoting CBDCs unless required by law.

How a Central Bank Digital Currency Works

CBDC design is not one-size-fits-all. The most important design decision is the distribution model. In a direct model, the central bank operates all accounts and processes all transactions — a radical expansion of central bank operations. In an intermediated (two-tier) model, the central bank issues the digital currency but commercial banks handle distribution, wallet management, and customer onboarding. Most central banks favor the two-tier approach because it preserves the existing banking system’s role in credit intermediation.

Several major economies have moved beyond research into active experimentation:

The Digital Payment Landscape

CBDCs do not exist in a vacuum. They enter a landscape of existing electronic payment systems, each with different characteristics. Understanding these systems clarifies what CBDCs add and what they cannot replace.

Wholesale payment rails form the backbone of the financial system. Fedwire, the Federal Reserve’s real-time gross settlement (RTGS) system, processed approximately $1,098 trillion in 2023, with each payment settling individually and with immediate finality. CHIPS (Clearing House Interbank Payments System) processed approximately $466 trillion in 2023 using prefunded positions and a liquidity-saving algorithm — most payments settle in seconds, not at end-of-day as in simple netting systems. ACH (Automated Clearing House) processed approximately $80 trillion in 2023 through batch processing, typically settling in one to three business days.

FedNow, launched in July 2023, represents the most significant recent upgrade to U.S. payment infrastructure. It enables real-time, 24/7/365 retail payments with a per-transaction limit raised to $10 million as of November 2025. FedNow dramatically reduces settlement times for everyday transactions. At the interbank level, FedNow settles through entries to Federal Reserve master accounts (central bank money), but the end-user claim being transferred is a commercial bank deposit — not a direct claim on the central bank.

Consumer payment interfaces like Apple Pay, Venmo, Zelle, and PayPal are not independent payment systems. They are technology layers that ride on top of existing infrastructure — card networks (Visa, Mastercard), ACH, or direct bank-account transfers. When you send money through Venmo, the underlying settlement still occurs through traditional banking rails.

In the developing world, M-Pesa in Kenya demonstrates that mobile-first payment systems can achieve massive financial inclusion without a CBDC. Launched in 2007, M-Pesa now serves over 30 million active users in Kenya and processes transactions equivalent to more than 50% of Kenya’s GDP — providing banking-like services to populations that traditional banks could not reach. For an analysis of how banking models are being disrupted, see our article on banking industry structure.

CBDC vs Stablecoins and Cryptocurrency

The private sector has not waited for central banks. Stablecoins — digital tokens pegged to a fiat currency — have emerged as a market-driven form of digital money. Reserve-backed stablecoins like Tether (USDT) and USD Coin (USDC) maintain their peg by holding dollar-denominated reserves. As of early 2024, the total stablecoin market capitalization was approximately $130 billion, with Tether alone accounting for roughly $95 billion.

However, not all stablecoins are backed by reserves. Algorithmic stablecoins attempt to maintain their peg through automated supply-and-demand mechanisms rather than asset backing.

From a Mishkin framework (Chapter 3), stablecoins function as private money — they create a liability structure similar to shadow banking, with reserve-asset quality risk, redemption uncertainty, and liquidity/run risk — without deposit insurance or lender-of-last-resort support. For deeper analysis of shadow banking dynamics, see our article on banking industry structure.

Cryptocurrency like Bitcoin faces fundamental limitations as money. Bitcoin’s extreme price volatility undermines its usefulness as a medium of exchange or store of value. Its throughput of approximately 7 transactions per second cannot support a modern payment system (Visa processes roughly 65,000 TPS at peak capacity). Second-layer solutions like the Lightning Network have expanded capacity but remain limited in adoption. As Mishkin emphasizes, money must serve as a medium of exchange, unit of account, and store of value — Bitcoin reliably performs none of these functions for everyday commerce. For the formal definitions of money and the money supply, see our article on money supply and money creation.

Implications for Banking and Monetary Policy

If widely adopted, CBDCs could fundamentally alter the structure of the banking system and the transmission of monetary policy.

CBDCs could also change monetary policy transmission. A CBDC infrastructure could enable direct fiscal transfers to citizens (sometimes called “helicopter money”), bypassing the banking system entirely. If CBDCs were interest-bearing, central banks would gain a new tool for influencing the economy — including the theoretical possibility of negative interest rates on digital cash holdings. For a detailed analysis of how monetary policy transmits through the economy, see our article on monetary policy transmission mechanisms.

Most central banks are pursuing two-tier designs precisely to mitigate disintermediation risk. By having commercial banks distribute and manage CBDC wallets, the two-tier model preserves banks’ customer relationships and their role in credit intermediation. The disintermediation risk also has implications for bank credit risk management, as reduced deposit funding could alter lending standards. Additional safeguards include holding limits (caps on how much CBDC an individual can hold) and zero or low interest on CBDC balances to discourage mass migration from bank deposits. For analysis of how deposit funding affects bank balance sheets, see our article on bank balance sheet management.

How to Compare Payment Systems

The most useful framework for comparing payment systems is by settlement asset — what type of money actually changes hands. This distinction clarifies the fundamental differences between cash, bank transfers, CBDCs, stablecoins, and cryptocurrency.

Common Mistakes

1. “Cryptocurrency and CBDCs are basically the same thing.” They are fundamentally different. Cryptocurrencies like Bitcoin are decentralized, not backed by any government, and exhibit extreme price volatility — Bitcoin’s price has swung more than 50% in a single year multiple times. CBDCs are centralized, issued by a government’s central bank, denominated in the national currency, and designed for price stability. A CBDC is digital fiat money; cryptocurrency is a speculative digital asset. The only thing they share is electronic form.

2. “A CBDC is just a digital version of physical cash.” While CBDCs share some properties with cash (direct central bank liability, legal tender), they differ in critical ways. Cash is anonymous and works offline without infrastructure; most CBDC designs involve some degree of transaction traceability and require digital access. Many CBDC designs use a two-tier distribution model with no parallel in physical cash. The privacy, accessibility, and operational characteristics of a CBDC depend entirely on design choices.

3. “Launching a CBDC is a monetary policy change.” A CBDC is payment infrastructure, not a monetary policy stance. Issuing a CBDC does not inherently alter the money supply, change interest rate targets, or modify the central bank’s policy framework. However, CBDC design could alter monetary policy transmission — by changing the demand for bank deposits, enabling direct fiscal transfers, or providing new tools like interest on digital cash holdings. The distinction between payment infrastructure and monetary policy tools is critical.

4. “FedNow is America’s CBDC.” FedNow is an instant payment rail operated by the Federal Reserve. While interbank settlement occurs through Fed master accounts (central bank money), the end-user claim being transferred is a commercial bank deposit — private money, not public money. A CBDC would give the public a direct claim on the Federal Reserve itself, fundamentally different from a faster way to move bank deposits. As of early 2026, the United States has not launched or committed to a CBDC.

Limitations

1. Unresolved design trade-offs. Privacy vs regulatory compliance, offline capability vs fraud prevention, and financial inclusion vs digital-divide risk are inherent tensions in CBDC design. No design simultaneously maximizes all objectives.

2. Digital infrastructure requirements. CBDCs require smartphones, internet connectivity, and digital literacy. In economies where the goal is financial inclusion, the populations most in need of banking access may be the least able to use digital-only instruments — as Nigeria’s low eNaira adoption illustrates.

3. Cryptocurrency scalability. Despite years of development, no major cryptocurrency has achieved the transaction throughput, price stability, and energy efficiency needed to function as a mainstream payment system. Second-layer solutions improve performance but add complexity and centralization.

4. Regulatory lag. Regulatory frameworks for digital currencies, stablecoins, and CBDCs are still evolving in most jurisdictions. The gap between technological capability and regulatory clarity creates uncertainty for all participants in the digital payments ecosystem.