Central Bank Digital Currency: What It Is, How It Works, and U.S. Status

A central bank digital currency is a digital form of government-issued money, created and backed directly by a country’s central bank. Unlike the dollars sitting in a checking account, which are liabilities of a private commercial bank, a CBDC is a direct liability of the central bank itself, which means it carries no credit risk from any private institution.¹ Three countries have fully launched retail CBDCs, dozens more are piloting or researching them, and the United States has taken the opposite path: a January 2025 executive order prohibits federal agencies from establishing, issuing, or promoting one.²

How a CBDC Differs From Money You Already Use

Most money people spend day to day is already digital. Debit cards, payment apps, and bank transfers all move numbers between accounts. But those numbers represent claims on a commercial bank. If the bank fails, deposit insurance protects you up to a limit; the money itself depends on the bank’s solvency.

A CBDC restructures that relationship. It is a direct liability of the central bank, backed by the sovereign government. The Federal Reserve describes a CBDC as “the safest digital asset available to the general public, with no associated credit or liquidity risk.”¹ The closest existing parallel is physical cash. Federal Reserve notes are authorized under 12 U.S.C. § 411, which designates them as “obligations of the United States” receivable for all taxes, customs, and other public dues.³ A CBDC would carry a similar legal character as a digital equivalent of banknotes, though whether it counts as legal tender depends on the authorizing legislation a country adopts.

This sovereign backing is also what separates a CBDC from a decentralized cryptocurrency. Bitcoin’s price floats on market demand with no government guarantee. A CBDC maintains parity with the physical currency it represents: one digital dollar equals one paper dollar, always. That guarantee lets a CBDC function as a medium of exchange, unit of account, and store of value in the same way physical cash does, while adding the speed and programmability of digital infrastructure.⁴

Retail and Wholesale CBDCs

CBDC designs split into two categories based on who can use them.

A retail CBDC is designed for everyday consumers: paying for groceries, sending money to a friend, settling a utility bill. It works as a digital replacement for cash, giving ordinary people a way to hold central bank money electronically rather than only through commercial bank accounts. The Bank for International Settlements describes retail CBDCs as providing “a risk-free and digital means of payment for everyday transactions.”⁴

A wholesale CBDC is restricted to financial institutions. Commercial banks and other large players use it for interbank settlement and clearing, the plumbing that moves large sums between institutions. India’s Reserve Bank runs a wholesale pilot with 16 participating banks and non-banks that use it to settle government securities trades, interbank lending, and certificates of deposit.⁵ A wholesale model doesn’t change how consumers interact with money, but it can sharply speed up large transactions that currently take hours or days to settle.

How a CBDC Actually Works

Beyond who holds it, several technical and monetary design choices determine how a CBDC operates.

Interest and Holding Rules

One of the most consequential decisions is whether the currency pays interest. A non-interest-bearing CBDC mimics cash: you hold it, and it doesn’t grow. This is the simpler approach and avoids competing directly with commercial bank deposits. Most launched CBDCs and early pilots take this route.

An interest-bearing CBDC introduces a stronger monetary policy tool. Research from the Bank for International Settlements finds that when a CBDC pays interest, that rate effectively becomes a floor for commercial bank deposit rates, because banks must offer at least as much or watch customers shift holdings into the CBDC. Setting the CBDC rate equal to the central bank’s policy rate produces full monetary policy pass-through to depositors.⁶ The tradeoff is real: a competitive rate on a risk-free government currency could pull deposits away from smaller banks.

China’s approach shows a middle path. Starting in 2026, digital yuan held in commercial bank wallets is classified as bank deposit liabilities, so banks must pay interest on those balances under prevailing deposit rate regulations and protect them with deposit insurance.⁷ The move shifts the digital yuan from a cash-like instrument toward something closer to a digital deposit.

Account-Based vs. Token-Based

An account-based system works the way most bank accounts do. Every transaction requires identifying the account holder, and a central database tracks balances tied to specific people. Security depends on verifying the person, not the money.

A token-based system flips the focus. The system verifies the digital token itself, confirming it is genuine and hasn’t already been spent. This is closer to how physical cash works: the recipient checks whether the bill is real, not who is handing it over. Token-based designs can offer greater privacy but make regulatory compliance harder, because the system doesn’t inherently know who is spending.

Two-Tier Distribution

Nearly every serious CBDC design uses a two-tier distribution model. The central bank creates the digital currency and issues it to authorized commercial banks or payment providers. Those intermediaries then distribute it to customers and manage individual wallets or accounts. This keeps the central bank out of the retail banking business. It doesn’t handle millions of customer accounts, service requests, or technical support inquiries. Commercial banks bring their existing infrastructure, compliance systems, and customer relationships to the task.⁴

Offline Payments

Physical cash works anywhere. No signal required. If a digital currency can’t do the same, it fails the populations that need it most: rural communities, areas hit by natural disasters, and regions with unreliable connectivity. The Bank for International Settlements identifies three modes of offline operation:⁸

Fully offline, where both sender and receiver complete a payment and spend the received funds without ever connecting to a central system.
Intermittently offline, where payments work offline but devices must periodically reconnect to refresh security parameters.
Staged offline, where the payment goes through immediately but the recipient can’t spend the received funds until their device reconnects and the transaction settles on the central ledger.

Offline systems depend on tamper-resistant hardware to prevent counterfeiting, meaning secure chips embedded in payment cards or smartphones that protect cryptographic keys even if someone physically disassembles the device. Transfers between devices can happen through contactless communication, Bluetooth, QR codes, or audio signals for basic feature phones.

Privacy, Surveillance, and AML Rules

Surveillance is the loudest objection to CBDCs, and it isn’t unfounded. A centrally managed digital ledger creates a transaction record far more detailed than cash and potentially more accessible to government than commercial bank records. Under the third-party doctrine, individuals generally have no Fourth Amendment expectation of privacy in information they voluntarily share with financial institutions, and courts have already applied this reasoning to cryptocurrency exchange records.

Anti-money-laundering rules also apply regardless of design. In the U.S., the Bank Secrecy Act requires financial institutions to help prevent money laundering and terrorist financing by maintaining records and filing reports on certain transactions.⁹ Any CBDC intermediary distributing digital currency or managing wallets would need to verify customer identities and monitor for suspicious activity. Financial institutions currently file Suspicious Activity Reports when they detect irregular transactions above $5,000.

Some proposals address this tension through tiered privacy, keeping small transactions anonymous while triggering identity checks on larger ones. The European Central Bank has explored a proof-of-concept system using “anonymity vouchers,” a limited number of tokens issued periodically that allow anonymous transfers up to a capped amount, with any excess routed through anti-money-laundering checks.¹⁰

Where CBDCs Exist Today

Three countries have fully launched retail CBDCs: the Bahamas (Sand Dollar), Jamaica (JAM-DEX), and Nigeria (eNaira). The Bahamas launched the Sand Dollar to reach communities spread across hundreds of islands where traditional banking infrastructure is sparse, aiming to reduce service delivery costs and promote financial inclusion.¹¹ Jamaica’s JAM-DEX serves a similar role in the country’s payment system modernization.¹²

China operates the largest pilot by far. As of November 2025, the digital yuan had processed 3.48 billion cumulative transactions worth roughly 16.7 trillion yuan ($2.37 trillion). Starting January 1, 2026, the People’s Bank of China upgraded its framework to classify digital yuan in commercial bank wallets as deposit liabilities earning interest and covered by deposit insurance, and it now requires non-bank payment institutions to hold 100% reserves against the digital yuan they manage.⁷

India’s Reserve Bank runs both retail and wholesale pilots. The retail pilot, live since December 2022, now involves 19 banks offering CBDC wallets to consumers and merchants across the country.⁵ The European Central Bank is preparing for a potential digital euro launch by 2029, with a pilot running for 12 months beginning in the second half of 2027, though the ECB has said it will only issue a digital euro once the European Parliament and Council adopt the enabling regulation.¹³

One CBDC per country solves domestic payments but creates a new problem internationally. Cross-border transfers stay slow if each central bank builds on incompatible technology, so international efforts focus on harmonizing standards, particularly ISO 20022 messaging formats and shared API frameworks, so CBDCs from different countries can communicate.¹⁴

U.S. Status: No CBDC, and None Coming

The United States has no CBDC and, under current policy, will not have one. On January 23, 2025, President Trump signed an executive order directing all federal agencies to terminate any plans or initiatives related to creating a CBDC. The order prohibits agencies from taking “any action to establish, issue, or promote CBDCs within the jurisdiction of the United States or abroad.”²

Congress has moved in the same direction. The Anti-CBDC Surveillance State Act (H.R. 1919) passed the House of Representatives in July 2025, prohibiting the Federal Reserve from issuing a CBDC directly or through intermediaries and barring the Fed from using a CBDC as a monetary policy tool.¹⁵ As of mid-2026, the bill has not passed the Senate, so the prohibition rests on executive action rather than statute. Even before the executive order, the Federal Reserve had stated in its 2022 discussion paper that it “does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of a specific authorizing law.”¹⁶

How a CBDC Would Be Taxed

A common misconception is that a CBDC would be taxed like cryptocurrency. It would not. The IRS defines a “digital asset” for reporting purposes as a digital representation of value recorded on a blockchain or similar technology, but explicitly excludes “cash (that is, U.S. dollars or any convertible foreign currency issued by a government or central bank).”¹⁷ A CBDC issued by a foreign central bank falls within that carve-out.

Starting in 2026, brokers must report sales of digital assets on Form 1099-DA, including gross proceeds and cost basis for covered securities acquired after 2025.¹⁷ Those reporting requirements apply to cryptocurrencies and similar tokens, not to CBDCs. Holding or spending a foreign CBDC would be treated like holding or spending foreign currency, with gains or losses arising from exchange rate fluctuations rather than from the asset being classified as property the way Bitcoin is.

1
Federal Reserve Board. Central Bank Digital Currency (CBDC)
2
The White House. Strengthening American Leadership in Digital Financial Technology
3
Office of the Law Revision Counsel. 12 USC 411 – Issuance to Reserve Banks; Nature of Obligation
4
Bank for International Settlements. Central Bank Digital Currencies – Executive Summary
5
Reserve Bank of India. Digital Rupee (e₹) FAQs
6
Bank for International Settlements. The Case for Convenience: How CBDC Design Choices Impact Monetary Policy Pass-Through
7
Gov.cn. China to Enhance Digital Yuan Management With Deposit Features Starting 2026
8
Bank for International Settlements. Project Polaris: Handbook for Offline Payments With CBDC
9
Office of the Law Revision Counsel. 31 USC 5311 – Declaration of Purpose
10
European Central Bank. Exploring Anonymity in Central Bank Digital Currencies
11
Central Bank of The Bahamas. Project Sand Dollar
12
Bank of Jamaica. Jamaica’s Central Bank Digital Currency (CBDC) – JAM-DEX
13
European Central Bank. The Digital Euro: Preparing for a Potential Launch
14
Bank for International Settlements. Cross-Border Payment Technologies: Innovations and Challenges
15
Congress.gov. Anti-CBDC Surveillance State Act 119th Congress (2025-2026)
16
Congress.gov. Central Bank Digital Currencies: Policy Issues
17
Internal Revenue Service. Instructions for Form 1099-DA