The concept of a “Central-Bank Digital Currency” (CBDC) may sound complex and unfamiliar, but it’s worth gaining familiarity as these digital versions of traditional currencies like dollars, yuan, euros, or yen are on the rise, with potentially profound implications for the banking system.

A staggering number of 114 nations are delving into the realm of digital currencies, representing over 95% of the world’s GDP, as per the Atlantic Council’s Central Bank Digital Currency tracker. Countries such as China, India, Nigeria, and the Bahamas are pioneers in this field, having already launched digital currencies. Meanwhile, nations like Sweden and Japan are gearing up for potential rollouts, while the U.S. is evaluating the possibility.

Discussions surrounding the necessity, utility, and pros and cons of digital currencies often end up convoluted, given each country’s unique approach towards implementation. Generally speaking, CBDCs can be categorized into two broad types: those aimed at financial institutions and those intended for the public at large.

The first type essentially represents a new mechanism for central banks to transfer funds to commercial banks, making interbank transactions quicker and safer. The approach, inspired by cryptocurrency and blockchain concepts, entails digital tokens representing central-bank money and transactions settled on a shared distributed ledger. A system of this nature is currently under trial by the New York Fed and several major U.S. financial institutions.

The second type of CBDC refers to a digital version of fiat currency accessible to the general public through accounts held by a central bank or a commercial bank. From an ordinary person or business’s perspective, this CBDC bears resemblance to the electronic money currently in their bank accounts—it’s just a digitized form of their currency. These CBDCs stand apart as they are created, and held, in accounts directly accessed by a central bank. Should another pandemic occur, for example, the Fed could effortlessly deposit stimulus checks into every U.S. citizen’s digital currency account.

This type of CBDC revolutionizes the creation and distribution of money, with individuals now having accounts or “wallets” containing money created by their country’s central bank, as opposed to their commercial bank. This shift positions central banks in direct contact with everyday people, veering from their conventional role of supplying money to a nation’s banking and financial system.

China’s digital yuan and India’s digital rupee are exemplars of such currencies, accessible to everyday people and capable of bypassing traditional banks.