Digital currency floating over a modern city.

Central Bank Digital Currencies: Are They the Future of Money?

Nico Varela in Business & Economy August 2025 • 4 min read.

"Explore the impact of digital currencies on transactional demand and the implications for China's monetary policy."

The rise of Central Bank Digital Currencies (CBDCs) signals a significant shift in the world of finance, propelled by advancements in blockchain, 5G, and other technologies. These digital currencies represent a move towards modernizing economies, driven by technological innovations in cryptography and digital transactions. Think of CBDCs as a digital form of a country's official currency, issued and regulated by its central bank.

China has been at the forefront of exploring and implementing CBDCs, particularly with its Digital Currency Electronic Payment (DC/EP) system. The DC/EP app made its debut on mobile platforms in January 2022, introducing digital currency into the daily lives of consumers. By the end of 2022, the circulating DC/EP amounted to 13.61 billion, marking a substantial step in integrating digital currency into the economy.

As digital currencies become more integrated into our lives, it’s crucial to understand how they affect traditional financial systems. Currency demand, a key factor in a country’s macro-economy, is inevitably influenced by the introduction of CBDCs. This impact raises important questions about the stability of money demand and the effectiveness of monetary policy.

CBDCs and Transactional Money Demand: What’s the Connection?

Digital currency floating over a modern city.

Transactional money demand refers to the amount of money people need for day-to-day transactions. Traditionally, this demand is influenced by factors like income levels, interest rates, and the ease of accessing cash. With the introduction of CBDCs, however, this landscape is changing. CBDCs offer a new way to conduct transactions, potentially reducing the need for physical cash.

To understand this shift, economists often use models like the Baumol-Tobin model, which helps analyze how people manage their money between holding cash and investing in interest-bearing assets. These models help to factor the convenience and security of digital transactions to analyze the potential impact of CBDCs on transactional money demand.

Reduced Transaction Costs: CBDCs can lower transaction costs, as they eliminate fees associated with traditional banking and payment systems.
Increased Convenience: Digital currencies offer greater convenience, allowing for instant transactions anytime, anywhere.
Monetization of Financial Assets: The ease of converting financial assets into CBDCs blurs the lines between investments and transactional money.

Research indicates that as CBDCs become more widely used, there's a potential decrease in the demand for physical cash. This is because people can easily use digital currency for their daily transactions, reducing the need to hold large amounts of cash. This shift has significant implications for how central banks manage monetary policy.

Navigating the Future of Digital Currency in China

The ongoing evolution of CBDCs requires careful consideration and strategic planning. China, as a pioneer in this digital frontier, faces unique challenges and opportunities. To fully leverage the potential of CBDCs, the central bank should focus on strengthening technical support, expanding application scenarios, and adapting monetary policy tools. Additionally, clear legal and regulatory frameworks are essential to foster a stable and innovative digital currency ecosystem.

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This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2401.06457,

Title: Analysis Of The Impact Of Central Bank Digital Currency On The Demand For Transactional Currency

Subject: econ.gn q-fin.ec

Authors: Ruimin Song, Tiantian Zhao, Chunhui Zhou

Published: 12-01-2024

Everything You Need To Know

What exactly are Central Bank Digital Currencies (CBDCs), and what technological advancements are driving their rise?

Central Bank Digital Currencies (CBDCs) are a digital form of a country's official currency, issued and regulated by its central bank. Their rise is driven by advancements in technologies like blockchain and 5G, as well as other innovations in cryptography and digital transactions. CBDCs represent a move towards modernizing economies by providing a digital alternative to physical cash.

How does the introduction of Central Bank Digital Currencies (CBDCs) like China's Digital Currency Electronic Payment (DC/EP) system impact transactional money demand?

The introduction of Central Bank Digital Currencies (CBDCs) can significantly impact transactional money demand, which is the amount of money people need for day-to-day transactions. CBDCs offer a new way to conduct transactions, potentially reducing the need for physical cash. Factors like reduced transaction costs, increased convenience, and the ease of converting financial assets into CBDCs contribute to this shift. Economists use models such as the Baumol-Tobin model to analyze how these factors affect transactional money demand.

In what ways do Central Bank Digital Currencies (CBDCs) reduce transaction costs compared to traditional banking and payment systems?

Central Bank Digital Currencies (CBDCs) reduce transaction costs by eliminating fees associated with traditional banking and payment systems. Since Central Banks regulate and issue the CBDC there are no intermediaries charging fees to move funds. Traditional systems incur costs from banking fees, credit card processing fees and other transaction charges that CBDCs avoid.

What key steps should China take to fully leverage the potential of its Digital Currency Electronic Payment (DC/EP) system and other Central Bank Digital Currencies (CBDCs)?

To fully leverage the potential of its Digital Currency Electronic Payment (DC/EP) system and other Central Bank Digital Currencies (CBDCs), China should focus on several key steps. These include strengthening technical support to ensure the reliability and security of the digital currency system, expanding application scenarios to increase the usability and adoption of the Digital Currency Electronic Payment (DC/EP), and adapting monetary policy tools to effectively manage the new digital currency ecosystem. Additionally, establishing clear legal and regulatory frameworks is essential to foster a stable and innovative digital currency environment.

What are the potential implications of Central Bank Digital Currencies (CBDCs) on traditional monetary policy, and how might central banks need to adapt?

Central Bank Digital Currencies (CBDCs) have significant implications for traditional monetary policy because they can alter the demand for physical cash and change how people manage their money. As Central Bank Digital Currencies (CBDCs) become more widely used, the demand for physical cash may decrease, affecting the money supply and interest rates. Central banks might need to adapt by developing new tools and strategies to effectively manage monetary policy in a digital currency environment. This could include adjusting interest rates on Central Bank Digital Currencies (CBDCs), implementing quantitative easing measures, or using other innovative approaches to maintain price stability and economic growth.