Central bank digital currencies (CBDCs) are gradually making inroads into the financial sector. Governments and banks globally have expressed avid interest in the phenomenon and are conducting research on the economic and technical feasibility of CBDCs.
CBDCs are a hot topic in the world of digital assets. According to the PwC CBDC global index, since 2014 more than 60 central banks all over the world have been exploring the potential of CBDCs while some of them have even started launching pilot projects.
Central bank digital currencies are poised to become powerful game-changers and take the financial world into uncharted waters. They can introduce citizens and corporates to novel and alternative payment solutions and could profoundly transform financial market settlement processes as well as interbank monetary transactions.
Yet, like any other nascent innovation, CBDCs have pitfalls and negative implications, which to some minds cast doubt on their feasibility and mean that they still have a long way to go before they become a real international presence. However, one thing is certain: CBDCs are here and they are here to stay, and in the short term and the long term, we will witness a growing number of CBDC projects and developments on the global landscape.
Read on to get more insights into central bank digital currencies, their features and working principles as well as their pros and cons, and find out which countries have started to develop their own CBDCs.
What is a CBDC and what makes it special?
A central bank digital currency (CBDC) is the digital representation of a country’s official fiat currency. Rather than printing money, the nation’s monetary authority (central bank) issues and regulates electronic coins that are backed by the government. An important thing to note is that CBDCs don’t aim to fully replace hard cash. On the contrary, they can both coexist, and together offer people the freedom to choose a means of payment that will be convenient to them.
The design and issuance of CBDCs is an independent decision of each jurisdiction. It’s based on a preliminary in-depth analysis of the viability, relevance, and usefulness of a CBDC and a prediction of whether it will be perceived by society as a convenient and, primarily, safe means of payment.
While using blockchain in the development of digital tokens is not necessary, the majority of both pilot and production CBDC projects run on this type of distributed ledger technology. The thing is that blockchain can bring about several benefits to CBDC development, the most prominent being advanced smart contract functionality, transparent audit trails, and configurable confidentiality features — therefore, opting for blockchain when working on CBDC implementation often turns out to be the right choice.
Types of CBDC
Central bank digital currencies can be divided into two main categories, retail and wholesale.
A retail CBDC is viewed as a digital form of cash that can be held by citizens and corporates, whereas a wholesale CBDC is restricted to financial institutions only, and is chiefly employed for interbank payments as well as financial settlement processes.
Retail CBDCs are primarily used between individuals and businesses. They allow for the transfer of central-government-backed digital currency directly to the consumer. This type of CBDC can be used to pay for goods and services as well as sending money to friends or family members.
Wholesale CBDCs are oftentimes compared to traditional central banks. They offer citizens a decent and more secure means of storing and keeping money, which in turn can reduce the number of deposits held within commercial banks. On top of that, wholesale CBDCs can enhance the speed and security of wholesale financial systems and even contribute to cost reduction.
What are the core instrument features of CBDCs?
Central bank digital currencies should meet certain parameters if they are intended to be embraced by citizens and used to their full potential. They need to be convertible, available to everyone, convenient and inexpensive to use. Let’s move on to consider each instrument feature of CBDCs in detail.
Availability and acceptability
A central bank digital currency should be available to everyone, without any exception and restriction, and recognized as legal tender for the country. However, CBDC availability can be limited to a predetermined group of users, e.g. commercial banks or Non-Banking Financial Institutions (NBFI).
As for acceptability, a CBDC should be just as usable and acceptable as cash in all types of transactions including point-of-sale and person-to-person.
In order to maintain the singleness and uniqueness of the national currency, a central bank should also guarantee the so-called at-par convertibility of a CBDC into cash or reserves. Such convertibility will help instill more trust amongst citizens and promote wider CBDC adoption.
Central bank digital currency payments should be as convenient to make as cash. Customers should be able to pay by tapping with a card or scanning a mobile phone so as to promote wider adoption and acceptance of CBDCs.
One of the key criteria for CBDC adoption is providing low-cost or no-cost CBDC payments. This will mean that end-users face minimal barriers to investing in technology and experience no financial hurdles.
What are the main system features of CBDCs?
To function properly and frictionlessly, CBDCs must meet certain system requirements. Without further ado, let’s take a look at some of the most important system features of central bank digital currencies.
It’s of paramount importance that both a CBDC’s infrastructure and its participants are highly resistant to cyberattacks, scams, and counterfeiting. Given that CBDCs are held in a digital wallet, citizens will normally use a mobile app or physical card to access them. This means that apps must be made resistant to any tampering and scams with the use of advanced security capabilities.
Another system feature worth mentioning is that a CBDC should be extremely resilient to operational failures and disruptions. And not only that: central bank digital currency must also be immune to natural disasters and electricity outages — in other words, it’s necessary to ensure CBDC resilience from all sides.
The entire central bank digital currency infrastructure should be very strong and be able to carry a high throughput. This means that a CBDC system should be capable of performing a high number of transactions per second.
The CBDC system should come with high-performing interaction mechanisms that provide excellent compatibility between private sector digital payment systems. This will consequently contribute to a better and more efficient flow of funds between systems.
Looking into the advantages of CBDCs
Central bank digital currencies have the potential to introduce us to new prospects. They can totally change our attitude towards money and provide us with substantial benefits such as greater efficiency, financial inclusion, a broader tax base, flexible monetary policy, and digital innovation.
Enhanced efficiency of processes
One of the greatest advantages of a CBDC is that it has the capability to reduce friction in existing payment systems. This in turn lowers monetary costs and boosts transaction speed while ensuring fast finalization.
Financial inclusion of the unbanked
Central bank digital currencies can be regarded as a reliable bridge to the world of finance for both banked and unbanked. It provides global access to electronic payment systems as well as numerous other products and services.
Broader tax base and prevention of illicit activity
CBDCs are also expected to bring about positive changes in the country’s tax net. They are set to limit tax evasion and even help generate more tax revenues. Because digital transactions can be traced, it’ll be next to impossible to use CBDCs for illegal activities, such as money laundering and terrorism financing.
Advanced and more flexible monetary policy
As an alternative means of payment, CBDCs can help preserve financial stability by offering relevant aggregated data for central banks. Carefully designed CBDCs could also simplify the implementation of non-distortionary helicopter money or central bank withdrawals because they do not rely on fiscal transfers.
On top of this, a CBDC would support the removal of low-value coins by delivering the electronic alternative. For example, in 2017 the Bank of Korea introduced a coinless society trial, enabling customers to load their change onto special prepaid cards rather than accepting small change from their purchases. As a result, the country managed to considerably reduce the costs of producing coins.
Encouragement of digital innovation
CBDC’s software model enables new firms to enter the payments sector more easily. This would then foster competition, stimulate innovation, and facilitate the globalization of services.
Considering the limitations of CBDCs
As well as multiple advantages, CBDCs also come with certain risks and limitations. Before starting to develop a CBDC and its surrounding infrastructure, it’s therefore advisable to consider what pitfalls may emerge along the way.
Loss of privacy
Even though CBDC promises to tackle the centralization issue, it’s important to understand that it won’t get over it completely as the central bank is still in charge of controlling transaction flow. In addition, when using retail CBDCs, users will be asked to provide sensitive data which will need to be processed by operators.
It’s unavoidable that there will be some technological issues. CBDCs are still terra incognita and a technical experiment for developers. CBDCs will require a great deal of time and effort to be properly designed and implemented, but the risk of security failures and design mistakes will remain. However, if you choose to hire a team of professional developers, you can be sure that the number of issues will be reduced to the barest minimum.
Slower economic growth
Once a CBDC is implemented, a central bank automatically becomes a direct competitor to payment service providers, which consequently means that commercial banks may lose income as people rush to withdraw funds in favor of central bank money. This will weaken banks and force them to put up interest rates on deposits to attract more customers, or else to increase interest rates on loans, in order to retain an adequate income.
Every innovation brings a certain amount of risk. The CBDC segment is still uncharted territory for the financial industry, and may therefore entail some regulatory risk. Regulators and governments worldwide may find it difficult to introduce viable and efficient tools and regulations to help properly govern the issuance and usage of CBDCs.
High development and maintenance costs
CBDCs are expected to substantially cut the printing and handling costs of cash. But it’s too early to tell if managing and launching CBDCs will be considerably cheaper. It’s important to consider the development, deployment, and maintenance costs of the CBDC infrastructure, the overall infrastructure cost (cloud or private), and software licensing prices. On top of this, the highest — and absolutely unavoidable — costs will be associated with network cybersecurity.
How does CBDC differ from cryptocurrency?
Though the concept of CBDCs stems from cryptocurrency, these are two completely different types of digital assets. The main difference between CBDCs vs cryptocurrency lies in centralization.
All cryptocurrencies are decentralized by default, meaning that no one can actually control them. Transactions are generally recorded and executed on the blockchain. As far as central bank digital currencies are concerned, they are controlled by banks, which means that they are centralized (thanks, Captain Obvious). This means that they do not provide the same level of anonymity as cryptos do since a central regulating body is there to supervise who owns what. So the two types of digital currency pursue different goals: CBDCs are designed to preserve the role of the global banking system while cryptos seek to democratize financial systems.
Also noteworthy is that while cryptocurrencies are always created on top of the distributed ledger, CBDCs can run on various technological platforms, with blockchain technology being one of them. In fact, blockchain per se can bring multiple benefits to CBDC development. Its smart contract programmability can support CBDCs as a novel form of a programmable monetary tool capable of initiating automated payments in accordance with pre-programmed conditions. Moreover, blockchain can introduce CBDCs to a wealth of other substantial bonuses such as highly transparent audit trails, customized confidentiality features, and a top level of interoperability with other digital assets via atomic swaps.
Overview of the most prominent CBDC projects across the globe
According to Kristalina Georgieva, the Managing Director of the International Monetary Fund, as of October 2021 “110 countries are ‘at some stage’ of CBDC development”.
However, it’s essential to point out that the use case for each CBDC must be carefully considered. Central banks will be better off if they carry out detailed research, ponder the motivations for issuing a CBDC, assess its risks and implications, and estimate how successful the CBDC project will be. All this could reveal that the country will not even benefit from CBDC implementation and should focus on other viable initiatives.
Moreover, a central bank has to decide which type of CBDC they will be launching — retail CBDC or wholesale CBDC. Retail central bank digital initiatives tend to be popular among emerging economies where total digitalization and financial inclusion are top priorities. Currently, the most prominent and live examples of retail CBDC adoption are in the Bahamas (the Sand Dollar) and Cambodia (Bakong Project).
Interbank/wholesale CBDCs, on the other hand, have drawn the attention of major economies. Because they usually have longer pilot stages, there are no live projects yet. However, some countries have risen to the challenge and launched pilot cross-border initiatives which are set to test connectivity and interoperability. Examples are Hong Kong SAR-Thailand, Singapore-Canada, Europe-Japan, and United Arab Emirates-Saudi Arabia.
Now let’s focus on five countries that have taken a keen interest in CBDC development and explore what progress they have made so far.
The Riksbank of Sweden has been analyzing the viability of e-krona since 2017.
The high penetration and usage of cards at the point of sale (POS) have contributed to the cashless economy in Sweden, and now the country seeks to explore and embrace a new means of payment.
So far, Sweden has provided excellent technical insights into its CBDC campaign. The Riksbank’s current vision of e-krona is that it should fulfill three key objectives: provide the general public with access to central bank money; strengthen the robustness of the payments system; promote competition and innovation. If or when launched, e-krona will serve the Swedish market. The target group is predicted to be EU as well as EES citizens who have economic ties to Sweden.
The initial e-krona pilot took place in December 2020. The Riksbank has also carried out an extensive review into the usefulness of having a digital currency within the country. The review is due to be completed by the end of November 2022.
Launched by the Central Bank of the Bahamas in October 2020, the Sand Dollar is one of two currently active retail CBDCs.
The Sand Dollar has the same legal status as the Bahamian standard currency (the Bahamian dollar) and is issued by authorized financial institutions. By introducing the CBDC, the Central Bank of the Bahamas is eager to become the leader in the financial services segment, reducing service delivery costs, increasing financial inclusion, and boosting transactional efficiency among financial services across the Bahamas.
On top of this, in February 2021 Mastercard and the Central Bank of the Bahamas signed an agreement that states that the former will issue a debit card supporting the Sand Dollar.
China is considered to be a front-runner in the global race to introduce a central bank digital currency. Back in 2014, the People’s Bank of China (PBoC) started developing its retail CBDC and in early 2021 it was already piloting its digital currency (digital yuan), carrying out testing in major cities such as Shenzhen, Beijing, and Shanghai. Noteworthy is that China has promised to prepare for widespread domestic use of the digital currency during the Winter Olympic Games (February 2022).
As of October 2021, China’s CBDC has been used to carry out around 62 billion yuan ($9.7 billion) of transactions, which looks rather impressive for a pilot stage.
The Digital Currency Electronic Payment (DCEP) project by the People’s Bank of China aims to enhance the efficiency of its payment system, replace cash, and ensure better security of P2P transactions. According to the central bank, DCEP transactions are designed to be registered and fully traceable. The transaction process will be augmented by data mining and big data analytics, which will help the PBoC have total control over CBDC usage.
The National Bank of Cambodia started considering the idea of implementing a CBDC back in June 2018. Project Bakong, a DLT-powered interbank payment system supporting transactions in Cambodian riel and US dollar, was launched in October 2020, making Cambodia the first country in Asia to introduce such a system.
In Cambodia, not all citizens have bank accounts. Though they use mobile phone-based accounts for transferring and saving money, they don’t have enormous trust in them. In addition, they face challenges when transferring money to individuals with different mobile apps.
The new blockchain-powered system has been designed to support financial stability and in a way that encourages citizens to adopt bank accounts. Bakong is poised to increase the country’s financial inclusion, enable interbank transactions, and, above all, promote transactions in Cambodian riels.
Another prominent feature of Bakong is that it aims to simplify access to credit for small and medium-sized enterprises as well as offering targeted lending products to micro-businesses.
In August 2021, the Bank of Korea (BoK) launched its pilot trial to test the potential and usefulness of a digital currency (e-won).
South Korea opted for blockchain technology to design its CBDC. In July 2021 it was announced that the BoK chose Ground X — a blockchain subsidiary of Kakao — as the winner of the CBDC tender and appointed it to be responsible for the development of the blockchain functionality. Samsung Electronics and Samsung SDS have also joined the consortium. Together with Ground X, they will be responsible for executing the simulation project consisting of the CBDC’s issuance, distribution, remittances, and payment in the virtual world.
Central bank digital currencies are undoubtedly a groundbreaking notion in the sphere of financial services. They have the potential to contribute to the modernization and enhancement of international monetary infrastructures and enable many more citizens to become part of the financial system of their country.
However, CBDCs come with certain risks and limitations. Before venturing into CBDC development, every central bank should carefully consider the viability and usefulness of retail or wholesale CBDC implementation and look into their challenges, which include regulatory and technological vulnerabilities as well as high development and maintenance costs.
But one thing is certain: CBDCs are the drivers of future progress and we’re on the verge of something really great.
When working on a CBDC project, it’s essential to find a trustworthy professional partner who will guarantee the frictionless development of the digital currency. The delivery team should ideally be well-versed in blockchain too, since a number of existing CBDC initiatives have favored this technology due to its many benefits, including better security and data protection.
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