Central Bank Digital Currencies
The development of central bank digital currencies (CBDCs) is currently being studied or considered in the majority of countries in the word, and research has shown that key factors for developing successful CBDCs include low demand for cash and/or with a lacking infrastructure for digital payments, user-friendly technological support for consumers to access CBDCs, cooperation with the banking/finance sector, and high levels of consumer confidence in the government. Countries like Uruguay and Barbados are among the earliest to test and launch CBDCs within nationalist payment systems. Within countries that decide to launch, CBDCs have the potential to significantly disrupt the operation of private businesses involved in credit lending, standard banking, and digital payment platforms unless countries develop payment partnerships with private companies to manage the use of CBDCs. Several countries, including China, France, and the Republic of the Marshall Islands, have officially announced their interest in developing CBDCs.
Key Success Factors for Developing CBDCs
Low Demand for Cash and/or Lacking Infrastructure for Digital Payments
- The rate of cash usage affects how useful a CBDC can be within a specific country or region. According to the European Central Bank (ECB) President, Mario Draghi, "there [is] 'no concrete need' to issue an additional currency within the eurozone at the moment, because the demand for cash banknotes 'continues to grow' in the EU." This position has been supported by Germany, whose Federal Ministry of Finance believes there are "no convincing reasons for issuing digital central bank money for a wide range of users in Germany and the eurozone...[and] that the potential benefits of a CBDC –– namely high-speed bank transfers –– could also be achieved in other ways."
- In Sweden, the country's central bank, Riksbank, began to develop its CBDC, e-Krona, for testing due to "the steeply dropping popularity of cash in the country."
- However, in countries that use less cash, having an existing infrastructure for digital payments is a barrier to countries' willingness to develop and launch a CBDC. After conducting research into the viability of a CBDC in Switzerland, the Swiss National Bank (SNB) has determined that CBDCs are unlikely to be useful to the general public. Originally, the board director of the SNB has stated "that cryptocurrencies and blockchain are not innovative enough to consider issuing a state-backed digital currency...arguing that cryptocurrencies merely imitate already existing products — such as 'digital shares, bonds, vouchers'."
- Switzerland is currently considered "the most crypto- and blockchain-friendly country in Europe" which means that there is little incentive for consumers to adopt a new digital payment system or for the government to develop a CBDC. This has been contributed to the low level of cash usage in the country, which means consumers and retailers have already integrated cryptocurrency and private digital payment platforms.
- Similarly, in Hong Kong, the government has announced its lack of interest in issuing a CBDC, "citing the existence of an already efficient payment infrastructure."
- Like Switzerland, Japan also has relatively high adoption rates of cryptocurrency, and Bitcoin is already recognized as an acceptable method of payment in the country. In October 2019, Masayoshi Amamiya, Deputy Governor of the Bank of Japan (BoJ), "expressed his doubts regarding the effectiveness of CBDC, adding that his agency won’t be issuing its digital currency in the near future.
- In contrast, Iran has begun developing its CBDC after "banning local banks from all crypto dealings," which means that the CBDC the country develops will not be competing for adoption in favor of already established blockchain currencies.
- In the Republic of the Marshal Islands, despite the country's heavy reliance on cash currency, the country plans to develop a CBDC to improve rates of financial inclusion with digit payments because "due to geographic isolation, the tiny Pacific nation is on the verge of losing its financial connection to the rest of the world, as the only bank that operates in the country considers closing its unprofitable branches." Barbados has developed its CBDC for similar reasons to help deliver "digital payments and transfers instratucture" for both businesses and consumers.
Technological Performance/Access to CBDCs
- Research from the European Central Bank has indicated that a major reason that the bank is not prepared to develop a CBDC in the near future is that "technologies which could potentially be used to issue a central bank digital currency, such as distributed ledgers, have not yet been thoroughly tested and require substantial further development' before the Central Bank would consider using them."
- The case study of the Petro, a digital currency backed by oil in Venezuela, has also revealed the central importance of user-friendly technological platforms for a digital currency. If countries want to avoid the failures of the Petro, their central banks need to develop CBDC platforms that "offer a margin of speed and ease of use over non-state competitors, such as Bitcoin."
- According to the Bank of International Settlements (BIS) in its study of central banks developing or researching CBDCs, "Users expect faster, easier payments anywhere and at any time, mirroring the digitalization and convenience of other aspects of life."
- Research from the Official Monetary and Financial Institutions Forum (OMFIF) has shown that "maintaining competitive payments systems (against private-sector alternatives) is the most significant factor motivating CBDC efforts" in countries that are considering CBDC development. This consideration has driven Turkey's development of its CBDC, the Lira, and the "development of a software platform for instant payment."
- Additionally, a major consideration in the development of a CBDC is the controlling government's ability to keep payments private for consumers but simultaneously traceable by government officials who need to monitor tax evasion, bribery, money laundering, and terrorism funding.
Cooperation with Commerical Banking & Finance Sectors
- A number of countries have concluded that a significant threat of using CBDCs is that developing one could bring instability to the banking and finance sectors. According to experts in economics and public policy, the adoption of a CBDC could displace existing private payment companies and banks in a country as consumers switching to keeping their funds exclusively with that country's central bank.
- As a result, the banking and finance markets would contract, which would result in the threat of bank runs due to the financial instability of only having a limited number of banks handling consumer deposits.
- This perspective is shared by many public officials who have studied the implications of using a CBDC, including Swiss National Bank Director Thomas Moser, who has said that "although there was initial interest among central banks in issuing CBDCs, 'enthusiasm has slowed again because of the implications it would have for financial stability.'" The governor of the People's Bank of China (PBoC), which has been consistently working toward developing a CBDC, has expressed that "that the PBoC 'must prevent substantial and irreparable damages' to the domestic economy".
- The Bank of Japan has publicly said that CBDCs have "a negative impact on the existing financial system," a view that aligns with much of the research that countries considering a CBDC have conducted.
- To combat this issue, some experts have suggested that the best way to avoid the financial instability CBDCs could cause would be to develop partnerships with private companies as part of the launch of a CBDC. These suggestions include plans to integrate payment systems with existing payment players or banks or to develop a system where the central bank lends out consumers' deposits to private financial companies.
Consumer Confidence in Government
- Another threat to the success of a CBDC is a lack of consumer confidence in the government. Although it was not strictly a CBDC, the example of Venezuela's Petro, a digital currency backed by oil shares, the government did not have the consumers' trust or willing cooperation in the adoption of this currency.
- Part of the problem was that "the Venezuelan government [seemed] to actively force Petro upon local citizens ahead of its public launch. For instance, Petro was recently made the only currency that Venezuelans can pay their passport fees in, while also increasing the fees: from October 8, a new passport costs 2 petros, and an extension costs 1 petro. The average monthly minimum wage in Venezuela, as Bloomberg reports, is four times less than the cost of the raised passport fee."
- Additionally, "the Petro lacked credibility at home and internationally, squeezing it out of any potential global markets and leaving it dead on arrival." While the oil-backed currency could have potentially succeeded with consumers, the was little "faith in the Venezuelan government to do what it said it was going to do regarding oil extraction."
- In Singapore, the managing director of the country's central bank, the Monetary Authority of Singapore has said that the rate of adoption of CBDCs would be controlled by how much trust consumers have in the central bank in comparison to how much they trusted private banks.
How CBDCs Are Linked to Nationalism in Payments
Case Study #1: Uruguay
- Starting in November 2017, the Central Bank of Uruguay conducted a pilot testing of the country's general-purpose CBDC that would allow consumers to send digital payments from mobile phones and other platforms.
- The test was developed as "part of a wider governmental financial inclusion program, which began in 2011, aiming for greater access, labor market formalization, and payment system efficiency. Since these efforts began, the availability of ATMs and other cash dispensing mechanisms has grown enormously but cash withdrawals have plateaued (Graph C) and cash in circulation has fallen."
- To test how its CBDC could make digital payments available for more consumers, during the pilot test, "unique digital banknotes in several denominations were issued for distribution to an e-note manager platform.' The platform acted as registry of the ownership of the digital banknotes. DLT was not used. In total, 20 million e-Pesos were issued, of which 7 million were distributed by a third-party PSP, which held an equivalent value of pesos in a central bank account. Individual users and businesses, in electronic wallets, could hold a maximum of 30,000 e-Pesos (roughly USD 1,000) and 200,000 e-Pesos respectively. Transfers took place instantly and peer-to-peer, via mobile phones using either text messages or the e-Peso app. The Central Bank of Uruguay’s legal mandate was sufficient to issue the electronic e-Peso as a complement to physical cash."
- The test ended 6 months later, in April 2018, and the country declared it a success. Currently, the CBDC development plan is being evaluated to determine if additional tests or needed or if the CBDC can be issued permanently. The country's considerations "include design-specific challenges...how best to manage the stock of digital banknotes in different denominations as well as wider questions... [for example] the level of anonymity the e-Peso would have, whether it would bear interest, the final role of the central bank and what the wider impact on businesses and the economy would be."
Case Study #2: Barbados
- In February 2019, "the Eastern Caribbean Central Bank (ECCB) and the Barbados-based fintech company, Bitt Inc. (Bitt) [signed] a contract to conduct a blockchain-issued Central Bank Digital Currency (CBDC) pilot within the Eastern Caribbean Currency Union (ECCU)." The pilot, which began in March 2019, consisted of 12 months of development and testing, followed by a 6-month implementation phase.
- To improve the success rate of the pilot, the ECCB implemented education programs to improve public engagement and use of the Eastern Caribbean Dollar (DXCD).
- According to the contracts, "the digital EC dollar [would] be distributed and used by Licensed Financial Institutions and Non-Bank Financial Institutions in the ECCU. The DXCD will be used for financial transactions between consumers and merchants, including peer-to-peer transactions, all using smart devices. For example, an individual in St Kitts and Nevis will be able to send DXCD securely from his/her smartphone to a friend in Grenada in seconds — and at no cost to either party."
- During the implementation phase, the ECCB determined that "small merchants on the island of Barbados have been able to reduce the costs for accepting electronic payments, save costs for securing cash, and start selling online."
- Because it is issued by the ECCB, which serves Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, the DXCD can be used between consumers in these countries, making digital transactions much more accessible in the region. "For example, an individual in Anguilla would be able to send DXCD securely from their smartphone to someone in Grenada. The press release stipulated that such transactions would, purportedly, take seconds and entail no fees." (4)
- According to a representative from the ECCB, "the rationale for a digital EC dollar is 'centered around policy goals of financial inclusion, competitiveness, and economic growth.' The ECCB’s 2017–2021 strategic plan aims to 'ensure a strong, diversified and resilient financial sector,' reduce cash usage within the ECCU by 50%, and 'actively promote the economic development of [ECCB] member territories.'"
- Additionally, ECCB Governor Timothy Antoine has "invited non-bank financial institutions, which provide wallet services, telecommunication service providers and other technology companies to join the effort" to improve the financial inclusion of ECCB member countries.
Potential Impact of CBDCs on International Payment Players
- The Bank of International Settlements (BIS) conducted a study of over 90% of countries' central banks and found that "in the short term, over 85% of central banks see themselves as either somewhat unlikely or very unlikely to issue any type of CBDC (Graph 8). No central banks are very likely to issue a wholesale CBDC in the short term, but two EME central banks are considering issuing a general-purpose CBDC over the same horizon."
- However, these insights into the potential impact of CBDCs on international payment players still give important information into how payment players could be affected in the future based on what type of CBDCs countries choose to issue. The two main types are general-purpose, which allow consumers to keep funds directly with the central bank, or wholesale, which are mainly used between the government and financial institutions and large businesses. As the BIS study reports, "beyond the short term, an increased proportion of central banks consider the issuance of both types of CBDC to be possible."
Disruption to Lending/Credit
- A major concern of issuing CBDCs is that research has found that "they would disrupt the current fractional-reserve system through which commercial banks create money by lending out more than they hold in liquid deposits. Banks need deposits in order to make loans and investment decisions. If all private bank deposits were to be moved into CBDCs, then traditional banks would need to become “loanable funds intermediaries,” borrowing long-term funds to finance long-term loans such as mortgages."
- As a result of these findings, officials in many central banks, including that of England, Germany, and the European Union, have expressed reluctance to risk the damage to the lending industry from issuing a CBDC. However, experts in economic policy have suggested that countries that issue a CBDC should develop public-private partnerships to avoid consumers exclusively keeping money in central banks. In countries that choose to go this route, there would be less risk to lenders.
Displacement of Private Digital Payment Systems
- The risk that consumers would start to exclusively store funds with central banks means that they would be much more likely to use internal digital payment processes to transfer funds or pay retailers. In a paper discussing the potential effects of a CBDC designed to be used for retail payments, the Bank of England has said "that a 'very successful CBDC could displace existing payment systems and ultimately reduce diversity of payment options, creating a new form of concentration risk'...the prospect of the introduction of CBDC could potentially discourage innovation in existing payment systems, potentially delaying other initiatives that could enhance resilience, speed, and efficiency.'"
- Professor of Economics at the Stern School of Business, New York University, Nouriel Roubini shares this perspective, stating that "CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies."
Reduction of Standard Banking with Private Companies
- The BIS study on countries research and/or development of CBDC found that the majority of countries are investigating the effects of using a general-purpose CBDC, which increases the chances that standard banking (checking and savings accounts) would be replaced with the use of CBDC digital wallets managed by the issuing central bank. While over 50% of countries researching CBDCs are considering both general-purpose and wholesale CBDCs, around 33% are only focusing on a general-purpose CBDC.
- Giving consumers and retailers access to accounts with central banks would completely change the current structure of most countries' financial systems, because "as matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system."
- Changing this aspect of how central banks operate would eliminate consumers' need for cash and standard checking and savings accounts.
- Despite the fact that countries issuing general-purpose CBDCs would have to invest significant resources into developing the operational and technological infrastructure for managing consumer digital wallets, the BIS study found that "overall, the likelihood of issuing both types of CBDC is somewhat similar, despite the perceived greater operational complexity and larger impact on the financial system of a general-purpose."
Potential Partnerships with Central Banks
- The threat that the adoption of general-purpose CBDCs poses to the financial industry, the banking industry, and the lending industry has contributed to many countries' current disinterest in developing a CBDC in the near future. However, experts have suggested the best way to combat this issue would be to develop public-private partnerships with private companies.
- These partnerships have been suggested in two main forms: allowing private companies to manage the digital wallets and/or having central banks loan deposits out to private banking companies whose customers switch to public banking.
- According to officials from the International Monetary Fund (IMF), having private companies manage the consumer interactions with CBDCs would provide financial stability, allow payment platforms to continue to innovate, and reduce costs for introducing a CBDC for central banks.
- Additionally, the Managing Director of the IMF, Christine Lagarde, has spoken on these proposed public-private partnerships: "'Individuals could hold regular deposits with financial firms, but transactions would ultimately get settled in digital currency between firms, she explained recently at the Singapore Fintech Festival. 'Similar to what happens today, but in a split-second.' The advantage of this arrangement is that payments 'would be immediate, safe, cheap, and potentially semi-anonymous.' Moreover, 'central banks would retain a sure footing in payments.'" This would allow international payment players the opportunity to not only keep its foothold in payment processing but potentially increase its customer base as CBDCs would increase rates of financial inclusion in areas where digital payments have not yet become common or feasible.
Reduced Transaction Costs in High-Inflation Countries
- Overall, the main incentives for developing a CBDC appear to be the reduction in costs of printing cash and the ability to increase financial inclusion in developing nations.
- In countries like Barbados, the Marshall Islands, the Bahamas and Uruguay, a major incentive for developing CBDCs is the countries' lack of infrastructure for digital payments, which a CBDC would be able to fill. A bank of International Settlements study found that for developing countries with high levels of inflation, introducing a CBDC could reduce the cost of performing digital transactions. This could be an opportunity for international payment players to affordably develop business in these countries' central banks if they develop partnerships with private companies, as Barbados has indicated it plans to do.
Little Effect on International Payments
- The BIS study of countries investigating CBDCs found that using a CBDC for international payments and exchanges was among the least important considerations for the majority of countries.
- This is especially true for developed countries. The study found that for those countries, "cross-border payments efficiency is the least important... [and] in contrast, for advanced economies, payments safety and financial stability are the primary motivators for potential issuance." This indicates that countries launching CBDCs in the near future are unlikely to invest resources into developing cross-border payment platforms, which means less competition for international payment players in international transactions.
Countries with Officially Announced Interest in CBDC Development
- In December 2019, the Bahamas' CBDC, the Sand Dollar, was launched and "it will undergo a pilot phase testing in Exuma, which will be extended in the first half of 2020 to Abaco."
- In February 2019, in Barbados, "a watershed contract was signed between the ECCB and Barbados-based fintech company Bitt Inc. to conduct a blockchain-issued Central Bank Digital Currency (CBDC) pilot project within the Eastern Caribbean Currency Union."
- As of March 2020, France has been "calling for [business] applications to experiment with the use of a digital euro, aiming to explore the potential CBDC opportunities for clearing and settlement of tokenized financial assets. Although the Bank of France previously called for blockchain-based settlement systems in Europe, the bank said that it doesn’t impose any specific technology within its newly announced CBDC experiment program."
- In February 2020, Sweden began testing its CBDC, the e-Krona, which it has been working on since 2017.
- In July 2019, Turkey "announced that the country is considering a centrally controlled cryptocurrency through the Central Bank of the Republic of Turkey (TCMB)... The development plan covers the Turkish national plans for development in various sectors including finance and technology through the year 2019 to 2023." Recently, President Erdogan has said that Iran plans to finish the CBDC by end of 2020.
- The Marshall Islands announced in September 2019 that it "is proceeding with the creation of a blockchain-based national currency, the Marshallese sovereign or SOV."
- Iran announced in July 2019 the upcoming launch "the country’s first cryptocurrency issued under permission of the Central Bank of Iran (CBI)."
- Senegal "issued its blockchain-based eCFA — named after the CFA franc, the Senegalese paper-based fiat currency — in December 2016."
- In November 2019, the central bank of Tunisia publicly stated that it was " considering a CBDC...[and] studying 'all existing alternatives. But there are no immediate plans for an E-Dinar to go live."
- The United Arab Emirates (UAE) and Saudi Arabia announced in January 2019 "an agreement to collaborate on the creation of a cryptocurrency for cross-border trading, confirming previous reports."
- Uruguay announced its plan to conduct a six-month pilot of a CBDC of the Uruguayan peso in November 2017.
- The Monetary Authority of Singapore announced in June 2017 that it would be releasing a study on the development of "tokenized form of the Singapore Dollar" in collaboration with blockchain consortium R3.
- "In May 2019, more details were published. Thus, the CBDC project, dubbed Inthanon, has been developed by blockchain consortium R3 and global IT company Wipro Limited to be used for interbank settlements in Thailand, according to the latest press release. Specifically, the solution will reportedly be used by the BOT and eight local commercial banks." Thailand (20)
- In August 2019, "a senior official at China's central bank announced at the China Finance 40 Group meeting...that the country will soon roll out its central bank digital currency (CBDC.)"
- In October 2017, President Vladimir Putin "announced Russia would be issuing its own state-sponsored cryptocurrency, currently known as the CryptoRuble."