The continuous development of crypto-assets and blockchain industry has brought new opportunities to the fintech area, specifically regarding the issuance and use of currency or other forms of digital assets. Our geopolitical, economic and social environment has created new expectations for secure, reliable, easy-to-use, globally available digital payments and means of exchange. This has inspired central banks to analyse the potential benefits of central bank digital currencies (CBDC).
According to a survey from the Bank of International Settlements, which includes 66 banks reaching 75% of the world’s population and representing 90% of its economy:
- Over 70% of central banks could potentially issue a digital currency with time.
- 1.6 billion people could have access to CBDCs in the next three years.
- Ten percent of the banks stated that they would issue the first general-purpose CBDCs in the next three years, reaching 20% of the world’s population.
CBDC is a new form of digitized sovereign currency, generally conceived to be equal to physical cash (general purpose) or reserves held at the central bank (wholesale):
- General purpose CBDC could be considered a new form of traditional curency, along with banknotes. It must be compared to other digital money solutions such as stablecoins.
- Wholesale CBDC, which is very different from general purpose, could be considered a new form of monetary policy instrument for financial institutions.
The implementation of a CBDC is complex and the implications are wide‑reaching. Policy‑makers find themselves in uncharted territories when attempting to evaluate the potential benefits and trade‑offs associated with CBDC. Both academics and central banks have started to analyse merits and dangers of introducing this new form of digitized sovereign currency.
The development of stablecoins, which are crypto-assets pegged to a stable asset, anchor the discussions on CBDC. Indeed, stablecoins, although different from CBDC, are suitable as means of payments. They would be expected to substitute banknotes and/or sight deposits with banks. They have currently a market cap over $5B USD. Other crypto-assets are not particularly suitable as means of payment as their value fluctuates heavily.
Pros and cons
Most countries today are analyzing the potential of CBDC, seeing it as a means for governments to maintain their role as issuers of national currencies. Yet the introduction of a CBDC would itself mean major changes to the existing monetary system and would raise a number of fundamental economic, monetary policy and legal questions. There is heated debate on the subject in both banking and academic circles.
Currently, central bank money is composed of physical cash (coins and bills) and reserves held at the central bank by financial institutions with access to the central bank’s deposit facility. CBDC would constitute a third form of central bank money.
CBDC could potentially be used as a tool to achieve policy objectives such as improved safety and resilience in payments systems; increased efficiency, access and competitiveness of payments systems; better data transmission and reporting to central banks; and financial inclusion. Core advantages seen by most economists and central bankers include making central bank money available to everyone, strengthening the availability of retail payments.
But CBDC also caused strong concerns, with regards to the risks of structural disintermediation of banks and of facilitation systemic runs on banks in crisis situations. It is therefore essential for existing institutions to be able to steer the issuance of CBDC in such a way that it serves the efficiency of retail payments, without necessarily putting into question the monetary order by making CBDC a major form of store of value.
Indeed, if households substitute commercial bank deposits with CBDC, commercial bank deposit funding could see higher instability. This raises fundamental issues that go far beyond payment systems and monetary policy transmission and implementation. This issue could be solved by applying negative interest rate and limiting the amount of CBDC individuals can possess and transact. But this could make a general purpose CBDC unattractive from a business standpoint.
For these reasons, central banks in Emerging Market Economies are moving more rapidly toward issuing general purpose CBDCs than those in established countries, that appear to be taking a more cautious stance on the transition from fiat currencies to digital. This is driven by historically issues in payment efficiencies, safety and financial inclusion. Central banks in more advanced economies may see less of a need for radical change and development.
The issuance of a wholesale CBDC can enhance the international role of an international currency by fostering the development of an associated digital ecosystem. Indeed, the international dominance of the dollar is due to important network effects, lower user costs than in other financial ecosystems (availability of market infrastructures and payment systems, depth and homogeneity of capital markets). Access to a wholesale CBDC can naturally enhance the international role of a currency. It is likely that the first large country issuing such a currency will benefit from a first mover advantage. Conversely, the status quo could mean accepting that private or decentralized initiatives will satisfy the demand for a quality digital currency.
Transaction validation for CBDC can occur with a single party such as the central bank validating transactions, or in a decentralized manner with multiple parties validating transactions using blockchain and distributed ledger technology (DLT). Most likely, DLT-based CBDC would operate best within a closed “permissioned” network of pre‑identified validating parties that use simpler and resource‑efficient consensus algorithms such as “proof of authority”. The central bank could remain a validating node if desired, and regulators or other institutions could participate as additional validating nodes or observer nodes where they could have validating or view privileges. The attractiveness of CBDC for payment purposes will depend on other features like remote internet access, mobile phones and cards, periodic payments to other accounts, debit orders, user-defined maximums for different types of transfers, etc.
CBDC will be launched only if central banks can be confident that its associated issues — undesired structural disintermediation of the banking system, and avoidance in systemic crises of a facilitation of aggregate bank runs — have been solved. Central banks need to ensure that implications of major changes are well understood. They are somewhat opened to studying CBDC, although the overall business case and the precise risks to change the financial system in a disruptive way deserve further analysis. The overall business case for CBDC will also still depend on preferences of households as money users and voters. In progressive countries, in which the use of banknotes falls rapidly and in which electronic payments have become the normal, a business case for CBDC seems relatively plausible.
From the financial institution point of view, the issuance of a retail CBDC could be motivated by the desire to curb the growth of crypto-assets like Bitcoin. A CBDC could discourage speculation on crypto-assets, which would become less attractive compared to a retail CBDC, which has the advantage of being a real payment instrument. But on the other hand, the co-founder and managing partner of Woodstock Fund, a multi-asset investment fund, shared its opinion on the topic:
“As CBDCs are rolled out, more and more people will want to understand what a digital currency is. Some will ignore them, and some will explore them further, leading to a net positive gain in the crypto-asset ecosystem. Developers will build tools that will allow for seamless exchange between CBDCs and crypto-assets, and the race for digital currency supremacy will take center stage in this decade.”
As consumers become more comfortable using digital means to exchange value, the transition to CBDCs is a natural progression. Once users are aware how easy CBDCs are to use, they could be keen to invest and experiment with crypto-assets.
 Central Bank Digital Currency Policy-Maker Toolkit, World Economic Forum
 Tiered CBDC and the financial System, European Central Bank
 La monnaie digitale de Banque Centrale, Banque de France
 Central Banks and the Future of Digital Money, Consensys
 Not All Central Banks Have an Interest in CBDCs, Cointelegraph