Central Bank Digital Currencies (CBDCs): A New Chapter in Money Evolution

In 2023, Central Bank Digital Currencies (CBDCs) have taken significant strides towards becoming a reality, marking a new era in the evolution of money. From the European Central Bank's (ECB) preparation for a digital euro to innovative cross-border projects, the landscape of digital currencies is rapidly changing.

What is CBDC? A simple guide for grandma.

CBDC stands for Central Bank Digital Currency. It is a new kind of money that you can use on your phone or computer. It is like the money you have in your bank account, but it is issued by the central bank of your country. The central bank is the one that controls the money supply and the interest rates in your country.

Some people think CBDCs are good because they can make payments faster, cheaper, and more secure. They can also help people who do not have bank accounts or access to financial services. They can also help the central bank to manage the economy better.

But some people think CBDCs are bad because they can cause problems for the banks, the privacy, and the freedom of the people. They can also make other countries lose their power and influence.

CBDCs are still not available in most countries. They are still being tested and studied. No one knows for sure what will happen if they become widely used. CBDCs are a big change for the money and the payment system. They have both benefits and risks.

Global Progress

130 countries, representing 98% of global GDP, are now exploring CBDCs. This includes 64 countries in advanced stages of CBDC development, like launch, pilot, or development phases. Such widespread exploration signifies the increasing interest and perceived potential of CBDCs in reshaping the global financial landscape.

93% of central banks are engaged in CBDC development, while nearly 20% are expected to issue a digital currency in the near term.

Key Developments in Major Economies

1. European Central Bank (ECB) and Digital Euro Pilot in 2023: The European Central Bank (ECB) is actively working on a digital euro project. This effort is part of a broader movement among central banks worldwide to explore and potentially implement central bank digital currencies (CBDCs).
2. China's Digital Yuan Pilot: China's digital yuan has been piloted with a reach of over 260 million people and has been tested in more than 200 scenarios. This makes it a prominent example of a large-scale application of a CBDC.
3. United States and Wholesale CBDC Development: The United States has been focusing on the development of a wholesale CBDC. This interest has increased due to recent geopolitical events, such as Russia's invasion of Ukraine, highlighting the need for secure cross-border digital transactions.
4. India and Brazil's Plans for CBDC Launch in 2024: Both India and Brazil are planning to launch their respective CBDCs in 2024, indicating a significant step towards a more digitalized financial system.
5. G7 Countries' CBDC Prototypes: Other major economies within the G7, such as the United Kingdom and Japan, are in the process of developing CBDC prototypes. These efforts include consultations with public and private sectors on issues related to privacy and financial stability

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Cross-Border CBDC Projects

Cross-border wholesale CBDC projects have doubled in response to recent global events. These projects, such as those undertaken by the Bank of International Settlements, focus on enhancing efficiency in international trade and payments. Such projects include:

1. Project Jura: Involving the Banque de France, the Swiss National Bank, and the BIS Innovation Hub, along with a private sector consortium, Project Jura focuses on testing the direct transfer of euro and Swiss franc wholesale CBDCs between French and Swiss banks using a DLT platform. It also explores the settlement of tokenized assets and forex trades using CBDCs.
2. Project Inthanon-LionRock: This project, involving the Bank of Thailand, the Hong Kong Monetary Authority, the BIS Innovation Hub, and banks from Thailand and Hong Kong, tests cross-border payments and forex transactions using Thai baht and Hong Kong dollar wholesale CBDCs on a DLT platform. It also explores the use of smart contracts and atomic settlement.
3. Project Dunbar: This involves the Reserve Bank of Australia, Bank Negara Malaysia, Monetary Authority of Singapore, South African Reserve Bank, and the BIS Innovation Hub. It tests cross-border payments and forex transactions using multiple wholesale CBDCs on a single DLT platform, focusing on the interoperability of different CBDC platforms and the use of multi-CBDC arrangements.
4. Project Mandala: Involving the Reserve Bank of Australia, Bank of Korea, Bank Negara Malaysia, Monetary Authority of Singapore, and the BIS Innovation Hub, this project tests the automation of compliance for cross-border transactions using CBDCs, tokenized deposit payments, and cross-border borrowing. It also focuses on the use of smart contracts and digital identity.

The Motivation Behind CBDCs

• Financial inclusion for unbanked and underbanked populations. CBDCs can provide access to digital payments and savings for people who do not have bank accounts or face high costs and barriers to using traditional financial services.
• Competition and resilience in domestic payment markets. CBDCs can increase the diversity and innovation of payment options, reduce the dominance of private payment providers, and enhance the security and reliability of payment systems.
• Increased efficiency and lower transaction costs. CBDCs can enable faster, cheaper, and more transparent payments and settlements, both domestically and cross-border.
• Programmable money to improve transparency in money flows. CBDCs can be embedded with smart contracts and digital identities, which can facilitate the automation of compliance, taxation, and reporting, as well as the tracking and verification of transactions.
• Seamless flow of monetary and fiscal policy. CBDCs can enhance the transmission and effectiveness of monetary and fiscal policy, by allowing direct and targeted interventions, such as helicopter money or negative interest rates.
• Innovation and modernisation of the payment system to keep pace with the digital economy and consumer preferences.
• Sovereignty and security of the national currency in the face of the emergence of private digital currencies and foreign CBDCs.
• Financial stability and monetary policy transmission in a scenario of declining cash use or increased demand for alternative forms of money.

Critics

Traceability and lack of anonymity: CBDCs would allow the central bank and the government to monitor and track every transaction made by the users, potentially violating their privacy and exposing them to censorship, surveillance, and coercion.

Disintermediation and financial instability: CBDCs would compete with bank deposits as a form of money, which could reduce the profitability and liquidity of the banking sector. If the users prefer to hold CBDCs rather than bank deposits, the banks would have to rely more on wholesale funding or central bank lending, which could increase their funding costs and risk exposure.

Technical and operational challenges: CBDCs would require a robust and secure technological infrastructure that can handle a large volume and variety of transactions, as well as ensure the resilience and reliability of the payment system. CBDCs would also pose significant operational risks, such as cyberattacks, fraud, theft, human error, and system failure, which could compromise the integrity and availability of the CBDCs.

Loss of freedom and sovereignty: CBDCs would give the central bank and the government more power and control over the money supply and the payment system, which could undermine the autonomy and independence of the users and the market participants. Additionally, CBDCs could threaten the sovereignty and competitiveness of the countries that do not issue CBDCs, as they could face the risk of dollarization or digital colonization by the dominant CBDC issuers.

FIN.

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