Updated: Aug 25
We’ve all heard the hype about ‘Britcoin’, but what is CBDC really all about?
Are governments seriously considering introducing their own cryptocurrencies? (spoiler alert – No).
In this session, we’ll take a look at central bank digital currencies – what are they, what are their benefits, and what does adoption of a CBDC mean for a country, its economy, financial institutions, businesses, and citizens?
We’ll look at how different design considerations give rise to different CBDC features, and also discuss some of the CBDC projects in flight around the world.
What does digital central bank currency mean for us?
With us today we have expert Jannah Patchay.
Jannah is the founder of Markets Evolution, a consultancy specialising in financial market simulation and helping financial institutions and fintechs to define, develop and execute their commercial strategies in highly regulated environments. She is a leader in CBDCs, central bank digital currencies.
CBDC, what is a central bank digital coin?
Central bank digital currencies sometimes mean slightly different things to different people.
Fundamentally, the easiest way to tell you what a central bank digital currency is to explain what it’s not. Central bank digital currency is as the name implies, a digital native form of central bank issued, otherwise known as fiat, currency.
And people often ask “well what do you mean by digital native?” because if we look at the money we use today when it’s not cash and increasingly it’s not cash these days, we’re transferring money to each other’s accounts through our online banking and we’re paying by card.
At the end of the day, there’s no expectation that wheelbarrows full of cash are going to be exchanged between financial institutions any longer. Arguably we already have digital forms of money.
Fiat VS Central Bank Digital Currency
What’s the difference between that and a central bank digital currency?
The digital money that we have today if we look at commercial bank money, is the money that we typically transact with digitally. These evolved over decades, verging on centuries, and the systems that they’ve evolved on are based on some underlying assumptions.
One of which is that there are actually wheelbarrows full of money being exchanged at the end of the day. And because this design has happened organically, these forms of digital money have evolved organically over the years. They also face the same constraints as money did decades ago when wheelbarrows of cash had to be exchanged in order to settle between banks. For example, when we look at a lot of the constraints on legacy payments infrastructure, things like multi-day settlement. If you transferred money from your bank account to someone else’s, it would take three days to reach there and it wasn’t just floating in the ether for three days.
Those latencies existed in systems because of the expectation of physical settlement in the first instance. With the advent of faster payments, payment systems have been upgraded to deal with a more instantaneous settlements. But to a large extent, there are a number of inbuilt inefficiencies, based on historical and outdated assumptions that are built into the money that we have now.
Central Bank digital currency is a digital native form of money. It’s what would happen if we set up the user requirements for money today. We design the solution to address those using the technology that we have today.
What is the type of money, the central bank-issued money that we could design if we didn’t have the technology constraints of the past hanging over us?
What sort of changes can CBDCs do over the money that we currently have?
When I talk about the benefits of CBDC, it’s important to distinguish between two types of use cases: wholesale and retail.
Those reflect the payments infrastructure that we have today. We have wholesale use cases which are financial institutions that need to settle between each other, either for delivery versus payment. That settlement of securities transactions or payments versus payments which is settlement of transactions or payments between each other.
And then there’s the retail side, which is everything else so business to business, consumer to consumer, transactions between businesses and consumers, payments to HMRC from your business or from yourself. Anything else is in the retail bucket.
Wholesale VS Retail
On the wholesale side, there are some very clear benefits to introducing CBDC. There’s a potential for more efficient cross border payments for example. If you think about the inefficiencies in the payment system of one jurisdiction and then extrapolate that to making cross border payments and going through two sets of inefficient infrastructure plus all the requirements for intermediaries and things like that correspondent banking. Many stablecoin issuers have already started using stablecoins as a means to make payments faster. CBDCs take that to the next logical step.
For CBDCs to power the evolution of digital asset markets and by digital assets I don’t just mean cryptocurrencies I mean security tokens, any type of digital native assets that can be itself settled instantaneously but need something for payments leg. CBDC can fill that gap.
On the retail side, there are huge benefits to designing the type of money that’s actually fit for the needs of society with the economy today. There’s the potential for having greater financial inclusion which is often cited for so many kinds of mobile native or digital native apps and solutions can be designed around the transmission of money using CBDC.
As we’ve seen in many developing countries it’s those digital native solutions that have often enabled much greater inclusivity.
There’s also potential to change the way that we transact with each other and with governments. For governments, it can be an important mechanism for policy delivery. There’s also the ability to support innovation in payments.
We might want to use payments in different ways, we’re increasingly seeing the rise of embedded payments and transactions and CBDCs allow for more frictionless payments to be made in those frontier technology-type solutions and apps using central bank-issued digital currency instead of for example privately issued stablecoins.
How do stablecoins differ from Bitcoin, and how CBDCs again differ from those two?
There’s a spectrum of digital money and cryptocurrencies would like to be on that spectrum but at the moment, most of them aren’t there. They’re on a separate spectrum.
If for example, you have cryptocurrencies like Bitcoin that were truly used as a means of payments then perhaps they could sit on the digital currency spectrum. But at the moment, I think generally they fall into something else because their typical uses right now are not really as a means of payment.
Cryptocurrencies tend to be, and this is more of a tend to be rather than an always the case, tied to a blockchain and instrumental to the functioning and operation of that blockchain. They’re native to certain blockchains and the idea is that they should be usable as a means of payment, but due to the volatility or the issues around tax which I think you have covered in various sessions, they aren’t often used for that intended purpose. They’re typically more of a store of value at the moment and that could change in future and there will be a lot of benefits if it did.
Moving on to the spectrum and rich forms of where fiat money sits. Stablecoins are at one end, and it’s a public-private spectrum.
Stablecoins: Private VS Public
On the private end are private issues of stablecoins. Stablecoins are tokens that are linked to the underlying currency, and examples will be tether, the USDC, the most famous of them all which is Facebook’s Diem, formerly known as Libra.
These stablecoins are in a way, already proving the use cases for CBDCs because their very existence, the fact that they’re being used as a means of payments and digital settlement proves the case that there is a need for digital native forms of money.
The problem with privately issued stablecoins is that they expose the user to counterparty risk. If Facebook, or the Diem association is issuing you with Diem coins, and you’re using those payments, and then for some reason the issuer goes down, it ceases operating, for example. What are you left with? Can you still do anything with those?
That’s the counterparty risk that you face being exposed to the issuer of a privately issued stablecoin. From a regulatory perspective, the potential for systemic importance of stablecoins is increasingly on regulators agenda. In the UK for example, the Treasury has recently concluded an open consultation on regulating stablecoins and crypto assets. It looks as though the UK, like many other jurisdictions is going to move towards implementing prudential regulations for issuers for stable coin. That will mean that for example, private issuers of stable coin will need to fully back them with the underlying currency and they will need to hold that in reserve accounts so that there’s some security there.
Moving along that spectrum, at the other end there are public forms of digital currency. That’s your central bank digital currencies.
Central bank digital currencies are issued by a central bank itself
Purists will say yes you still have counterparty risk there to the central bank and that’s true all the money you hold today anyway. Depending on which jurisdiction you’re in that degree of risk will be higher.
But in most G20 countries it’s pretty much zero risk effectively. By virtue of being issued by the central bank are a form of public money. They’re not commercial bank money. They’re not issued by private stablecoin issuers and therefore central banks can also use them as a means of affecting public monetary and public policy as well.
How do you build a CBDC? Does it have to be on a blockchain?
No is the short answer. You don’t have to build a blockchain.
There are some implementations at the moment. Some central banks are exploring options that are not built on blockchain, or on any form of DLT. And you don’t have to.
There are some potential technical benefits to doing so, there are also some benefits in terms of perception of public trust. It’s by no means a pre requisite that it’d be built on blockchain technology.
What are the sort of site design considerations that countries are looking at and what do you think people should be considering?
That’s a pretty huge question. From a design perspective, there are a few key decisions every jurisdiction has to go through when it’s assessing the type of CBDC that it would like to implement.
The first is, whether it’s going to be direct CBDC or an indirect model. In the direct model the central bank issues the CBDC and everyone who uses that CBDC basically accesses directly with the central bank. In effect, the central bank then has to operate a whole account infrastructure. Everyone has their holdings directly with the central bank itself on that infrastructure.
Now no one in the world is actually considering that model, which is interesting because typically when you mention CBDC to a member of the public or many economic correspondents for newspapers and other publications. The first thing they’ll tell you is about all the disadvantages of having a CBDC associated with everyone having to have accounts directly with a central bank.
Again, no one is actually exploring that model. Many of those arguments are moot.
The model that’s typically looked at or various variations on it is an indirect model whereby, much like in our current payments infrastructure today, you have a set of intermediaries who basically have accounts directly with the central bank, and they access the CBDC, and then they act as intermediaries of CBDC services to their customers who are the end users, businesses and consumers.
An example of an intermediary would be a bank or any other regulated financial institution like payment service provider, or e-money institution. They could all hold accounts directly with the central bank, they could all access CBDC and they could then provide CBDC accounts and services to their end users. And it’s variations on that that most jurisdictions are looking at at the moment.
Other design considerations, whether you’re going for an account based or token based model is quite important as well. These terms mean different things to different people. They’re not necessarily mutually exclusive either. With an account based model for example, movement of the CBDC are represented by debits and credits on ledger or accounts.
You’ve got to have an account in order to transact to the CBDC in the first instance. In a token based model on the other hand, the CBDC is issued in the form of tokens, and you could hold the token in an account and you could hold the token in a wallet on your device and there’s a potential for greater flexibility there.
But there’s also potential to combine those approaches as well.
To look at models in which smaller transactions could be transacted on more anonymous basis between individually held wallets and devices, and large transactions would need to go through accounts.
That leads us on to privacy considerations, because privacy is a huge area of concern around CBDC. Obviously from governments of all political stripes, there is a massive appeal in the idea of having full visibility over all of your citizens and businesses transactions and CBDC holdings, but from the individuals perspective that’s not always desirable.
Again, many privacy advocates make out though it’s one or the other. It’s either completely anonymous or completely visible with no privacy. That’s not necessarily the case.
Sweden and its Riksbank are exploring that model of smaller transactions being able to be conducted on an anonymous basis where as large transactions have to go through accounts and have the necessary reporting built in.
Invasion of Privacy?
Looking at what’s available from open banking – you’ve probably used open banking or given permission to apps to access information about your bank accounts by open banking. There’s a huge amount of detailed transactional data available there as well.
The key is really building in safeguards so that people can be assured that they have some control over their data and how their data is going to be used and where it’s going to be used.
One of the features of CBDC is the potential for having programmable money.
CBDC is not just money that can be used for payments, it’s money that can have functionality programmed into it. For example, it can have smart contracts governing its usage. Some of those smart contracts can be reporting to HMRC on transactions, some of them could be setting up automated payments or enabling helicopter money payments to be made by government that could even potentially evaporate if money isn’t used within a certain time period.
It could be used for lots of use cases but some people might think are fairly intrusive.
CBDCs for the people!
For example, benefits money could be ring fenced for certain usages, money that’s paid out for childcare to parents, or money that’s paid out for housing could be ring fenced for that usage and actually strictly controlled. Some might say, that’s a huge potential privacy impact and is incredibly invasive.
The flip side of that is actually at the moment, most governments have no idea really how ‘benefits money’ is being used. Childcare credits for example, are they actually always be used for child care, or is housing, always used specifically for housing? Is it in fact being used to subsidise something else.
If you know how the money is being spent, then you can also see where your policies are failing, where you need to actually be topping up a certain type of benefit or increasing it because people are meeting the shortfalls they experience, and the inadequacy of that benefit as it currently is, by using other benefits to top it up instead.
I think implementing these in making it appealing to users and encouraging take-up, it’s really important to build in sufficient privacy control so that people want to use it and feel safe using it. It can’t really get traction or adoption if people believe that they’re giving too much away and can stick with other forms of money instead.
What does the adoption of CBDC mean for a country?
Most citizens don’t really understand or care about money that they’re transferring between their bank account and someone else’s or using to make payments and CBDC should be seamless in that respect as well. It’s arguable that people should care more and they should know more as well but ultimately, it should be a pretty seamless experience for individuals.
For most businesses, the introduction of CBDC may be able to create more innovative business models so some of them may use CBDCs as fundamental to their business to their new business model.
Others may find that they can just offer slightly different services more easily using a CBDC than they can at the moment so anything that involves any innovation and payments. The ability to have internet of things type sensors around your house that detect something’s running low and automatically ordering it from Amazon, as an example.
Having payment made automatically through the device, actually, the device being programmed to know what its kind of tolerances are. Those are the innovations that businesses can do that are not directly related to CBDC but they’re enabled by CBDC.
There are probably millions of things that we can’t foresee at the moment.
For financial institutions, it enables them to take that next leap forward into the digital economy and digital financial markets and to really move away from the legacy constraints and infrastructure that they have now as well.
For a country. It gets a little bit more philosophical. I touched on the private money versus public money spectrum. And the niche filled by stable coin issuers at the moment,
People should care a lot more about what money they’re using when they’re accessing their bank accounts for making payments. I think everyone realises there’s been a major decline in the use of cash over the last 10 years. That decline has been accelerated by the rise of mobile devices, and the increasing use of mobile payments. The decreasing use of cash has been a trend for a couple of decades but it’s really gone down exponentially over the last decade.
Cash is public money. Cash is central bank issued money and it’s bearers instruments as well so you know you’ve exchanged that and the cash belongs to you because it’s sitting in your hand. The money that’s in your bank account on the other hand is not public money, it’s actually a form of private money itself. It’s commercial bank money, it’s created by commercial banks.
You’re entirely reliant on the commercial bank which holds it and the standing of that commercial bank in the long run when it comes to your deposits being safe. Not quite entirely so in the UK for example, we’ve got the Financial Services compensation scheme which basically underwrites banks and protects your deposits up to about £85k per accounts that you have.
But from a monetary policy perspective, if you’re a government and you’re seeing this rapid shift from public money to private money, then it could have repercussions for you in terms of your ability to control monetary policy. Especially if this is going to move to global issues of systemically important stable coins, whose activities you can’t always control.
You’re giving up a degree of monetary sovereignty, a control over what you can do with public money at your disposal and how you implement your monetary policy.
There’s those very important philosophical considerations there for some countries around the type of money that they want to have in circulation and the degree to which should be public versus private.
CBDC projects in place around the world
There’s a variety of CBDC projects that are in flight around the world and almost every major jurisdiction is doing something at the moment and many minor jurisdictions as well. There’s a variety of different projects on at the moment.
Bahamas went live with this Sand Dollar project which is the world’s press CBDC, and that was earlier this year.
Cambodia also went live with it’s Bakong project. Some would call it to CBDC, I would call it a to synthetic CBDC.
This is more of a design consideration, but if you’re implementing a CBDC there are different ways to do it completely digitally native, or you could basically build your own stable coin that represents underlying central bank money that tells existing central bank systems.
And that’s known as a synthetic CBDC that Cambodia’s implemented. Their aim with that was to promote financial inclusion and facilitate greater use of mobile devices for payments. To that extent it’s really effective, and it’s probably a good model for developing countries or for those who don’t necessarily want to be the initial leaders in the space, to get in on because it gives you the benefits, but in a way where you can still observe what the rest of the world is doing, and transition potentially to a digital native CBDC at some point in the future.
On the wholesale side, there’s quite a lot going on as well. There have been a number of cross border experiments between different central banks. So, project Jasper was Singapore, and Canada. I think project Uben as well which is Singapore, and some other Asian countries.
They’ve all been looking at the use of wholesale use cases and applications of CBDCs particularly affecting passport payments and settlements. Numerous countries have declared an interest and are starting to build out Proof of Concept.
Sweden‘s Riksbank has done quite a lot in this space, it’s also looking at how it can balance out privacy considerations.
China is a really notable one. China has actually got its CBDC, well it’s digital currency electronic payment system in advanced pilots actually being used for payments but with some businesses at the moment. China also has, shall we say, an ability to coercively control the rollout of it and adoption of instant currency, which gives it an advantage in terms that it doesn’t need to wait for a popular buy in, it can push ahead.
Although I don’t think anyone is strongly against using it, given the potential benefits. But this also puts China in an interesting position when it comes to some of its global initiatives. If you look at its Belt and Road initiative for example, if China was to start asking for all payments to and from companies that are involved in that Belt and Road initiative to be made in its digital currency, then that could actually have the potential to challenge the reserve status of the US dollar. Now that’s again, quite speculative although it’s been put forward by many commentators.
In reality, it’s not clear that China would want its currency to become the world’s reserve currency. But it just gives you an example of the potential for impacting global geopolitics CBDC can have its, it’s not just about the country’s internal use, it’s also about how it expresses itself on the world stage as well.
Amongst all of this interoperability is a major challenge and if we don’t have some degree of interoperability between different CBDC systems then this seriously constrains the benefits that can be realised from CBDC when it comes to cross border payments. The BIS, Bank for International Settlements recently published a really interesting paper on interoperability, where they described different levels of interoperability.
At one level, you can have all CBDCs essentially having direct interoperability with each other. This would be quite challenging to implement because you’d have to get some kind of global consensus. Other levels of interoperability that they looked at or other solutions to the problem of interoperability included things like having consistent interfaces that each CBDC would implement or having an underlying payment rail that each CBDC could plug into that connected them all together, and all of those solutions have their own challenges as well.