Central bank digital currencies are diverse, but all should be open

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It is obvious that in the next couple of years we will see central bank digital currencies being issued for real around the world. According to a recent Bank for International Settlements survey, 20% of the world's population could have access to CBDCs in the next three years.

While most people focus on figuring out who will be first, we should look closer at who will be best. A CBDC has the potential to be a real game changer for the payment industry if one condition is met: The central bank digital currencies must be built as an open and shared infrastructure for the private sector to build on top of. It has to be open, transparent and accessible, because nobody wants to use siloed systems.

I recommend central banks pay attention to the transformations taking place in public blockchains, particularly Ethereum, and find the courage to build a similar open structure that will foster digital innovation. It's time to embrace the benefits of decentralization with the rock-solid trust offered by central banks.

As the core mandate of central banks is to ensure monetary and financial stability, the decrease of cash usage and the innovation of blockchain and stablecoin technologies have forced these institutions to assess if the transformation of the payment industry brings some risks. Among solutions proposed is for central banks to provide an alternative to private digital means of payment, with a digital form of cash called central bank digital currencies.

Cash is the most recognizable form of central bank money, used by the general public and mostly for smaller value transactions. It is a legal tender issued by the central bank that represents a claim against the central bank. This is different from commercial bank money, which represents a claim against the commercial bank. However, in terms of value, central bank money is mostly used by financial institutions for interbank settlement and is called wholesale central bank money. In simple terms, this means that financial institutions have a bank account at the central bank, whereas individuals cannot.

Just like cash and commercial bank claims against the central bank, there are two main types of CBDC that are being considered around the world:

Wholesale CBDC: This type of currency would be used by financial institutions to buy and sell financial assets (e.g., bonds, shares) and would replace Real Time Gross Settlement (RTGS) systems.

Retail CBDC: This type of currency would be used by the individuals to pay for things, to send money to friends and family, and possibly to receive government incentives and subsidies.

For the scope of this article, I will focus on retail CBDC, which is akin to a digital form of cash. From now on, the term “CBDC” is used to describe a “retail CBDC.”

While there are lot of design possibilities for a retail CBDC, most central banks around the world agree on the following key principles:

A CBDC would be a new form of central bank money, issued and controlled by the central bank. The CBDC supply is determined by monetary policy and controlled by the central bank. Bringing a new form of central bank money into the market would be a significant change for central banks as it has seldom happened in the past. A CBDC is a liability to the central bank balance sheet, as opposed to commercial bank money which is a claim against a commercial bank.

A CBDC must be accepted as a means of payment, legal tender, and a safe store of value by all citizens, enterprises and government agencies.

A CBDC is distributed at one-to-one parity with relevant fiat by the central bank, and should be seamlessly and freely convertible against commercial bank money and cash.

Consumers should not need a bank account to obtain and use a CBDC.

A CBDC should be built on an open infrastructure, to enable private companies to build innovative products and services. The CBDC infrastructure would be a public good that will foster digital transformation.

The cost of transaction should be lower than current systems.

According to the Bank for International Settlements, more than 80% of central banks are engaged in some work on CBDC. China, Sweden, Cambodia, the Bahamas and the Eastern Caribbean are among the most advanced initiatives of retail CBDC. They are running live pilots, and most plan to go live by the end of 2021. Canada, England and South Africa are also quite advanced and every few weeks, another central bank announces a plan to start a CBDC pilot, most recently the Netherlands and South Korea. However, among those central banks, not all plan to go live with CBDC. A number of them, such as the Bank of Canada and the South African Reserve Bank, have stated that they are launching pilots to properly assess the opportunities and risks of a CBDC and get as ready as possible to issue a CBDC if necessary.

While a number of central banks will probably issue a CBDC in the coming years, it is quite certain that they will not be exactly the same. There are many design options which depend on the national context and questions such as: Is cash used? Are people attached to the privacy afforded by cash? Is commercial bank money secure and cheap? What is the level of financial inclusion?

Among the ongoing initiatives, some differences can already be observed. For example, the Sand Dollar project in the Bahamas is designed to give residents easier access to financial services in light of economic difficulties following damages to the financial infrastructure caused by Hurricane Dorian. Hence they enable the public to use the CBDC wallet without a bank account and without asking for user identification for small amounts. They plan to go live as early as the end of this year.

China’s objective is different. They have been working on the Digital Currency and Electronic Payment (DCEP) project since 2014 in order to compete with the dollar’s dominance as global reserve currency, as part of their broader Belt and Road strategy.

There are ongoing pilots in four cities and 20 private companies including McDonald’s and Starbucks are part of the experiment. Apparently, the Chinese CBDC does not use blockchain but uses some of its key components like asymmetric cryptography and smart contracts.

Sweden has a unique economic position: It is the least cash-dependent country in the world with only 1% of GDP in cash, compared with 11% for the eurozone. The decrease of cash usage observed over the last couple of years has led some merchants to refuse it as a means of payment because it was too costly. They don’t yet plan to go live, but this is often described as one of the most advanced initiatives.

The Bank of England has not built any technology for CBDC yet, but it has published a very thorough discussion paper. A possible architecture design is described that is based on a public-private platform model.

The concept is that CBDC, as the store of value, would be accounted for on a core ledger operated by the central bank, which could leverage a private and permissioned blockchain. While the core ledger will provide the simplest payment functionalities, some authorized private companies would provide user-friendly interfaces to use the CBDC, and additional services such as loans and interest-bearing saving accounts. This partnership between the central bank and commercial banks would mean that a CBDC will not only provide a reliable and efficient payment infrastructure, but also encourage digital innovation from private companies.

Beyond the national CBDCs that are being tested, what if the central banks around the world were working together to build common CBDC standards? Such global standards would simplify interoperability between the central bank systems, which would significantly reduce the cost and complexity of cross-border payments. There are a number of initiatives on this path, including the Bank for International Settlements’ new central bank group, along with six other central banks that formed a working group earlier this year to explore shared standards. Unfortunately, this initiative is still isolated and no information has been publicly shared on the deliverables yet.