Is the world on the brink of radical financial change? Over the next few years, Central Bank Digital Currencies (CBDCs) could reinvent the future of global money and financial systems.
Central banks in 130 countries, at varying stages of progress, are now actively exploring the feasibility of CBDCs. This represents 98% of global gross domestic product. There are several reasons why governments and central banks view this as a necessary, even essential, step.
CBDCs are pegged to the sovereign currency of the issuing country and are controlled by its federal reserve. There are two major categories, retail and wholesale, that cater to individuals and businesses, and financial institutions. The retail digital version is held by users in CBDC wallets with transactions made on a centralized ledger.
Digital currencies, like Bitcoin and stablecoin, already exist, but they are run on decentralized, public, distributed ledger technology. CBDCs operate on a central hub using private distributed ledgers.
This offers a single point of control, which could allow a central bank to monitor all transactions, and gather unprecedented amounts of financial data.
The benefits for the world’s central banks:
- Increased powers to fight money laundering and cybercrime.
- More competition in domestic payments markets.
- Financial inclusion for the unbanked.
- More transparent money flows
- Faster, cheaper, more secure transaction processing.
- More ability for central banks to dictate monetary policy.
Central banks across the globe have plenty of incentive then. But CBDC adoption is not without its complications for central banks and governments. In terms of the financial infrastructure, design, technology, regulation, and scope of what a potential Central Bank Digital Currency will look like – major questions remain.
Before we move on to contrast the progress of the world’s top 12 major economies, let’s first set the scene. According to the Atlantic Council, 11 countries have already launched a CBDC.
These are The Bahamas, Jamaica, Anguilla, seven Eastern Caribbean Central Bank jurisdictions, and Nigeria. All of these use only the retail version, with the exception of Jamaica, which uses traditional banking architecture, they all employ distributed ledger technology.
In the Bahamas, for example, the world’s first CBDC program, The Sand Dollar, aims to enhance financial inclusion and reduce transaction costs.
There are strict limits on how much of the currency can be held, to protect the cash volumes held in commercial banks. They range from $8,000 for citizens, and up to $1 million for regulated companies.
Counties exploring CBDC
There is very much a sense that developments in digital currency are happening at pace, and are in a constant date of flux. Clearly, it will be easier for central banks in smaller nations to implement, where traditional monetary systems are less complex, populations are smaller, and the potential for disruption easier to control.
For the bigger players, there’s a lot more at stake. When you consider the sheer global economic power of the U.S., China, and the Eurozone, and the way their currencies dictate global financial markets, you would assume that treading carefully would be sensible.
Mounting concerns over privacy, at least in democratic nations, are forcing governments to consider appropriate security protocols and validation architecture. Given the experimental nature of the technology, where choices between token or account based CBDC, and the potential combination of distributed ledger and traditional architecture, it’s understandable. It’s therefore vital to make the right technology choices, that both protect privacy and offer governments the benefits we outlined earlier.
Central Bank Digital Currency – CBDC challenges
Another challenge is maintaining fiscal and monetary stability in the translation to avoid a run on the banks, not undermine financial institutions, or weaken the sovereign currency. Add to that the interplay between CBDC and existing systems for international remittances, credit facilities, and point of sale, for example, and the picture is far from straightforward.
With 21 countries in pilot, 23 in development, and 45 in the research phase, there is evidently a lot to consider.
These challenges could be responsible for stalling the U.S.’s retail digital dollar project. Some commentators argue that because of technology’s limitations it would require a high level of public-private collaboration to succeed. Instead of being a pure central bank currency, it could end up being a hybrid version.
However, progress is moving forward on an American wholesale CBDC. This is welcome news, when you consider that China’s digi-yuan pilot, running since 2014, and involving 260 million people in vast cities including Chengdu, Shenzhen, and Suzhou, has given them a first mover advantage.
In economic terms the geopolitical consequences of China operating its own digital currency long before the west, would be destabilizing. The potential absence of proper global leadership and human rights standards adds to concerns.
Despite this, it appears that the U.S. doesn’t favor speed over creating a digital currency that ‘makes sense’ for both the country and citizens, in the words of Fed Chair Jermome Powell. In fact, Powell has already stated that the Chinese model ‘would not work’ as it would allow every CBDC payment to be seen by the government in real time.
Progress in top 12 economies by global GDP
The United States – pilot phase
- The Digital Dollar Project pilot study with Western Union, Accenture, BDO has concluded.
- The Boston and New York Fed’s completed Project Hamilton for wholesale and cross-border CBDC uses.
Despite technical and political challenges the US Government is determined that plans move forward. Fears around cash elimination, cyberattacks, and government control continue to influence public opinion.
Republican Congressman Warren Davidson tweeted that CBDC ”corrupts money into a tool for control and coercion”, calling it the “the financial equivalent of the Death Star.”
China – pilot phase
China is substantially ahead of other countries, the People’s Bank of China claiming recently to have processed CBDC transactions with around $250 billion to date.
It continues to explore new ways to promote further digital yuan growth. The cities of Suzhou and Shanghai and Suzhou are looking at more progress as interest in CBDC expands. However, recent evidence suggests that use for corporate and government financial transactions is the primary driver. Chinese social media and messaging app WeChat is reported to be integrating CBDC for in-platform payment transactions.
A recent conference highlighted issues over retail settlements, with bulk and high-frequency payments using the digital yuan and the Singapore dollar needing better coordination.
Japan – pilot phase
A pilot program started in April 2023, to evaluate the digital yen in response to rapid Chinese progress. This is after an experimental phase of two years to decide if CBDC was worth issuing.
Tech firm Soramitsu is developing a cross-border platform leveraging CBDCs and stablecoins to improve cross-border transactions between Japan, China, South East Asia, and India. Pegged to the Cambodian Bakong, if a purchase is made on a Japanese e-commerce site, for example, the payment would then be converted to a yen-denominated digital currency on an asset exchange.
Eurozone (Germany, France, Italy) – research phase
- Potentially, the digital euro would only be available to euro area residents, governments, and merchants.
- It would use current banking apps, with a digital wallet for person-to-person and offline payments for those with limited connectivity.
- To preserve key aspects of financial stability, digital currencies would complement and not replace cash held in bank accounts.
- Distribution would be facilitated by banks and other existing payment service providers.
- Would only be available to EU citizens and payment providers as the European Central Bank is keen to protect financial sovereignty.
India – pilot phase
In 2021 The Reserve Bank of India unveiled plans for retail and wholesale CBDC trials. Its Finance Minister claimed the Digital Rupee would be available in 2023. India is now exploring cross-border projects, notable with The United Arab Emirates to develop an interoperability framework.
Motivations include:
- Benefits of financial inclusion – in 2021 Findex calculated that 22% of adults are unbanked.
- Supports advances in digital currencies by removing the wide-scale preference for cash transaction.
- Cost savings using CBDCs over printing, storing, and transporting cash.
- CBDC is less volatile than other digital assets.
India’s plans for a retail digital rupee are moving ahead with $1 million in circulation. Its central bank now hopes to expand the experiment to ten further regions and five financial institutions, reaching one million people.
United Kingdom – development phase
The Bank of England announced a partnership with HM Treasury in 2021 to create a task force to explore CBDC viability. Then in 2022 it collaborated with Massachusetts Institute of Technology on a 12-month CBDC research program. The project explores technical challenges, opportunities and risks, and trade-offs in the design of a CBDC system.
The latest development is the release of a consultation paper which concluded it was ‘too early’ to make a decision on the introduction of a digital pound.
However, preparation is ongoing and The Bank of England has formed an academic advisory of experts on finance, law, policy, finance, and industrial organization.
Just recently the Institute of Chartered Accountants warned of the potential consequences of a CBDC. These include, the impact on lending, the ability to fight crime, the friction possible in design choices and consumer protection issues.
Russia – pilot phase
Having worked on it since 2022, Russia intends to beta test a digital ruble this year. It began piloting the scheme on the eve of war with Ukraine. Reports suggest Russia is testing cross-border, wholesale CBDC. Motivations include reducing US dollar dependence and evading sanctions. The project, now that heavy sanctions by Europe and the U.S. are in force, could aim to help Russia circumvent Western imposed financial restrictions.
Canada – development phase
The Bank of Canada has no immediate plans to launch a Central Bank Digital Currency – CBDC research over the last two years calling its usefulness into question.
In a country that does not have large gaps in access to payment methods, where 98% of adults have a bank account and 87% own credit cards, the case for a digital form of the currency is weaker. Fears surround the difficulties consumers would have if merchants were no longer accepted paper money.
Consumer feedback to the national bank highlighted resistance:
- 56% raised concerns over fraudulent activity.
- 53% expressed apprehension over cyberattacks.
- 25% were skeptical about privacy safeguards.
Brazil – pilot phase
In August 2023, the IMF praised Brazil’s central bank for flagship financial innovation in its pilot of the Digital Real. This was based in part on Brazil’s establishment of PIX in 2022 – a centralized system for instant digital payments that’s been adopted by 70% of the population.
The PIX system has been tested for its ability to integrate with CBDC, traditional banking services, and crypto assets. In April this year, Brazil’s Central Bank governor said a CBDC launch will aim to happen in 2024.
PIX saw many Brazillians enter the digital economy through emerging blockchains, and CBDC will continue to provide safe, inclusive programmable digital currency.
Australia – pilot phase
Similar to the US, The United Kingdom and other western allies, there appears to be little appetite by central banks to rush into the adoption of CBDC. That said, it took part in Project Dunbar, a wholesale CBDC cross-border initiative exploring international settlements with reserve banks in Singapore, Malaysia, and South Africa.
This year, Australia and New Zealand Bank said it had completed a pilot run by the Reserve Bank of Australia, for tokenized settlement, repayment, and funding of loans on an ethereum distributed ledger. Wholesale CBDCs could also be tested for bank to bank FX settlements and corporate bonds, pensions, and offline payments.
Conclusion
Central banks in western power house economies are hesitant over the adoption of digital currencies, where plans remain controversial. Privacy concerns, lack of incentive, technology and policy implications, and fears over destabilizing existing currencies and financial systems, are all factors.
This has prompted some critics to argue that the west should pay more attention to digital currencies. And while the federal reserve in the U.S., Eurozone, UK, Canada and others grapple with these issues, China, Russia, and Brazil are making significant progress.
The adoption of central bank digital currencies seems inevitable for large swathes of the global economy. As the west falls behind, the big question is whether it risks the creation of a financial system that isn’t shaped by democratic norms? That’s something we could all end up paying for.
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