If you’re a regular gambler at the best crypto casino, you’re probably brushing up on all things blockchain and cryptocurrency-related. One of the terms you will have come across in the news recently is CBDC, which stands for Central Bank Digital Currency.
With ongoing digitisation dominating our current times, the need to use cash is dwindling globally. At the same time, the concept of cryptocurrencies has seen an exponential rise worldwide. There are two types of digital money in circulation, i.e., fiat money kept in central bank accounts and decentralised cryptocurrencies.
While cryptocurrencies have displayed remarkable growth, they are often accompanied by extreme volatility. Due to the unpredictable nature of cryptos, regulators have issued warnings and bans. With that being said, many believe that unpredictable digital assets are inadequate for transacting.
To address this extreme volatility, digital currency models known as stablecoins have been created to deliver some price stability. This is done by pegging their value to another asset less likely to fluctuate erratically.
A Global Payment System In Upheaval
The advent of cryptocurrencies, stablecoins, and private initiatives like Facebook’s Libra, not to mention the digitisation of the global payment system, has meant that central banks have realised that they must adapt to this changing landscape.
With central banks being the primary authority in charge of the money, they need to examine potential opportunities and risks that digital currencies pose in the financial economy. This is where the Central Bank Digital Currency comes into the picture.
So, What Is A CBDC?
A CBDC is an electronic type of central bank money that people can use to store value and make digital payments securely. Using CBDCs, concerns over cryptocurrency’s volatile nature and decentralised platform are overcome as it operates using the same type of distributed ledger technology as cryptos.
Governments recognise CBDCs as legal tender within the jurisdiction of that issuing bank, enabling people to use them for payments and for merchants to accept those payments.
The three main elements of CBDCs are that it is a digital currency issued by the central bank and is accessible globally.
Why Issue CBDCs When Fiat Currency Exists?
Just like fiat currencies, CBDCs are considered legal tender and, as such, will be recognised as an official form of payment and act as a claim on the government or central banks.
These currencies provide increased safety and efficiency for retail and wholesale payment systems. In wholesale, the CBDC will help settle retail payments and enhance the efficiency and convenience of making point-of-sale payments or payments where different parties are involved.
No coins or notes are required as the currency is completely digital, with money being exchanged electronically. With scepticism surrounding cryptocurrencies, if a country intends to adopt a cashless society, then a digital currency with support from the government and central banks might be a credible solution. There is, indeed, a lot of pressure placed on the shoulders of governments and central banks as more people are opting for private e-money on decentralised platforms.
By introducing CBDCs, the central banks and governments will gain some advantage over those providers who encourage investments and engagement through decentralised platforms. CBDCs are always available, with privacy at the forefront to diminish the threat of counterparty credit risk.
Different Types Of CBDCs
CBDCs are categorised into two different types based on specific target markets.
1. Retail Central Bank Digital Currency
Retail CBDC is founded on distributed ledger technology and is anonymous, traceable, and available at all times. There is potential for interest rate applications also.
Considering these benefits, a retail CBDC will focus on supporting the general public. Moreover, it will promote financial inclusion and lower the cost of printing actual money.
Retail payments are generally between individuals and businesses. Although they tend to be low in value, they are large in volume and are facilitated through different payment instruments. Retail CBDCs could be given to the public in two ways, i.e., digitally issued tokens or deposit accounts at a central bank.
Digitally issued CBDC tokens represent a digital alternative to traditional banknotes and coins. They would only be issued from the central bank and distributed through commercial banks. With deposit accounts, individuals and businesses can open accounts at their central bank and take advantage of the same benefits offered through commercial banks. They can send and receive payments and view their accounts’ balances.
The primary difference between these two types is the verification required when using them.
If you are using CBDC tokens, you need to have your authenticity checked together with a confirmation that the token has not already been spent elsewhere.
If you are using CBDC deposit accounts, the verification will take place at the account-holder level, with Know-Your-Customer procedures likely to be involved.
2. Wholesale Central Bank Digital Currency
With Wholesale CBDC, there is an increased efficiency in terms of payments and security settlement while aiming to resolve liquidity and counterparty risk concerns.
This is a fantastic option for financial institutions with reserves kept in a central bank. It will undoubtedly improve the speed and security of a wholesale financial system, and central banks will favour this as an excellent alternative to existing systems used today.
With the Wholesale CBDC model, banks already have access to electronic central bank funds, so this would enhance the processes involved. Both the risk management and efficiency of the settlement process would be improved. The benefits could be intensified by extending the availability of Wholesale CBDC to those participants in the financial market that don’t currently have the authority to hold central bank accounts.
Not only does a Wholesale CBDC apply to primary money transfers, but it could potentially be used when the need arises for asset transfers that involve securities. For example, if two parties wish to trade an asset using a Wholesale CBDC, the payment and delivery of the asset can occur instantly.
In terms of implementation, the currency could also be considered for cross-border transactions through a much more simplified process using a degree of automation.
Central banks are currently considering two models for Wholesale CBDC transactions, i.e., Wholesale CBDC for domestic payments and Wholesale CBDC for cross-border payments.
Wholesale CBDC For Domestic Payments
Great value, institutional counterparties, and quick settlement times characterise wholesale transactions. The payments are executed by real-time gross settlement (RTGS) systems routed through central banks.
Once the originating financial institution instructs to pay a beneficiary bank, the system will reconcile, confirm, and finalise the transaction with a funds transfer between the banks’ accounts. In essence, the transaction is completed in real time with immediate finality.
This system will be more suitable for regions struggling to facilitate quick, reliable, and secure domestic payments of high value.
Wholesale CBDC For Cross-Border Payments
Existing cross-border payment structures usually involve many intermediaries and jurisdictions in a single payment. A local originator would send payment instructions to a local originating bank and then send that instruction to the central bank.
The central bank would then communicate with intermediary banks and, once the transaction is deemed successful, would be transferred to the foreign beneficiary.
Countries & Institutions Experimenting With The Currencies
Banque de France
The Banque de France has been experimenting with CBDC interbank settlements. Currently, it is in a pilot phase in collaboration with eight candidates and will be conducted over the next few months. This would fall under Wholesale CBDC.
Accenture and the Digital Dollar Foundation
This partnership wants to identify practical opportunities to ascertain vital elements of a US CBDC as part of its Digital Dollar project. So far, there have been nine pilot programs created.
These would fall under both Wholesale and Retail CBDC.
Central Bank of Sweden
The Central Bank of Sweden aims to evaluate e-wallets and interoperability with commercial banks. They rely on the R3’s Corda system as the underlying technology, with the central bank allowing commercial banks to connect with it through Application Programming Interfaces (APIs).
Another project in the pipeline is a 24/7 e-wallet that can be integrated with credit cards, apps, and smartwatches. This would fall under Retail CBDC.
People’s Bank of China
The People’s Bank of China is working on a project dubbed the Digital Currency Electronic Payment (DCEP) that hopes to improve efficiency in their existing payment system, make peer-to-peer transactions more secure, and ultimately replace cash as a means to transact.
The test phase is well underway, with pilot projects conducted in many cities thus far. Commercial banks have conducted internal tests on specifics like account balance checks, payments, and cash-to-digital money conversions. This would fall under Retail CBDC.
Monetary Authority of Singapore
The Monetary Authority of Singapore has launched an exciting project dubbed Ubin. It works with the industry to examine the clearing and settlements of payments and securities with over 40 firms.
This project focuses on tokenising the local currency, redesigning real-time gross settlement, improving cross-border payments, and enabling a broad ecosystem collaboration, falling under Wholesale CBDC.
South African Reserve Bank
The South African Reserve Bank has initiated a project called Khokha in collaboration with selected South African settlement banks and some non-financial conglomerates.
This initiative aims to create a proof-of-concept wholesale payment system designed for interbank settlement using tokenised South African Rand. It is a Wholesale CBDC.
Bank of Canada
Jasper is a project piloted by the Bank of Canada examining the capabilities of starting a Retail CBDC and the pros and cons of new technologies for Wholesale CBDC.
Contingency plans are being tested on Retail CBDC if the use of cash suddenly drops. This is both Wholesale and Retail CBDC.
Central Bank of the Federal Republic of Germany
The German Bundesbank has explored the benefits and risks of CBDCs. There has been support in these regions around incorporating a European e-Euro and digital currencies into the current financial systems.
The European Central Bank’s governing council has also looked at the possibility of issuing digital Euros. This would be considered a Wholesale CBDC.
The Bahamas has initiated a Sand Dollar CBDC project. The Sand Dollar is a digital variation of the Bahamanian Dollar and hopes to create a more inclusive environment for access to financial services and regulated payments.
This would be a Retail CBDC.
The Eastern Caribbean Central Bank, the monetary authority in the region, has piloted a DXCD project that hopes to impact those financially excluded.
It is currently piloted in St. Kitts and Nevis, Saint Lucia, Grenada, Barbuda, and Antigua. This CBDC project aims to create an efficient and secure payment system for people who don’t have credit cards, merchants, and those who want low costs of e-commerce payments.
It is considered a Retail CBDC.
Key Attributes of CBDC Implementation
To adopt any CBDC system, the technology platform must fulfil specific key attributes:
- Convenience will enable users to engage easier with CBDCs, and smartphones will undoubtedly be helpful, especially with QR code payments or tap-to-pay options.
- Security and resilience are vital, and data protection for users will be critical to the success of these currencies. Both hardware and software-based privacy enforcement are critical to the system.
- Speed and scalability are other vital elements when transaction volumes and throughput must be maintained cost-effectively.
- Interoperability will ensure that the APIs can support interoperating technologies and enable inter-account transactions.
When evaluating the effort and attention that many global banks are dedicating towards CBDCs, it is evident that digital currencies are the way forward. By introducing these currencies, crypto adoption will receive a welcome boost as more people will have access to platforms that make crypto conversions to legal tender currency easier. Additionally, it will be a more inclusive option for those financially excluded from the system.
As central banks and governments have realised, digital assets like crypto are here for the long haul, and a digital currency can pave the way to a bright new future.