In January the Blockchain and Distributed Ledger Technology team from the World Economic Forum (WEF) in the US issued a comprehensive toolkit to help central banks develop their Central Bank Digital Currency (CBDC) policy by giving them a step by step process to follow, supported by detailed worksheets.
The report was based on input from 45 central banks actively working on CBDCs and covers every type of CBDC whether for small or large, emerging or developed countries. The report considers technology at a policy rather than an implementation level.
The introduction said that the drivers of interest in CBDCs are financial inclusion and payment system stability, but as you read the paper and consider the scope of what has to be considered, the implications of CBDCs extend much further than that.
The report lists some of the challenges faced to deliver these benefits. As with any digital payment solution, CBDCs face network failure and operational risks. The challenges of achieving cyber security are immense and continuously developing. The report suggests that cash will be needed for some time to come.
Delivering on the much talked about desire for financial inclusion will be difficult. 1.7 billion people are said not to have any government ID documents. Not everywhere has the internet nor can everyone afford smartphones or the costs of phone networks, which means that the solution cannot be phone dependent. There are large numbers of people for whom digital solutions are a challenge. Not just the elderly or the disabled, but even tourists travelling abroad.
The key is in the choices made when planning a CBDC, and this toolkit aims to ensure all of the challenges and choices are properly considered.
A purely domestic wholesale CBDC has the equivalent use as today’s reserves held by commercial organisations at the central bank. If a country has an efficient interbank payment system in place, then a wholesale CBDC is not necessary. If a country does not have an efficient system in place, then a wholesale CBDC might offer a route to this.
It is rare for financial private institutions to have accounts with foreign central banks. As a result, payments have to be routed through correspondent banks and other interbank payment networks, which slows transactions and increases costs.
A wholesale CBDC could unlock this and address problems with legacy systems, solve the issue of differing intermediary time zones and hours or cut off times, and allow payment v payment interbank securities transactions and fund transfers.
The circumstances of each central bank will differ; however, retail CBDCs have the potential to bring real benefits, particularly where existing arrangements are ineffective. These include:
Efficient cross border payments if people can hold foreign CBDCs. If a domestic CBDC is being exchanged for another CBDC, then a degree of exchange rate and process friction will take place. This assumes that current arrangements are inefficient.
A digital currency can enable better payment data, useful for tracking illicit activity of all types. They will require significant investment in cyber security to ensure the system is resilient.
Reduce the costs and friction of cash management.
Act as a counterweight to the market power of today’s Payment Service Providers (PSPs). The existence of a CBDC increases competition and provides the public with a stable public option for payment services. There is an argument that existing regulations can already deliver this.
Provide a public money option in countries where cash usage is in decline. Again, the need to manage the risks of CBDCs being counterfeited or system failures is important, because any failure of a CBDC would be worse than a currency failure.
Provide a public safe haven for savings. If there is confidence in the deposit guarantee on commercial bank accounts, this benefit will be less important.
Challenge commercial banks for deposits, which should result in commercial banks offering higher interest rates and better services. If significant levels of funds left the commercial banks, this might reduce their profits and their ability to lend. In the event of a crisis, the public might move funds to CBDCs at a speed and volume that could severely disrupt the banking system.
Improve monetary policy transmission and effectiveness, depending on interest rate policy in the economy. There are, though, alternative approaches to be considered, such as negative interest rates on reserves or fiscal policy measures such as tax rebates.
Support financial inclusion goals, although the existence of a CBDC does not address how to get the excluded to move to digital payments.
Support the continued usage of domestic currency if de facto dollarisation takes place or the public or business start using foreign currencies.
1. Account based – the public have accounts at the central bank. The problems that could come with the disintermediation of the commercial banks has been referred to already.
2. Token based – the value is represented in a token and it is this which is transacted. This means that anonymity and the privacy of the transaction is easier to achieve. If the exchange of tokens does not require identity to be established, then a token based CBDC would be easier to use for cross border payments and it would be easier to achieve wide spread access and use of the CBDC. On the other hand, regulations such as Know Your Customer, Anti Money Laundering and Countering Financial Terrorism becomes harder. Payment limits can be considered to counter this.
3. Two tiered – the core ledger is held by the central bank, but the private sector acts as PSPs, delivering accounts and services to the public. There is a question about whether the PSPs would need to hold 100% reserves at the central bank in order for the CBDC to remain a liability of the central bank.
A Hybrid CBDC is where the issuer, a commercial organisation, lodges reserves at the central bank and then issues digital currency or tokens to the public. The advantages of doing this are that they should be quicker to implement than if a central bank does this, the lodging of reserves at the central bank means that the public’s funds are safeguarded and protected, and the central bank can use its reserve management policies and oversight to regulate them.
Perhaps the regulatory and policy considerations are easier to say than to implement. There may also be an impact on seigniorage. It is not clear how a Hybrid CBDC is better than a two tier CBDC, described above.
The WEF policy-maker toolkit is a well thought through, practical document providing a road map for central banks to work through every step from whether they need a CBDC to how to design one to how to implement one. The end-to-end journey laid out.
