In recent years, technology has significantly transformed the financial and banking sectors. With the advent of regtech and fintech initiatives, technology has accelerated the digital transformation of financial institutions, shaping the digital habits of a new generation of consumers.

The Emergence of New Digital Currencies

The rise of cryptocurrencies and distributed ledger technologies (DLT) has captured the attention of researchers and policymakers. While the speculative nature of cryptocurrencies like Bitcoin has raised concerns, it has also spurred interest in digital currency projects, such as Facebook’s Libra.

Libra falls under the category of ‘stablecoins,’ privately managed digital assets pegged to existing assets like the USD or euro. These stablecoins are based on private blockchain technology, allowing users to send them via dedicated smartphone apps. However, these initiatives pose challenges to the traditional roles of banks and central banks in managing currency.

In a rapidly changing world, we must contemplate the evolution of payment systems, the technologies we can leverage, the necessary regulatory frameworks, and the roles of central banks in addressing customer demands and structural monetary policy requirements.

What Is a CBDC?

Currently, central banks provide electronic accounts to financial institutions and banks. Consumers can only possess central bank-issued money in physical form, such as banknotes or coins. Electronic central bank money, known as ‘reserves,’ can only be held by banks and financial institutions.

However, a central bank digital currency (CBDC) would enable the public to store assets and make payments using digital assets issued by the central bank. This has implications for monetary policy, financial stability, and the overall financial ecosystem.

CBDCs differ from cryptocurrencies, which are privately issued and lack central backing. Cryptocurrencies are often too volatile to be a reliable store of value, are not universally accepted as a medium of exchange, and are not used as a unit of account. Some privately issued cryptoassets, called ‘stablecoins,’ aim to address these issues by seeking stability through backing, albeit with potential risks depending on the assets that provide that backing.

Central Banks’ Exploration of CBDCs

In 2019, six central banks initiated collaboration on the development of a central bank digital currency. In October 2020, they published a joint report titled “Central bank digital currencies: foundational principles and core features.” The group consisted of the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank (ECB), the Sveriges Riksbank (Sweden), and the Swiss National Bank, along with the Bank for International Settlements (BIS).

While none of these central banks has officially decided to issue a CBDC, the report represents a significant step in outlining common principles and essential features for creating such a digital currency. The report considers monetary policy implications, features, trade-offs, regulatory concerns, and design logic.

A CBDC framework should emphasize resilience, security, low or no cost to end users, adherence to standards and legal frameworks, and the promotion of competition and innovation, including a role for the private sector. From a technological perspective, it is crucial to analyze the risks and benefits of using distributed ledger technology (DLT) compared to a more traditional centralized approach.

Motivations and objectives for supporting the CBDC initiative include trends in declining cash usage, increased payment system diversity, improved cross-border payments, financial inclusion, public privacy, and faster government and central direct payments.

The report concludes that further exploration is needed, and the development of CBDCs requires practical policy analysis and technical experimentation.

Recent Developments in the CBDC Landscape

Many central banks worldwide are actively pursuing CBDC projects. For example:

  • The People’s Bank of China (PBoC) is advanced in its efforts to issue a retail digital currency, supported by state-owned banks and telecom companies.
  • The Monetary Authority of Singapore is progressing with Project Ubin, supported by state investment firm Temasek and J.P. Morgan.
  • The Bank of Thailand is collaborating on Project Inthanon and conducting cross-border CBDC experiments with the Hong Kong Monetary Authority’s LionRock project.

Prospects for a Digital Euro

Amid the rapid evolution of digital payments and increased demand for digital currency, the European Central Bank (ECB) established a High-Level Task Force in January 2020 to explore the concept of a digital euro. In October 2020, the ECB published a report outlining the potential for a digital euro for retail transactions and public use.

The digital euro would be a complement to cash and central bank deposits, recorded as a liability of the Eurosystem in digital form. The ECB aims for the digital euro to be easily accessible to the general public and convertible on par with other forms of the euro.

The ECB’s key assumption is that citizens place more trust in digital currency issued by their domestic monetary authority than in private initiatives. The recent shift in payment habits due to the COVID-19 crisis highlights the need for digital solutions.

However, challenges remain, particularly regarding privacy, user information, and potential impacts on banks and their funding costs. The ECB’s report emphasizes the importance of a digital euro framework that adheres to principles of robustness, safety, efficiency, and privacy, while complying with relevant legislation.

The ECB supports the idea that the public sector is best positioned to provide safety, convenience, accessibility, and scale for digital payments, involving citizens, businesses, and financial institutions.

In mid-2021, the ECB will consider launching a digital euro project, leading to an investigation phase aimed at identifying a minimum viable product that meets specified requirements.

First-Mover Advantage

The majority of central banks are actively working on CBDC projects, making it a global phenomenon. The primary objectives of central banks are to maintain monetary and financial stability, and CBDCs must be structured to support these goals.

The ECB views the digital euro as a symbol of progress and integration in Europe, offering citizens and businesses greater choice and easier access to digital payment methods. However, the competition between public and private initiatives, like Facebook Libra 2.0, poses challenges and opportunities for the future of digital currency.

Regulatory compliance, user-friendliness, and speed to market will be critical factors in this rapidly evolving space. The COVID-19 pandemic has accelerated the decline of cash usage and the rise of contactless payments, making the development of CBDCs and digital currencies even more significant.