By Kannan Agarwal

The central bank digital currency (CBDC) landscape is bursting with activity. In a previous issue of Banking Insight, we reported that over 85% of central banks polled by the Bank of International Settlements (BIS) in October 2020 confirmed that they were engaged in some form of work on CBDCs. Coincidentally, around the same time, the Sand Dollar – the Bahamas’ digital iteration of its fiat currency – was piloted and China’s digital renminbi, the e-CNY, was tested in several cities.

Since then, the pace has ramped-up in the CBDC space, mostly in the wholesale segment, in both emerging and advanced economies. At least 100 jurisdictions are currently experimenting with some form of CBDC, with the most successful demonstrations coming out of those which partner the spectrum of financial stakeholders – banks, non-banks, tech companies, advisory firms – in designing their CBDCs. Here’s a round-up of some of the latest experiments:

+ Project Jura: Named after the mountain range along the Franco-Swiss border, this joint CBDC experiment was completed in December 2021 involving Banque de France, Swiss National Bank (SNB), the BIS Innovation Hub Swiss Centre and a private consortium comprising Accenture, Credit Suisse, Natixis, R4, SIX Digital Exchange, and UBS. The project experimented on the cross-border settlement of two wholesale CBDCs (wCBDCs) and one French digital instrument using a distributed ledger technology (DLT) platform. Detailed findings are discussed in the report Project Jura: Cross-border Settlement Using Wholesale CBDC, available on the BIS website.

+ Project Helvetia: A joint proof-of-concept by the BIS, SIX, and SNB. It explores how a DLT-based tokenised financial asset could be used to test the settlement of interbank and cross-border transactions. Phase I, concluded in December 2020, demonstrated the veracity of the platform for trading and settlement of tokenised assets; Phase II, completed in January 2022, was expanded to include modelled processes with commercial banks, integration of wCBDC into the system, and running end-to-end transactions. The reports are publicly available on the BIS website.

+ Project Ubin: A collaboration between the Monetary Authority of Singapore (MAS) and Singapore Exchange together with JP Morgan and Temasek to potentially develop more efficient alternatives for the clearing and settlement of payments and securities using blockchain. The five-phase investigation was completed in 2020, including a collaborative phase with the Bank of Canada. The MAS has since shifted its priorities as it announced it would forgo retail and focus its work in the wCBDC segment instead due to constrained demand in Singapore.

+ Project Atom: The Reserve Bank of Australia recently completed its two-year investigation into the potential of wCBDC for syndicated lending, in partnership with banks, one non-bank and a software company. The ethereum-based DLT platform demonstrated that with the appropriate controls in place, wCBDCs removed friction points in loan syndication for larger business customers, whilst automation and digitalisation added to efficiency gains and reduced operational risks.

These experiments are part of a burgeoning move to explore how ledger technology can assist in optimising payments and achieving financial resilience goals.

Countering Crypto Bros

CBDC projects – retail as well as wholesale – have come a long way since they were first openly contemplated by regulators in 2019, their response in some ways a reaction to Facebook’s announcement about designing its own cryptocurrency called Libra. However, that was many moons (and rebrands) ago as the social media behemoth – now known as Meta – has since shelved all cryptocurrency aspirations under an avalanche of privacy criticisms and security concerns, not least by the US Treasury, Federal Reserve, and Congress. This February, the tech company threw in the towel and announced that it was winding down the crypto project in a USD182-million asset sale to NYSE-listed Silvergate Capital Corp, the holding company of a namesake cryptocurrency bank.

Perhaps Facebook/Meta thought that launching its in-house cryptocurrency would attract the same valuations that followed bitcoin and ethereum or gain cult-like status among ‘crypto bros’, an urban term for someone with a poor grasp of cryptocurrency and/or blockchain but is nonetheless a highly opinionated crypto punter. After all, Facebook/Meta itself didn’t have any expertise on cryptocurrency, relying on collaborations and a broad panel of technical members in order to design Libra.

Ironically, the process of scrutinising every aspect of Facebook/Meta and iterations of its stablecoin Libra (later rebranded Diem) has in some measure informed the process of creating an optimal CBDC, one that is governed according to the standards of fiat currency and functions on existing technologies in the financial world.

In the Now

The evolving attitudes of regulators and policymakers, who today are actively exploring the potential of CBDCs, was most recently reflected by Italian economist Fabio Panetta, who is also a member of the Executive Board of the European Central Bank.

During a panel discussion on CBDCs at the US Monetary Policy Forum in New York this February, Panetta outlined how centrally issued digital coins can perform an exceptional role in safeguarding public interest and enhancing financial resilience:

“A CBDC would preserve the coexistence of sovereign and private money in a digital world. This is not an abstract benefit – it is the basis for financial and monetary stability, ensuring competition and efficiency in payment markets. But a CBDC could generate even more benefits for users…It could improve the confidentiality of digital payments…

“If a digital currency were offered by an independent public institution such as the central bank – which has no interest in exploiting individual payment data for any purpose – it could enhance, not reduce, the confidentiality of electronic payments. Potential users clearly want this: when we consulted the public on the topic, privacy was identified as the most important aspect of a digital euro. Sound governance arrangements that comply with data protection regulations would ensure that payment information is only accessed for permitted purposes, such as countering illegal activities. We are cooperating with the relevant European authorities on this issue.”

The economist also detailed the bloc’s vision with regard to financial inclusion: “A digital euro would also increase choice and reduce costs, contributing to a level playing field in payments. Key segments of the euro area payments market, such as cards and e-payments, are dominated by a handful of players, which strengthens their pricing power. Some estimates suggest that Europeans pay about 1.4% of gross domestic product for payments services. In the United States, the costs are higher.

“One might argue that private service providers are already well equipped to offer low-cost digital payment solutions. However, the limited evidence available suggests that low-income households use digital payments less than high-income households. This is consistent with the hypothesis that digital payments remain expensive for many users. And even in advanced financial systems, many citizens are ‘unbanked’ or ‘underbanked’. Although financial inclusion depends on several factors, such as financial and digital literacy, the cost of financial services is likely to play a role.

“Our digital euro project comes with a commitment that all – including vulnerable population groups – will have access to safe public money in the digital era.”

This captures the motivations for central banks in emerging and advanced economies to embark on their respective digital currencies in a hyperconnected world.

Architecting Transformation

Acknowledgement that CBDCs can help modernise the global monetary and payments landscape, regulators and policymakers are working shoulder to shoulder with industry to address risks in order to support this transition. These risks are neatly summarised by London-based Finextra Research in a January 2022 paper:

> Economic risks.

– Inflation. A CBDC can inflate the money supply without any corresponding increase in GDP. This risk can be mitigated by issuing CBDC to individuals and businesses only in return for bank deposits or collateral paid for with bank deposits; and to government only in return for bonds that have a reasonable chance of being repaid through taxes.

– Large-scale misallocation of capital and effort. CBDCs require nationwide infrastructure for distribution and payments. There is a risk that CBDC infrastructure that is designed and built by bureaucrats (separate from private sector initiatives) will result in low adoption of CBDC due to poor utility and poor user experience.

> Financial risks.

This includes exchange rate risk, higher lending costs, and operational risks. In its recent discussion paper New Forms of Digital Money, the Bank of England identified increased lending costs as a risk due to a possible decrease in bank lending using CBDC and an increase in more expensive market-based financing. There is also the risk of a centralised CBDC system suffering outages and cyberattacks.

> Human rights risks.

If designed inappropriately, CBDCs could be used as tools of surveillance and control. Every transaction is recorded and any authority with access to the CBDC ledger could see all transactions. The combination of digital identity and CBDC is also a big risk. Access and addressability are needed for digital payments, but these are different to digital identity. In a world of programmable money, digital identity can go beyond just enabling access to your funds. While digital identity is needed to find fraudsters, money launderers, and other criminals, there is no monetary reason to combine CBDC with digital identity.

Pilot

Since 2019, the People’s Bank of China (PBOC) has moved to the next stage with its sovereign digital currency, e-CNY. This January, the central bank announced that home-grown tech giants Alibaba and Tencent will make the CBDC available as a payment method on their mobile platforms, Alipay and TenPay, respectively.

The PBOC’s own app, a digital wallet for the e-CNY, has now been piloted in 10 major cities, including Shanghai and Beijing. Users choose between individual or corporate wallets, each bearing different transaction limits. There are also options for either a software-based platform (mobile app) or hardware-based via an electronic card.

Although China, like her peers, have remained technology agnostic, the e-CNY is currently built on a centralised ledger, however this does not rule out the possibility of transitioning to a permissioned distributed ledger technology in the future. National rollout is still some ways off, but the country is ahead of its global peers. The digital currency’s use was tracked during the winter Olympics to test scalability and throughput.

Speaking to the Atlantic Council GeoEconomics Center this February, Mu Changchun, Director General of the Digital Currency Initiative at the PBOC, states that the e-CNY rate of 10,000 transactions per second (TPS) outstrips Visa’s 1,700 TPS by a mile, but is far behind AliPay’s 544,000 TPS rate and will be beefed up to 300,000 TPS soon.

On the wCBDC front, Mu says: “We have already developed the mBridge project [a multilateral CBDC platform that supports instant cross-border payment in multiple currencies and multiple jurisdictions]…At the same time, we have strict capital management matters in place.”

It is also crucial that China’s digital currency be accurately designed to ensure greater financial resilience in case of disruption to its domestic payment ecosystem, which is currently dominated by AliPay and TenPay. The Atlantic Council notes in a March 2022 report that the current e-CNY structure has several disincentives that could hamper widespread adoption: unlike Renminbi holdings, it does not carry any interest, is not covered under the national deposit insurance mechanism, and could be subject to a small fee for frequent withdrawals from the platform under times of financial distress.

Even at the forefront of CBDC, there’s ample room for growth and improvements in all aspects of its design and rollout. What’s certain is that the shift is coming and, by the looks of it, sooner rather than later.

Kannan Agarwal is a Singapore-based researcher with Akasaa, a boutique content development firm with presence in Malaysia, Singapore, and the UK.