Are Central Bank Digital Currencies (CBDCs) like E-krona the money of tomorrow?

This topic has the following sections

1. What is money?
2. What are CBDCs & What are their forms?
3. What are CBDC use cases?
4. What are the pros and cons of CBDCs?
5. What is the difference between CBDC and cryptocurrency?
6. What are the beneifts of CBDCs for end users?
7. Which countries have adopted CBDCs?
8. Future?

Let’s first define the purpose of money and role of central bank in current financial ecosystem

1. What is money ?

Money is a special kind of “I owe you” that is universally trusted. Money has constantly evolved over the years from debt, bartering, commodity money, coins, paper money and most recent e-money through de-materialisation & digitalisation. Money usually serves as

1. A store of value, acting as an asset that sustains value over time
2. A medium of exchange to purchase and sell goods & services
3. A unit of account used to price a particular good or service and as well as to denote a certain debt

Today most money is in the form of bills, coins and it’s electronic equivalent, fiat currency. There are 2 types of fiat money

1. Central bank money is in the form of central bank reserves and bank notes. Central bank reserves are mainly used to settle payments for financial institutions. Bank notes are normally exchanged against the reserves and held in commercial bank vaults or ATMs.
2. Commercial Banks hold both Central bank money and Commercial bank money in the form of bank deposits held at commercial banks by general public and Bank notes provided to public through commercial bank counters or ATMs

A common misconception is that central banks create most money. In fact, in modern economy , money is created by commercial banks making loans & so called commercial bank money. Central banks can only indirectly affect the amount of money lent to individuals and businesses.

2. What are CBDCs & What are their forms ?

Central bank digital currencies (CBDCs) are a digital form of the currency issued by a central bank. They are regulated by a country’s monetary authority, and are implemented using a database which is controlled by the central bank, government, or authorized private-sector entities.

Account-based

Account-based CBDCs, previously described as central bank electronic money, work just like regular deposit accounts. The user is required to set up an account with which they can perform transactions, as well as send and receive digital currency. A transaction requires accessing the users’ information to verify the ID of the sender and receiver.

Digital tokens

Tokens were previously described as central bank cryptocurrency. Token based systems involve the transfer of an object of value from one wallet to another. In traditional financial systems a token can be a banknote or a coin, and in cryptocurrency a token is a bitcoin for example. Digital-token-based-systems do not require the user to verify their identity to send or receive a payment. However, the transaction is approved based on public-private key pairs and digital signatures between the sender and receiver.

3. What are CBDC use cases ?

Currently CBDCs are built for either retail or wholesale payments.

Retail CBDC

Retail CBDCs are used in the same manner as banknotes, to make payments between individuals, or between individuals and businesses. Retail payments are carried out via banknotes, cards, and online transactions. Public users can have retail CBDCs in the forms of deposit accounts and/or digital tokens.

Wholesale CBDC

Wholesale CBDCs are used to enable transactions between financial institutions and entities that have accounts in central banks. According to the Bank of International Settlements (BIS), wholesale CBDCs can:

• improve the development of capital markets
• enhance cyber security
• provide improvements in securities trading and settlement

4. What are the pros and cons of CBDCs ?

With the rise of blockchain technology and cryptocurrency, central bank digital currencies (CBDCs) are gaining increasing popularity among global financial institutions. If implemented correctly, CBDCs can have the following pros & cons for the financial system:

Pros

Central bank digital currencies (CBDC) can significantly change the financial services by facilitating the accessibility as well as the usage of fiat currency. The main benefits of CBDCs are:

• Allowing real-time monitoring and analytics of all the finances running through the central bank
• Enhancing the efficiency of central banking systems
• Enabling faster and easier transactions via mobile applications
• Reducing costs of financial services by:
• limiting the printing of banknotes
• eliminating physical cash distribution and destruction from circulation

Additionally, compared to crypto coins, CBDCs can be more broadly accepted by the general population because they are subject to legal and government regulations. They do not have the stigma of being preferred by those who want to avoid detection by authorities.

Cons

CBDCs face some challenges due to the economic situation within a country in addition to other reasons, such as:

• Widespread adoption challenges: Increased digitalization may leave a portion of society behind due to potential barriers around trust and data privacy, digital knowledge, and access to IT. For example, the central bank of Ecuador launched retail CBDCs in 2014. However, the program stopped due to low citizen adoption.
• Cyber risks: Defending against cyber attacks will be more difficult as the number of endpoints in a general purpose CBDC system will be significantly larger than those of current wholesale central bank systems.
• Cross-border payments: CBDCs can facilitate cross-border and cross-currency payments independent from work-hours and holidays in different time zones. However, different legal and regulatory frameworks present a significant obstacle to cross-border payments. Harmonizing these frameworks would be a challenge.

5. What is the difference between CBDC and cryptocurrency ?

CBDC and cryptocurrency are both a type of currency enabled by blockchains. However, the main differences between CBDC and cryptocurrency are:

Money creation:

• CBDCs are legally owned by governments or a very limited number of individuals (e.g. El Salvador bank was founded as a private company). On the other hand, the cryptocurrency approach focuses on democratizing financial systems.
• CBDCs are created by central banks, whereas cryptocurrencies enable users to create money with the help of a consensus algorithm. Therefore, money creation is controlled by the consensus algorithm and the participants in the consensus process. Money creation process may involve proof of work (i.e. completion of a complex work package) or proof of stake (i.e. users stake to receive new money in a process moderated by the consensus algorithm).

Representation: Both CBDCs and cryptocurrencies are virtually represented assets.

Centralization: CBDC transactions still have to go through the banking system, whereas crypto relies on peer-to-peer transactions with no middle man.

Other: Both CBDCs and cryptocurrencies’ market price changes based on supply and demand and therefore the beliefs of market participants about the current and future value of these currencies. A CBDC’s worth should be directly linked to the governments’ treasury value and the fiat currency prices. Crypto’s value should rely on its utility within a certain blockchain ecosystem.

6. What are the beneifts of CBDCs for end users ?

Important benefits are reduced burden of cash handling and risk of financial intermediaries failing.

CBDCs are similar to other forms of mobile payment applications from a user perspective. So for a Chinese user, the benefits are similar to using Alipay for mobile payments or investment. For the user, important point is adoption. If there can be universal adoption for CBDCs, then CBDC adopters may forgo using cash altogether which saves them from keeping cash on themselves which requires regular trips to the ATM or bank.

Whenever you use a mobile payment app, a credit card or any other type of digitalized money, there is risk that the financial institution providing the infrastructure may fail. That is why governments provide protection for deposits for example. However, these protections are only limited. Relying on the central bank rather than the financial institution would remove an intermediary and reduce risk of bankruptcy of your financial solution provider.

7. Which countries have adopted CBDCs ?

According to Deloitte:

• ±60 central banks are researching CBDC adoption and effects
• 36 banks are considering retail and wholesale CBDCs
• 18 banks are considering only retails CBDCs

Ranked based on project maturity, wholesale projects are led by:

1. Thailand and Hong Kong: Project Inthanon-LionRock
2. Singapore: Project Ubin
3. Canada: Project Jasper
4. UK: Cross-border interbank payment and settlements
5. France: Digital Euro
6. South Africa: Project Khokha
7. Europe: Project Stella
8. UAE: Project Aber
9. Japan: Project Stella

On the other hand, retail projects are led by:

1. The Bahamas: Project Sand Dollar
2. Cambodia: Project Bakong
3. Mainland China: e-CNY
4. Ukraine: e-Hryvnia
5. Uruguay: e-Peso
6. Ecuador: Dinero Electronico
7. Eastern Caribbean: DCash
8. Sweden: e-Krona
9. South Korea: e-Won
10. Turkey: Digital Lira

8. Future ?

There has been impressive growth in the number and value of cryptocurrencies that are challenging the current Central Bank’s monopoly in money issuance. Till date 6,726 cryptocurrencies have been issued with total market cap touching $2 Trillion.

It is only a matter of time. CBDCs will become a reality soon. So, we must be ready to cope. CBDCs could stimulate the supply of new payment services & offer another way to supply money to the society. They would also complement the current offering of cash & wholesale central bank deposits.

Introduction of CBDCs will be a game changer, promoting payment efficiency and representing an additional alternative to the current money model from both operational and technology point of view. There is great scope for payment service providers to get involved and create value & smooth experience to the users, leading the way into the future.

Look at CBDCs as additional payment methods. They are NOT MEANT to replace cash & bank deposits but to coexist!

references/copied:

Deloitte, https://research.aimultiple.com/cbdc/