Central bank digital currencies (CBDCs) have gained significant traction in the last two years as more countries have made progress into the extensive research and development necessary to the launch of a national digital currency. According to the Atlantic Council, which tracks CBDC development, there are now 105 countries exploring a CBDC, representing over 95% of global GDP. In contrast, in May 2020 only 35 countries were considering a CBDC.
This article provides an overview of the development to date and considers the impact of CBDCs on the established digital asset markets.
Why issue a CBDC?
In launching a CBDC, governments may be seeking several benefits, not least the convenience and speed that digital money can bring to transactions. Depending on the underlying infrastructure, a CBDC could offer the opportunity to streamline and simplify legacy financial systems, particularly when sending payments between financial institutions or across borders.
Beyond that, though, CBDCs could enhance control over monetary policy and enable banks to introduce measures that are practically impossible under the current system, such as negative interest rates. Digital money is also far cheaper to produce than physical cash. According to the US Federal Reserve, the cost of minting a $1 note is around 7.5% of its face value, so a CBDC offers the chance for substantial savings.
CBDCs could also make it easier to disburse payments – such as welfare or emergency relief – to citizens and potentially reduce fraud. Conversely, digital money could also automate payments to the state, deducting income tax from a salary payment at the point of remittance.
Finally, CBDCs have the potential to enhance financial inclusion by removing any physical barriers to accessing money and further improving on the benefits that the digitalization of banking has already brought.
Of course, none of these outcomes are a given, and they depend on how the CBDC is designed and used in practice.
Defining the scope of a CBDC
While CBDCs are a type of digital asset, they bear very little resemblance to assets like Bitcoin or Ethereum, which are issued on public, permissionless infrastructure. The design of a CBDC is entirely under the control of the issuing central bank, and as such, it may or may not share any of the characteristics of established digital assets. By the same logic, a CBDC does not necessarily have to be based on any kind of distributed ledger – it could be issued and managed using a centralized database run on traditional servers.
The scope of a CBDC is another consideration. Many of the successful CBDC experiments that have been run to date have involved so-called “wholesale” CBDCs that are only used to facilitate payments between financial institutions. Limiting the scope to institutions offers some of the benefits listed above and is certainly easier to implement than a “retail” CBDC, which is defined as general-purpose digital money available for everyone to use as a substitute for physical cash.
The Bank of International Settlements has been one of the most substantial contributors to CBDC research and development over recent years – understandably so, considering it has skin in the game. A 2018 BIS paper introduces a taxonomy of money using a visualization called the “money flower,” which defines four broad categorizations of CBDC according to whether the currency is wholesale or retail and whether it uses a token-based issuance model or a reserves and settlement accounts model.
Thus, determining which approach to use is among the most fundamental decisions facing issuers, and managing the risks of each approach will be the biggest factor governing the decision. Issuing a CBDC cannot introduce any attack vector that would allow fraud or manipulation, putting the entire monetary system in jeopardy. However, ensuring a secure system typically comes with trade-offs for user privacy, and campaigners and advocates are already warning that CBDCs could enable unprecedented government surveillance of citizens’ spending. After all, cash remains one of the only ways to transact with relative anonymity.
Despite the scale of the challenges, governments are forging ahead with the research and development of CBDCs, with projects in various stages of progress worldwide.
According to the Atlantic Council, there are eleven jurisdictions where a CBDC has been fully launched. These are predominantly Caribbean countries, including Jamaica and the Bahamas. In October 2021, Nigeria, the largest economy in Africa, became the first nation on the continent to launch a CBDC.
The most progress within a G20 economy is in China, which has been running a pilot of the digital yuan, called e-CNY, since 2020. Not much is known about how it operates, but the People’s Bank of China has confirmed it will be expanding the trial to four more provinces, including Guangdong, the most populous.
Progress in the G7 has been more restrained. The EU is working on a digital euro, which will be a retail currency with legal tender. In September, a progress report was issued, and next steps laid out. One notable decision has been to use the digital euro to target payments and implement measures to deter using it as an investment vehicle, as a means of ensuring a launch does not cause monetary instability. Most recently, ECB President Christine Lagarde announced plans to prepare a legislative and design framework for a Europe-wide CBDC. As yet, there is no decision on whether the bloc will choose to launch the currency on a distributed ledger infrastructure.
In the US and the UK, progress has been slower. The Digital Dollar project has been underway since 2020 but remains in the research stage. More recently, a group of financial institutions announced a proof of concept experiment alongside the Federal Reserve Bank of New York aimed at using blockchain to improve financial settlements; however, Australia has just written off its own similar project.
Although UK lawmakers had previously concluded that there was no convincing case for a digital pound, more recently, the deputy governor of the Bank of England made a statement indicating that the country might need to issue a digital pound as part of a more regulated digital asset landscape.
In contrast, Japan is proceeding at full steam, having recently announced experiments on a digital yen with three of the nation’s megabanks, due to run for two years from 2023. The government will then determine whether it will proceed with a full CBDC implementation in 2026.
Implications for the digital asset markets
Given the clear distinctions between established digital assets like Bitcoin and the direction of CBDCs, it seems fair to say that the impact could be negligible; there is no reason the two types of currency cannot exist in tandem. The existence of retail CBDCs could perhaps lead governments to introduce new or heavier regulation of digital assets.
But there is one segment of the digital asset markets that may be more significantly impacted by the launch of a retail CBDC – stablecoins. Regulators in the US and UK already have stablecoins in the crosshairs, thanks to the collapse of Terra’s UST earlier this year. Given that the primary use case of a fiat-pegged stablecoin is to replicate fiat money in a digital form, it is easy to see how regulators could perceive stablecoins such as Tether’s USDT or Circle’s USDC as a threat to the success of a CBDC.
Conversely, even without regulatory intervention, a successful CBDC poses an existential threat to stablecoins, which were popularized as a means of trading in and out of volatile cryptocurrencies. A CBDC can serve this purpose and would be more seamlessly integrated with the established banking system, effectively making stablecoins a redundant intermediary.
It is also plausible that any blockchain-based CBDC could promote the adoption of innovations from decentralized finance, such as automated lending or peer-to-peer exchange protocols.
CBDCs do not necessarily introduce any direct opportunities for digital asset investors. Still, they could have some intriguing effects on the established digital asset markets, depending on how much governments choose to leverage existing innovations and infrastructure. Spotting these opportunities as they arise requires the kind of market intelligence and in-depth insights that Nuant’s integrated dashboard was designed to provide. It enables you to build custom queries and gives a complete overview of your entire portfolio in a single unified view. For a free demo or more information, register your interest today.
- Committee on Payments and Market Infrastructures: Markets Committee, (March 2018), “Central Bank Digital Currencies”, Bank of International Settlements. Available at: https://www.bis.org/cpmi/publ/d174.pdf