Governments around the world are preparing to upgrade their national money from the paper to the digital era.
Some argue the introduction of central bank digital currencies (CBDC) will mark the biggest change to the world’s financial system for 75 years. Others say the current CBDC hype is way overblown.
Which view is right? It’s probably too early to tell. But here are ten key attributes that will determine whether states make a success of digital money.
Simplicity
To help its users, a CBDC should be as simple to understand and use as the physical banknotes and coins it will deplace.
But there are difficult trade-offs in CBDC design. For example, if central banks favour processing speed, allowing for hundreds of thousands of transactions per second, they may have to make the overall system less secure.
“The potential complexities of any CBDC and the interlinkages between design choices create multifaceted trade-offs,” the Bank for International Settlements (BIS), the key CBDC thinktank, said last week.
Utility
Is a CBDC worth something to the public? Does it meet a need?
As cash disappears from circulation, CBDC will fill a vital gap, argue central bankers.
“Trusted money is a public good,” the BIS said in a new report on CBDCs, published last week.
“Trusted money is a public good”
“It offers a common unit of account, store of value and medium of exchange for the sale of goods and services and settlement of financial transactions.”
But at the moment we’re heading towards a system of multiple national digital currencies. Many argue this will be of little help for the functioning of the financial system.
“We don’t want to end up with the same fragmentation [we have] as of today, with local CBDCs only as additional currencies to manage,” said Frantz Teissèdre, head of interbank relations at Société Générale, speaking at the 2020 SIBOS conference.
Usability
In technology design, user experience is key. Getting it right can rapidly propel you to the top of the pile.
In China, the popular mobile apps WeChat Pay and Alipay—which, as well as handling money transfers, allow users to book taxis, shop, order food and date online—have already completely replaced banknotes and plastic.
“Chinese people now go out shopping without any wallets, credit or debit cards. They only take their phones with them”
“Chinese people now go out shopping without any wallets, credit or debit cards. They only take their phones with them,” said Changchun Mu, head of China’s national digital currency initiative.
Other CDBC designers accept they will probably have to emulate the Chinese model.
“Users could access the digital euro either directly or through supervised intermediaries,” the European Central Bank (ECB) said earlier this month.
“An intermediated access model is preferable,” the ECB said.
But outsourcing the consumer-facing front-end of payments to third parties will put central banks in the spotlight if things go wrong.
Programmability
Digital currency is about much more than money. Because it will be programmable, CBDC will be capable of being used in unfamiliar ways.
“Programmable digital money is such a rich world,” Alistair Milne, professor of financial economics at Loughborough University, said at SIBOS.
“Most central banks don’t know what digital currencies are going to look like”
“Everything—including your TV set and coffee machine–is going to be an economic actor,” explained digital currency expert David Birch.
Our mental model of money will have to evolve to adapt to digitalisation.
Meanwhile, CBDC designers face a blank sheet of paper.
“Most central banks don’t know what digital currencies are going to look like, how they are going to use them and how they are going to control them,” said Tom Zschach, chief innovation officer at SWIFT.
Fairness
Fairness, and particularly ensuring that citizens have equal access to payment systems, is a huge issue of concern for policymakers.
“The payments industry is a system of social categorisation and distinction, of membership and exclusion”
As money becomes digitalised, more and more people are already being cut out of the economy, warns Lana Swartz, an assistant professor of media studies at the University of Virginia.
“The payments industry is a system of social categorisation and distinction, of membership and exclusion,” Swartz wrote in her recent book, ‘New money: how payment became social media’.
Speaking at the SIBOS conference, Scott Hendry of Canada’s central bank spelled out his concerns.
“There are still some people who rely heavily on cash,” said Hendry, “such as people in remote communities and some people even in cities, especially the poor.”
“These are some important demographics and we need to make sure they all have access. It isn’t so much about financial inclusion, it’s about making sure there isn’t financial exclusion,” said Hendry.
Privacy
By comparison with cash, which relies on a legal trick to ensure its past transactions are invisible, digital money is inherently traceable.
“If CBDCs are successful, money will carry a data footprint, meaning that there are implications for both government surveillance and the commercial use of data,” says Arwen Smit, an expert on digital identity.
“Regulations do not allow anonymity in electronic payments”
Having fought with the principle of user anonymity underlying cryptocurrencies like bitcoin, central bankers have been unwilling to permit digital versions of bearer instruments on any significant scale.
In its recent paper on a digital euro, the ECB said that “While [anonymity] is currently the case for banknotes and coins, regulations do not allow anonymity in electronic payments and the digital euro must in principle comply with such regulations.”
According to financial blogger JP Koning, this is a change to existing European policy on money and privacy—in favour of greater state surveillance.
Power
The ability to create money confers power. And dominant countries, such as the US under the post-World War II monetary system, have the most to lose by changing the existing set-up.
The major battle between currency zones may still lie ahead.
But China’s digital currency chef made it clear last week that his country’s planned introduction of a CBDC reflects national interests, though he cited cryptocurrencies, not the dollar, as the main competitive threat.
“The first driver of our digital yu’an project is our wish to safeguard monetary sovereignty,” said Changchun Mu.
“The development of cryptoassets like bitcoin, ethereum and stablecoins has already threatened that sovereignty,” he said.
Cost
Under new, tech-enabled national payments schemes, like the UK’s Faster Payments and the eurozone’s Single Euro Payments Area, domestic money transfers in many countries have been getting faster, easier, safer and cheaper.
But the same can’t be said for global money movements.
The costs of cross-border transfers—and the risk involved in managing them—remain stubbornly high. Could CBDCs help? Yes, according to Frantz Teissèdre of Société Générale.
“There’s huge interest to see if we could reduce frictions in cross-border payments”
“There’s huge interest to see if we could reduce frictions in cross-border payments and make them easier and more transparent for clients,” he said last week.
“With initiatives like SWIFT GPI, today more than 50 percent of our international transfers are settled within 30 minutes. But we want to see if we can improve further using CBDCs,” he said.
SWIFT GPI, introduced in 2018, is a new messaging standard for cross-border payments.
Urgency
How soon can we expect to see CBDCs? According to a recent survey among industry experts, they are on their way—but not yet.
“In a straw poll at SIBOS, zero percent of people thought a CBDC would never happen. It’s not a matter of if it’s going to happen, it’s when and in what format,” said SWIFT’s Tom Zschach.
Central bankers caution against unrealistic expectations.
“It’s going to take a long time to change the current system,” said the Bank of Canada’s Scott Hendry.
Riskiness
Rather than improving it, could CBDCs even destabilise the financial system?
One regulatory expert last year called state digital currency a ‘terrifyingly bad idea’ because he said it might precipitate a run on the banking sector and an economic crash. Now he says he thinks CBDCs are less risky—and less significant—an invention.
“I don’t think CBDCs will work the way the central banks think that they will,” Simon Gleeson, partner at Clifford Chance, told New Money Review.
“It actually all comes down in practice to the question of whether customers will put them in bank accounts the way they do notes and coins today. If they do, then CBDCs go back to being an intra-bank settlement system, which at least renders them harmless as regards the real economy,” Gleeson said.
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