From barter to centralised currencies, money has evolved beyond all recognition.
Today, a time when digital payment methods are in the ascendency, central banks are considering whether it’s appropriate for money to evolve once again.
Due to the rise of cryptocurrencies, falling cash use and the demand for instant and cheap cross-border payments, digital currencies are in favour—and central banks don’t want to be left behind.
A central bank digital currency (CBDC) is the digital form a country’s fiat currency. According to Atlantic Council, a US think tank, 114 countries, representing more than 95% of global GDP, are exploring a CBDC.
The Bahamian sand dollar was the first ever nationwide CBDC in the world; Nigeria, Africa’s largest economy, launched the e-naira in 2021; while Jamaica is the latest country to launch with the JAM-DEX.
The European Central Bank is in the investigative phase of a digital euro. If it is introduced, it would be alongside cash, not to replace it.
Christine Lagarde, its president, said in an October 2020 report on the digital euro that a digital currency may be needed “to ensure that consumers continue to have unfettered access to central bank money in a way that meets their needs in the digital age”.
The rise of digital assets also led US President Joe Biden to sign an executive order for his government to explore a CBDC.
And the Bank of Japan has been testing a CBDC since April 2021, it will complete the proof-of-concept stage in March, which tested the basic functions of a CBDC—issuance, payout and transfer—ahead of the pilot launch in April.
Bank notes for the digital age
Many central banks are looking into a digital currency out of necessity, but also because of the genuine benefits it would provide, for the banks and the public.
A CBDC would hold the same benefits as physical central money—settlement finality, liquidity and integrity, according to the Bank for International Settlements (BIS).
It would be cheaper and easier to move money across borders, it could make e-payments possible for those without bank accounts, and it could also hinder tax evasion, drug deals and terrorism financing, which all rely on anonymous cash transactions.
On the benefits, a spokesperson for Riks Bank, Sweden’s central bank—which is in the proof-of-concept phase of a CBDC—told FinTech Intel: “In a digital age where physical bank notes could lose their role as a reference value in payments, central banks must consider how to ensure that public money can remain a payment anchor in a digital world.
“A CBDC could preserve the co-existence of public and private money in a digital world. Designed in a good way, a CBDC should be able to co-exist with other forms of money and help guarantee the smooth functioning of the payments market, as well as provide additional resiliency and competition in the payment ecosystem and improve financial inclusion.”
A fine balance between two opposite risks
Despite these potential benefits, there are obvious risks inherent in launching a CBDC.
As the digital economy continues to grow, so will the amount of personal data collected and processed. This raises issues of data governance, consumer protection and anti-competitive practices from data silos, according to BIS.
There is also the issue of cyberwarfare. Individual accounts could be compromised through weaknesses in cyber security. A centralised CBDC ledger would be a target for attack and if a server is taken down it could potentially affect the entire economy.
Another concern is state intervention. It will become much easier for governments to completely block payments on certain transactions, giving those with a dim view of press freedom the power to prevent a CBDC from being used to pay for newspapers from foreign sellers.
The Atlantic Council said that citizens could pull out too much money from the banks at once by purchasing CBDCs, triggering a run on banks, affecting their ability to lend and sending a shock to interest rates. This is especially a problem for countries with unstable financial systems.
Due to the perceived risks, the UK government concluded in January 2022 that there is no convincing case for launching a CBDC. While it may provide some advantages, it could present “significant challenges for financial stability and the protection of privacy”.
The UK Treasury and the Bank of England have since launched a public consultation on a potential digital pound—dubbed the britcoin—in a bid to further weight the benefits and risks.
In February of this year, Jeremy Hunt, the UK’s chancellor, said: “While cash is here to stay, a digital pound issued and backed by the Bank of England could be a new way to pay that’s trusted, accessible and easy to use.
“That’s why we want to investigate what is possible first, whilst always making sure we protect financial stability.”
The Riks Bank spokesperson told FinTech Intel that there are risks whether a CBDC is not used enough or is too successful. “There is a fine balance between two opposite risks. If a CBDC is ‘too successful’ it risks crowding out private payment solutions and financial intermediation.
“This risk can off course be handled in various ways, for example, by introducing measures to disincentivise excessive holding of a CBDC. If a CBDC is ‘not successful enough’ this will affect adoption and usage negatively.”
Solutions to these various problems are currently being explored. One idea for privacy is to use a modified two-tier system. Central bank digital money could be available to the general public as a direct claim on the central bank, just as cash is now.
Individual users could be given access to the CBDC based on a password-like digital signature using a private-public key cryptography, without requiring personal identification.
Another solution would be a digital identity scheme, replacing physical identity checks currently used.
One example is the sand dollar. Users of the Bahamian digital currency can hold up to $500 without providing any information to set up an account, but those wishing to hold up to $8k must pass identity checks.
The Riks Bank spokesperson commented on the barriers CBDCs face: “The principle of co-existence of CBDC and other forms of money require a certain degree of interoperability. Examples of barriers to achieve such interoperability could be technical, commercial and legal.
“In addition, given the vast supply of private digital monies and value-added services available today, end-users may lack incentives to fully appreciate the benefits of a CBDC.”
Many central banks are still in the experimenting or testing phase. Around 80% of central banks are exploring CBDCs and 14% are already deploying CBDC pilot projects.
The overriding concern on whether to introduce a CBDC should be its benefit to the public.
For CBDCs to be accepted globally, the Riks Banks spokesperson said: “Any CBDC, regardless in which market or country it exists, need to be carefully designed to ensure it supports competition in the ecosystem and ensure usability for the end-user. This will be key for adoption and wider acceptance of a CBDC.”