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CBDCs: Central banks seize the initiative in the race to consign cash to history

The Bank for International Settlement (BIS) defines a Central Bank Digital Currency (CBDC) as a digital payment instrument, denominated in the national unit of account, that is a direct liability of the Central Bank. It is the legal tender issued by the Central Bank in a digital form as a medium of exchange, store of value and unit of account. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. In other words, it exists within the regulated financial environment as an alternative to hard cash and can be used by the general public.

In 2020, global headlines were preoccupied with the global health emergency and largely missed the fact that the Bahamas had launched the Sand Dollar, one of the world’s first operational CBDCs, ideally suited to the payment needs of a wealthy island nation which enjoys greater than 90% mobile penetration. When trials for the digital Yuan began in China in June 2021, it gained more attention, as the People’s Bank of China made no secret of its ambition to wean the world’s largest national population away from cash and the pandemic had seriously accelerated the momentum towards expunging banknotes and coins.

As at July 2022, more than 90% of the world’s Central Banks are actively engaged in exploring the potential of CBDCs (Deloitte).

From Canada to Cambodia and Sweden to Saudi Arabia, Deloitte sees the role of CBDCs as maintaining and streamlining the Central Bank’s function of providing money, financial stability and access to banking services. In many countries, it seems highly likely that they will be used to expand the everyday payment channels available to consumers and businesses.

The establishment of a workable CBDC, however, requires a more sophisticated use case than the simple desire to reduce cash. It also necessitates a well-planned infrastructure, which may change the role of the Central Bank from regulatory oversight and creation of monetary policy to direct involvement in the provision of payment technology, including the operation of a financial market infrastructure (FMI) which provides a secure platform for CBDC transactions and integration with other aspects of the national payments ecosystem.

The use case for the CBDC will differ from one country to the next. Arguments in favour might include increased financial inclusion, reducing the risks of carrying cash while maintaining the convenience of physical currency, eliminating costs or reducing the size of the grey economy. It may also extend to increasing the resilience and security of payment systems available in the market, for example increasing transparency to prevent money laundering. Nevertheless, the introduction of a CBDC might not have the same positive impact in all countries – an existing Instant Payments System can also achieve these aims. Central Banks need to balance the desire to innovate and avoid the risks of private digital and cryptocurrencies against any potential risks to monetary policy, or the danger of disintermediating commercial banks and PSPs.

From a technology perspective, the undertaking is significant, and it is important to test alternative platforms for managing CBDC transactions while achieving optimum architectural flexibility. Consideration must be given to existing alternatives, especially for managing cross-border payments where distributed ledger technology (DLT) is attractive but may be unnecessary if other secure, scalable, multi-currency systems are already in place to serve the needs of consumers and businesses.

eMcREY has significant experience in working alongside Central Banks around the world to investigate the use case and technology requirements for CBDCs. We also have a strong track record in design and implementation of FMIs for seamless and secure handling of national and cross-border payments.

We work in an advisory capacity to help make key regulatory and design decisions – assessing the added value of a CBDC, defining objectives and proposing potential solutions. If the introduction of a CBDC is considered feasible and beneficial, our technology solutions and expertise are ready to move to the proof of concept, pilot and implementation phases of the project.

As Central Bank interest in CBDCs accelerates, we anticipate a wide range of answers to the same set of questions and problems, allowing regulatory authorities to determine on a case-by-case basis whether the CBDC route justifies the time and investment in getting it right.

Central banks seize the initiative in the race to consign cash to history