beginning of the rise of cryptocurrencies, supporters made comments that banks
and financial institutions would have to adapt to the new wave of
digitalisation, or they would disappear. Central bank digital currencies may be
their ticket into this new world.
itself tells us that central bank digital currencies, also referred to as CBDC,
are digital tokens, similar to cryptocurrency in many respects, issued by a
central bank. Therefore, it is about digital or virtual money, which is pegged
to the value of that country’s fiat currency.
80 countries worldwide are already researching or developing CBDCs; in some
places, projects have been set aside or even cancelled, and in others, digital
currencies have already been introduced.
The path to Central Bank
fiat basically refers to government-issued currency. In the past, such
currencies were backed by the value of something tangible, such as gold or
silver, but that is no longer the case.
There is a
general agreement that fiat currency is a form of legal tender that can be used
to exchange goods and services. It started in the form of banknotes and coins,
but technology has allowed financial institutions to supplement physical fiat
money by digitally recorded balances and transactions.
and coins still play an essential role in everyday life. However, some
countries have experienced a significant decrease in the use of cash. That
trend accelerated during the COVID-19 pandemic when we saw signs at many
different places that contactless means of payment (payment cards) were
development of cryptocurrencies, which can be highly volatile – their value can
rise high or fall very low in an extremely short time – also contributed to the
interest in virtual or digital currencies and payment methods.
together with governments worldwide, are therefore thinking in the direction of
their digital currencies, which would have a much more stable value. In return,
we would have to give up one of the benefits of cryptocurrencies. CBDCs would
be supervised by central banks, which is not the case with cryptocurrencies.
Together with the Bank for International Settlements (BIS), a group of seven central banks published a report two years ago outlining the basic principles that all CBDCs should follow.
The report was compiled by the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank (ECB), the US Federal Reserve (FED), and the Sveriges Riksbank (Sweden’s central bank). The report emphasises that a CBDC must be able to coexist with cash and other types of money in a flexible and innovative payment system.
addition, any introduction should support broad policy objectives and not harm
monetary and financial stability, and the characteristics of the digital
currency should promote innovation and efficiency.
for and against issuing a CBDC and the design choices being considered are
driven by domestic circumstances,” they wrote. “There will be no ‘one
size fits all’ CBDC. Yet domestic CBDCs would still have international
implications. Cooperation and coordination are essential to prevent negative
international spillovers and simultaneously ensure that much-needed
improvements to cross-border payments are not overlooked.”
Wholesale CBDC and Retail
In last year’s annual report, the Bank for International Settlements explained that there are two types of central bank digital currencies, wholesale and retail. Namely, CBDCs can be designed for use either among financial intermediaries only (wholesale CBDC) or for use by the wider economy, consumers (retail CBDC).
CBDCs would operate similarly to central bank reserves. They build on the
current two-tier structure, which places the central bank at the foundation of
the payment system. At the same time, activities for consumers and other
customers are assigned to commercial banks and other payment service providers.
bank grant accounts to a financial institution for the deposit of funds or the
settlement of interbank transfers. Wholesale CBDCs are intended to settle
interbank transfers and related wholesale transactions. For example, to settle
payments between financial institutions. The BIS added that the introduction of
a wholesale CBDC could make central bank money programmable to support
automation and mitigate risks.
the introduction of retail CBDCs is a much more far-reaching innovation. The
CBDCs, described as retail, make central bank digital money available to the
general public in a similar way as cash is available to the general public as a
direct claim on the central bank.
not sound special, as we already have ways to put cash into digital form by
depositing it in our bank account and sending the money to a friend or making a
payment. However, with the CBDCs, this type of transaction would not take more
business days and travel through several different banks. Everything could
happen almost instantly within one digital database.
One of the
characteristics of such CBDCs is that they do not pose any credit risk to users
of the payment system, as they act as a direct claim on the central bank.
The figure above shows that retail CBDC is akin to a digital form of cash, the provision of which is a core responsibility of central banks.
of digital retail money represent a claim on an intermediary, leading to
payment outages due to a temporary lack of funds or even insolvency. Such risks
are already substantially reduced through collateralisation and other
safeguards, but the CBDCs would put an end to any residual risk.
two variants of retail CBDCs that differ in how individual users access and use
option makes for a cash-like design, allowing for token-based access and
anonymity in payments. This option would give individual users access to their
money based on a password-like digital signature using private-public key
cryptography known in the world of cryptocurrencies. Access would be possible
without requiring personal identification.
option of CBDCs is built on verifying users’ identities so that access would be
possible based on a personal user account. The BIS notes that this approach is
more compatible with monitoring illicit activity in a payment system and would
not rule out preserving privacy. With the appropriate design of the payment
authentication process, personal transaction data could be shielded from
commercial parties as well as from a government or public authorities.
Weaknesses of CBDCs
great, and we could almost say that CBDCs represent a unique and developed solution.
However, as with any new thing, we can find some downsides here as well.
switching to digital, we always pause at the issue of privacy. Despite
assurances that CBDCs bring some form of anonymity, we cannot ignore this
issue. No matter how well transactions of this kind are protected, we must not
forget that they are digital transactions still, and in one form or another,
they will certainly be visible to central banks.
the use of cash brings an unattainable degree of anonymity, as it is virtually
impossible to link a specific banknote to previous owners.
The Motley Fool website also drew attention to the fact that if consumers have access to retail CBDCs, commercial banks could lose a significant portion of their business. As mentioned above, transactions would no longer travel through commercial banks. This would be bad for banks and could impact the stock market since bank stocks could drop in value.
the option discussed is the use of CBDCs in combination with cash, but
theoretically, eventually, cash could also disappear. In this case, there are
some additional disadvantages of digital currencies. Namely, central banks
could stimulate consumption and accelerate money circulation through negative
interest rates on deposits at banks.
would no longer be able to withdraw their money in cash and leave it in the piggy
bank, so there would be only two options available to them. They either spend
the money or lose part of it due to negative interest rates.
An even more extreme example is the possibility of programming digital currencies by central banks. In this case, they may decide to introduce an “expiry date” for the money, which China has already talked about. This means that a certain amount of money would disappear if not used in a specific timeframe.
Author: Marko Želko
Keywords: digitisation, CBDC, digital currencies,
article is part of joint project of the Wilfried Martens Centre for European
Studies and the Anton Korošec Institute (INAK) Following the path of
digitalization in Slovenia and Europe. This project receives funding from the
and views set out in this article are those of the author and do not
necessarily reflect the official opinion of the European Union
institutions/Wilfried Martens Centre for European Studies/ Anton Korošec
Institute. Organizations mentioned above assume no responsibility for facts or
opinions expressed in this article or any subsequent use of the information