A very hot topic at the moment are the so-called CBDCs, short for "Central Bank Digital Currencies". These are the recent reply of central banks to the continuing success of crypto-currencies like Bitcoin and Ether(eum). After the unsuccessful attempts of several governments to restrict or even ban these crypto-currencies, there is more and more a consensus of "If you can’t beat them, join them", resulting in the setup of an alternative that fits better the agenda of governments and of central banks to stay relevant and in control of monetary policy.
Very simplistically said, CBDCs are a digital version of the fiat currencies that people use in their daily lives. They take over a number of features, characteristics and technologies of crypto-currencies (CBDCs will be crypto tokens), but instead of being decentralized (and bypass central bank and government control), they ensure some degree of centralization, allowing the central banks to keep control over money flows and keep the ability to enforce a monetary policy in line with their objectives, i.e. economic growth and financial stability.
With more than half of the world’s central banks actively conceptualizing CBDCs, this will likely stay a hot topic in the coming months and years. However at the moment it is still unclear how these CBDCs will exactly function and as a result also which value they can/will exactly bring.
The goal of all central banks is however clear, i.e. setup a digital currency which provides:
- A cheaper way to transfer money (initiate payments), both nationally and internationally. This will boost (international) business and reduce counterparty risks, but also opens the way for micro-payments (cfr. my blog "https://bankloch.blogspot.com/2020/02/micro-payments-revolution-in-payments.html" - Micro Payments - A revolution in the payments landscape)
- Real-time (instantaneous) transfer of money, compared to the current - often batch driven - system where international payments can often take several days to get processed
- A secure way of doing payments, i.e. secure for the user (less fraud and theft), but also respecting laws with regards to AML and general fraud detection
- More financial inclusion, i.e. allow anyone to have a bank account and execute digital payments
- A pure digital currency, without the strong fluctuations (a CBDC would have the same value as the existing currency equivalent) and speculative nature of today’s crypto-currencies. Additionally they would have a much wider usage, as these digital currencies would be usable at any place where you can pay today with the fiat currency
- More insights into the money flows (as the central bank would have a central register of every transaction happening on its currency), although this will probably be heavily regulated, as people would not be open to lose all their (financial) privacy.
The funny thing is that a digital currency, with a high degree of centralization (i.e. the central bank would keep a central record of everyone’s position and transactions), is not really new for a central bank. Today central banks already do clearing and settlement of all money flows and already the majority of money in circulation exists purely digitally. As such, CBDCs might just be a marketing term to get the necessary investments and attention to make this clearing and settlement process more efficient.
As always some people are very enthusiastic of this new concept, while others are skeptic, with several camps within this skeptical group. On the one hand you have a camp saying that there is no need for CBDCs as the existing crypto-currencies can already deliver all the answers. Others say that the traditional (often bank-based) payment infrastructure can also evolve and provide those objectives. Even others say that BigTechs could also play this role and potentially even better, like Facebook with Diem (formerly known as Libra).
This evolution of the existing payment infrastructure to become more real-time, cheaper and more frictionless is already in full progress with initiatives like:
- The different instant payment schemes being rolled-out all over the world
- The SWIFT gpi initiative aiming to reduce the time for international payments and allow to monitor them better
- New ways of initiating payments, like the PSD2 payment initiation or the new SEPA "Request to Pay" (SRTP) scheme
- Peer-to-peer payment solutions (like PayPal, Venmo, Payconiq…) becoming more and more established, more international and offering more value-added services, like group reimbursements, group gifts… (cfr. my blog "https://bankloch.blogspot.com/2020/12/peer-to-peer-payments-crucial-component.html" - Peer-to-peer payments - A crucial component towards a cashless society)
- Card payments evolving heavily as terminals offer more value-added services (like showing QR codes or the ability to deploy certain apps on a terminal, e.g. a loyalty app), terminal vendors and PSPs (like Adyen or VIVA Wallet) offering fully integrated multi-channel solutions, mobile payments becoming more a standard (like Apple Pay and Google Pay)…
Obviously, the main question for those CBDCs is where individuals (and companies) will hold their account. Will every person be able to hold an account directly at the central bank or do they still need to pass via a commercial bank like today is the case? In the 2nd scenario, all objectives of CBDCs stated above will be hard to achieve, as the setup will be very similar to the current payment flows. As a result, most people are convinced that the 1st scenario is required to achieve the objectives, but this comes with several pitfalls:
- Is a Central Bank capable of handling such volumes and the added-value services on top (like currency conversion, hedging, monitoring, cash management, peer-to-peer payments, online payments, cards, PFM…). Most likely these value-added services will not be offered by Central Banks, but by Commercial Banks, requiring a good "Open Banking" architecture, where users can give a consent to the Commercial Bank to read and/or initiate payments on his behalf on his Central Bank account.
- Banks will strongly lobby against this offer, as they risk losing control and also important revenues (i.e. fees charged by commercial banks for money transfers).
- If individuals will retain accounts at Central Banks and do payments on it, all complex rules, procedures and tooling for AML and KYC will also need to be setup by Central Banks. Do they have the skills and technology to do this properly?
- Is a central bank able to offer the necessary customer support, in case of questions/issues?
- What is the business case for the central bank? The setup of this solution will cost millions and the day-to-day operations as well. If central banks want to meet their objectives of reducing payment costs and increasing financial inclusion, only small fees can be charged. This means it is unlikely to be profitable, thus raising the question who will pay the costs?
- How to ensure interoperability with existing point of sale terminals (in-store) or with digital platforms (like eCommerce or PSPs), but also how to support offline payments?
- How to avoid in times of financial crisis that people not massively convert their money on commercial bank accounts to CBDCs deposited directly on a central bank account and as such resulting in a "bank run". This means some kind of limits (e.g. maximum amount to hold in CBDCs or maximum transaction amount per day) will be required, thus reducing the ease of use and usefulness of CBDCs for consumers.
- With every Central Bank in the world setting up its own CBDC, there will still be a lot of integration between Central Banks required to ensure real-time international payments with CBDCs. Will every Central Bank setup a connection with any other Central Bank or will a system of hubs be required, thus complexifying the model?
Clearly a lot of questions still need to be answered, but CBDCs are definitely an interesting evolution, which raises awareness (of governments) of the existing inefficiencies in the payment flows. However it would be naive to think that CBDCs can transform the payment landscape in a short period of time. The current payment landscape has been carefully built up by thousands of integrations and as such forms a complex web of interactions all providing a piece of the puzzle. A new solution like a CBDC would require all those parties to make adaptations (to integrate this new technology) in a relatively short period of time, which is quite unlikely to happen. Instead CBDCs will probably be deployed first as a mechanism to coordinate the flows between Commercial Banks more efficiently and then gradually evolve towards the scenario described. This will - in my humble opinion - take however at least a decade (if not much more) before this target scenario takes shape.