Championing CBDCs — Who’s Who in the Race?

Central banks front and centre, of course — but little is straightforward in the biggest currency jump we’ve faced since shells went out of fashion…

The emergence of Bitcoin over a decade ago was a revelation. Even with the turbulent and chronically under-regulated waves of crypto speculation that followed, its arrival provided real proof of concept.

And it was Bitcoin that sowed the seeds for central bank digital currencies (CBDCs), with all the flexibility of crypto and all the benefits of government backing. Those seeds have grown from the kernel of an idea into a reality for over a dozen countries worldwide, each with different characteristics and goals.

With cash in dramatic decline and the potential benefits of a regulated, government-issued digital currency becoming accepted, at least 100 more governments are considering making the jump to maintain control in a rapidly evolving monetary climate.

Influential players such as the US Federal Reserve (the Fed), the Bank of England (BoE) and the European Central Bank (ECB) collectively account for 38 percent of global GDP have so far moved with caution. But with US President Joe Biden’s executive order on CBDC research last year, and the UK announcing a digital pound taskforce with HM Treasury this spring, the direction of travel is clear.

The ECB is moving into an “investigation phase” on a digital euro that could be in circulation as early as 2027. But as these giants of the global economy weigh up the pros and cons of an entirely new currency system, who is pulling ahead?

Countdown to Launch

One of the reasons for the muted response to news of the UK’s digital pound consultation earlier this year is the conclusion that such a currency would take years to develop and launch. The Fed, meanwhile, has found itself snagged on thorny issues such as the consumer privacy and support from key stakeholders.

In this mixed picture, EU central banks are arguably ahead of their US and UK counterparts, responding deftly in a sphere where agility rules. The EU is expected to publish draft CBDC legislation within weeks, with a proposal for its design due in October. This means a digital euro could emerge in the next five years.

This trajectory will probably be helped by the fact that several EU countries have been developing CBDCs of their own. Sweden’s Riksbank has been testing its e-krona since 2017, while the Banque de France has been experimenting with a digital euro since early 2020. In July 2020, the Bank of Lithuania launched a pre-sale of its LBcoin, a digital collector coin that doubles as a testing ground for a CBDC.

ID and Digital Wallets

The pace of innovation is only half the battle. As The White House points out, part of the appeal of a digital currency is its potential to make financial services accessible to all, including the estimated seven million unbanked Americans and the 24 million who rely on non-bank services, such as money orders.

For this transition to happen, however, CBDCs must have robust systems of authentication and access in place, including digital wallets. The BoE has already laid out a blueprint of sorts. While the bank itself would issue the digital pound and provide the infrastructure, including the “core ledger”, private sector companies (including banks or approved non-bank brands) would create the interface in the form of digital wallets. Private firms are “much better placed at providing innovative products and services to the public”, the BoE believes.

Creating this bridge may help accelerate solutions for consumers. Coupling private-sector versatility with government-backed regulation is the best of both worlds — and a development that could give the UK an advantage over product innovation.

Risk Management

A regulated digital currency could potentially enhance payment security, reducing the chance of fraud. But the traceability of digital money raises serious questions about consumer privacy.

In its research paper, The US Dollar in the Age of Digital Transformation, the Fed highlights the balancing act required. Consumer privacy rights must be safeguarded while allowing enough transparency to combat illicit finance. It goes on to propose the use of an intermediated model to facilitate the use of existing privacy and identity-management frameworks.

Infrastructure is another major stumbling block in the journey to CBDCs. The way they operate, and the nature of the services associated with their use, have not been clarified by the Central Banks discussed here. And each CBDC programme being considered by the US, the UK and Europe seems to suggest a varying range of capabilities and features that would need to be co-ordinated between issuers.

Perhaps an international effort to fine-tune specific features offers a path ahead. In October 2020, the BoE joined seven other central banks to collaborate on a ground-breaking CBDC research project. The focus was on the technical and practical feasibility of CBDCs in cross-border payments.

Europe probably has the firmest grasp of issues such as system design and interoperability. Its plans for a staggered rollout would begin with the bank releasing its CBDC for use in person-to-person and e-commerce transactions. The bank would then add support for on- and offline digital euro payments at the point of sale and person- or business-to-government payments (including taxes and customs duties), according to an ECB presentation published online.

Scale of Adoption

An effective CBDC could break down barriers to provide fairer financial support for all as well as stimulate innovation by giving entrepreneurs a platform. But these benefits only come into play if users at all levels of society understand the value proposition behind a digital currency well enough to make it a viable and trusted part of everyday finances.

The UK, Europe, and US governments are all being proactive in encouraging public debate, raising awareness of the concept. As the Fed points out, “While a CBDC could provide a safe, digital payment option for households and businesses as the payments system continues to evolve, and may result in faster payment options between countries, there may also be downsides. They include how to ensure a CBDC would preserve monetary and financial stability as well as complement existing means of payment.” Working transparently invites public dialogue about the emergence of a digital dollar in an environment that will not favour any particular policy outcome.

The BoE, meanwhile, is at pains to explain how a digital pound would be designed for use by everyone, including those who aren’t comfortable with tech. “Most people would access their digital pounds through a virtual wallet on their smartphone,” it says. “But we are also looking at other ways too, for example, a physical card, like a debit card.”

HM Treasury’s decision to see stablecoins recognised as a valid form of payment last year set the stage for wider collaboration with digital currencies — with government regulation intended to provide businesses with the confidence they need for long-term investment and innovation.

The Bigger Picture

But it’s the ECB that again that reaches further on knowledge and education efforts, with a deep dive into data. It recently commissioned Kantar to survey EU members about digital wallets, with a series of focus-group sessions carried out in all euro area countries from December 2022 to January 2023.

As expected, younger people were more willing to adopt digital wallets, while older respondents were more wary. Uptake also appears to depend on the way it is introduced, and involving local commercial banks is essential.

As a result, the ECB knows more about the Eurozone’s most highly valued wallet functionalities: budget management and peer-to-peer payments. And it’s putting emphasis on a digital currency design that would be available via existing banking apps, along with a custom-made digital euro app.

It’s this kind of precise and nuanced picture that central banks need to focus on as the race to CBDC maturity picks up pace. The consultation process between governments, private specialists and end users should be open and circular, with each new round of consultations used to enhance product features — and prompt a new round of questions.

We’re now closer to the reality of CBDCs than we’ve ever been; the idea of them initially complementing — and eventually becoming indistinguishable from — fiat currencies is gaining traction. But technical, operational, ethical, and communication challenges remain.

The UK could yet become a global hub for crypto asset technology, while a US CBDC could help to maintain the dollar’s global role as the most widely-used investment and payments currency. Alternatively, the ECB’s plans for a digital euro could outmanoeuvre them both. All of these options must also consider a possible challenge to the Western economic powers in the form of an alternative CBDC, possibly in the form of a digital Chinese Yuan.

The situation is fluid enough that there’s still everything to play for.

by Alessandro Hatami

• Alessandro Hatami is managing director of strategic consultancy Pacemakers.