What is Central Bank Digital Currency (CBDC)?
CBDC: An electronic form of Central Bank (CB) money that could be used by households and businesses to make payments and store value.
Currently, public can hold Central Bank banknotes. But only banks and some financial institutions can hold electronic CB money.
Types of CBDCs: Retail and wholesale CBDCs.
Retail CBDC: The type of CBDC to be used in payments involving households and/or small or medium-sized businesses.
Wholesale CBDC: The type of CBDC to be used in payments involving financial institutions and/or large (mostly multinational) corporations.
Current forms of money versus CBDCs
Current forms of money are banknotes, bank deposits, and CB reserves (i.e. commercial banks' deposits at the CB). It is important to build a CBDC that offers three main functions of fiat money and adds more on to that in order to ensure substitutability from current forms of money to CBDC.
3 Main Functions of Money:
A store of value: To be able to transfer purchasing power from today to the future,
A medium of exchange: To be able to make payments for goods and services,
A unit of account: To be able to measure the value of a particular good, service, savings product or loan.
Important principles in the economic design of CBDCs
It should maintain these three main functions of money besides its convertibility into cash and bank deposits.
For example, a CBDC would be denominated in local currency, just like banknotes, so $10 of CBDC would always worth $10 as a banknote.
It should be equally safe and free of credit risk as physical cash and secured bank deposits.
It should be more convenient than cash to make the electronic and remote payments for households and businesses.
Commercial banks may offer non-bank businesses with a CBDC account the use of credit facilities and other benefits due to relationship lending.
It should be in line with the relevant CB's primary objectives such as maintaining monetary and financial stability.
It may not replace the other forms of money currently hold but rather complement them.
Important principles in the technological design of CBDCs
It requires the creation of new payments infrastructure that uses blockchain technology, fits into the wider payments landscape, and interacts and complements the other initiatives to improve payments.
It could be ultimately faster, more efficient, with new functionality added in the future.
It could be built by using the Distributed Ledger Technology (DLT) as well as centralized technology.
It should be user-friendly, widely accessible and addressing the privacy concerns of its users.
It should be resilient, secure, fast, efficient, extensible, available, and scalable.
It should offer more transparency via increased capability for bankers to monitor the market activity, trace and track every transaction in real-time to help eliminate money laundering and illegal purchases.
Differences between cryptocurrencies, cryptoassets, and CBDCs
Many cryptocurrencies are privately issued and not backed by central party.
Cryptocurrencies are not considered a currency or money since they do not have the three main functions of money.
Their value is too volatile to be a reliable store of value.
They are not widely accepted as a means of exchange.
They are not used as a unit of account.
Cryptoassets (stable coins) generally provide stability of value via some form of backing but it depends mostly on the nature of the asset.
CBDCs would be risk-free, issued and backed by the relevant CB, and perform three main functions of money.
More Questions to be Answered:
Effectiveness of monetary policy: As CBs may issue, destroy, transfer, and hold all currency on the ledger, can CBDCs add more to monetary policy effectiveness?
Banking fee structure: In the current banking structure, local banks charge customers fees to maintain the banking infrastructure. However, after the CBDCs, if customers may work directly with the CB, should banking system need a new fee strategy?
The future of relationship lending: Since CBDC may allow bank customers to open accounts directly with the CBs, can it lead to a weakened relationship lending in the future?
Interest-bearing or not? Depending on the decision of CBDC to be designed with interest-bearing or not, how could CBs ensure that the interest rate on local currency denominated savings deposits and interest rate on local CBDC would be the same? If not, this would cause arbitrage.
Exchange rates of CBDCs: How can CBs ensure that the exchange rate on two different local currencies in fiat money would be equal to that of CBDCs? Otherwise, there would be arbitrage opportunities.
Sanctions, tariffs, and taxes: How can governments ensure that the legal and technological infrastructure of CBDCs would consider the sanctions, tariffs, and tax collection regarding each country, industry, goods and services? Would this require all CBs to be connected at least for the cross-border payments?
Adoption of CBDCs: Why emerging market economies (EMEs) are faster than the advanced economies to adopt and issue CBDCs?
References
[1] Central Bank Digital Currency: Opportunities, challenges and design. March 2020. Bank of England Discussion Paper. https://www.bankofengland.co.uk/-/media/boe/files/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design.pdf
[2] Hamilton, D. June 5, 2020. What are Central Bank Digital Currencies (CBDCs)? https://www.securities.io/what-are-central-bank-digital-currencies-cbdcs
A goodbye message from the author:
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More subtopics yet to come:
Economic design and impacts on monetary and financial stability
Reasons fostering or discouraging the implementation of CBDC
Technology design of central bank digital currency