CBDC – A new form of money.

I get CBDC stands for Central Bank (Issued) Digital Currency, but what is it?   

The responsibility of ‘issuing’ currency in a country rests with its Central Bank. Traditionally Central Banks have been issuing currencies in the form of Notes and Coins. Now Central banks across the world have come up to issue currency in digital form also, in addition to Notes and coins.

Isn’t money already digital?  

Yes money in the sense that ordinary people & companies use, is mostly in digital form. Our account balances held with banks don’t sit in physical (notes & coins) form but as entries in the banks’ digital core banking system. We pay each other digitally using apps and other electronic means. In that sense our transactions have become digital. However, originally as money, the central bank issued it in some physical form. As ‘users’ of money, we use it digitally but still retain the ability to convert our digital money to cash. So now Central banks also want to issue currency digitally. Such digital currency will never see any physical form.

 Ok, but if we already have digital transactions, why need CBDC at all?   

This is a question that needs more elaboration in different dimensions. Stay along as we explore.

 Monetary stability 

1. Central banks are tasked with managing the monetary system of their respective countries. This includes maintaining a trustable currency which is the foundation of the monetary system. The last decade has seen several crypto currencies gaining popularity that seem to offer an alternate monetary mechanism – outside the purview of governments. Some people are attracted to private digital currencies for the data privacy it offers. There are growing concerns of banks accumulating enormous data of their customers’ transactions. With increased technological capabilities of AI, ML, and cheap computing power, the privacy concerns of many law-abiding citizens are real.  Such customers, especially those who either have the technical familiarity or have excess wealth to experiment with, gravitate towards such cryptocurrencies. This brings in unknown (and sometimes undesirable) private enterprises creating a parallel monetary system which seems to offer alternate payment mechanisms.  This creates an apparent & even real impression that central banks ceding control of monetary policy to private actors. To remedy this situation, central banks are pushed to publish their own digital currencies that offer most, if not all of the features private currencies do.
2. As the Global Financial Crisis of 2008 indicates, money chasing dubious assets creates far-fetched misery in the larger economy – even across borders in our connected world. Central bankers and governments want to avoid such crises. Many people who convert real world money to crypto currency, do so out of greed (the lure of supposed superior returns), and some, for de-risking themselves from govt sanctions through the existing financial system or for genuine privacy concerns. In addition to bringing financial misery to the individuals who purchase those crypto currencies, at an aggregate level it diverts national resources to unproductive & purely speculative assets. So central banks across the world are forced to take notice and do something about it.  
3. Currently people transacting through private crypto currencies do so outside the purview of the regulatory framework. With a view to leveraging the blockchain technology of cryptocurrency and also bring much of these transactions inside the regulatory purview, central banks first want to launch their own digital cryptocurrencies before a possible ban on private currencies across the world.

 Strategic reasons 

We will address this in an answer to a subsequent question.

 Improving operational efficiency   

1. Today Central banks spend a lot of money in printing cash in security (read expensive) paper, store it in high security vaults (read high costs), transfer to banks’ currency chests (incurring transport & transit insurance costs), plan and arrange for checking counterfeits & reissuing soiled notes (more expenses). All these costs can be avoided if currency is issued digitally. Of course, this will entail costs in hardware, software, network, application building & maintenance etc. But these costs will not be directly proportional to the amount of currency issued. So there will be net savings by issuing currency digitally. The shift to a digital currency -instead of cash- is a step towards reducing cash in the economy in the coming years. If the CBDC projects of different countries pass their pilot project and move into production mode, we will progressively see lesser and lesser cash in our economies going forward.
2. Distribution of bulk cash, along with being a risky activity, is a tedious activity too for some countries. Take countries that are far-flung, dispersed over several islands of an archipelago (The Bahamas and Jamaica, which straddle multiple islands, mention this as a primary reason they are going digital with their currency).
3. A digital currency makes a brilliant case for efficient implementation of targeted social welfare programs. Let’s take an example. A country provides cash subsidies to its farmers to purchase fertilizers. The farmers are issued cash, with the intent they will use it to buy fertilizers only. But cash being fungible, can be used to buy anything. From a genuine farmer using it to buy liquor, to a conman pretending to be a farmer just to get some free money, the subsidy can be misused. Being digital, CBDCs can be issued like tokens with numbers on them, so it can be used only at fertilizer shops (as an example). Or it can have an expiry date, so the subsidy is not rolled over to a different season / year.
4. Built in blockchain technology, CBDCs can be integrated with a variety of platforms. We saw a brief example in this artice where CBDC can be automatically settled between two traders through smart contracts, without the need for costly trust providers. 
5. Banking is also undergoing another change. Many markets, for instance in Europe and in India, have Open banking, which allows customers to hold accounts in one bank, allows another operator to transfer it and the end customer to own her data – not the banks. In this “open banking” era and the growing data governance to safeguard customers’ privacy, the use cases for CBDCs are plenty!
6. The CBDC allows an alternative to cash and if implemented in “anonymous” mode (called a “token” based system),, one doesn’t need an account with a bank to even transact it. Just like how two people can transact in cash without having a bank in between, two people can transact in CBDC using their smartphones through an app.

 But if a bank account is not needed, does it mean that the central banks are sidestepping the banks and the banking system in their respective countries?   

The banking system and banks will continue to be the essential nervous system of the economy of the country. To dissuade people from sidestepping the banking system, central banks are making it clear that the CBDC held by people will NOT earn any interest. It is exactly like cash in our wallets and under the mattress. Even today we all hold some cash and at an aggregate level, forms a very small fraction of the overall money supply. CBDC will be like that. People will hold it in small quantities – if at all.

 If it is not going to be held in large quantities and by large number of people, why at all issue CBDCs then? What are the central banks trying to achieve?   

CBDCs are being issued in two variants.

(i)      CBDC-Retail, meant to be used by general public like you and me

(ii)    CBDC-Wholesale, meant to be used by banks for their interbank settlement – amongst themselves, across borders. It is this feature that is a bigger and more important use of CDBC. The ability to settle between banks directly without the need for regular channels of banking or using messaging platforms like SWIFT. This alternate cross border payment mechanism can be a redundant payment rail for payments supporting trade or a conscious route to de-risk economies from being sanctioned & sabotaged. Read more about these risks in this Show Me My Money! and The Kill Switch. articles. 

 How many countries are getting into CBDC? 

119 countries are in various stages of issuing CBDC.  Yes 119. That is most of the countries.

11 have launched and are using it now. This includes Nigeria (eNaira), the Bahamas (Sand Dollar), Jamaica (JAM-DEX) and 8 countries in the Eastern Caribbean island countries. Most of these countries have gone the CBDC-retail way. The biggest success has been in the Bahamas and in Jamaica,  which had trouble in managing cash logistics across the archipelago.

Some 17 countries have launched pilot projects. Notable among them are China, Thailand, the UAE, Hong Kong and India that have launched the CBDC- Wholesale variant. This is significant because of its usefulness in cross border payment & settlements

The remaining countries are in research and development mode.   The below pictures gives an idea of which countries are in what stage.

 

This widespread blooming of CBDCs across the continents tells us a story, that a new mode of money is born, a new mechanism of payment & settlement is in progress and it is here to stay and transform international settlements.