What are the challenges and opportunities for a major reserve currency issuing a CBDC?

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Just four countries have issued a central bank digital currency (CBDC). But the CBDC Tracker suggests that interest in CBDCs is far from moribund. In September 2024 26 central banks had a CBDC at the pilot stage and another 30 at the proof-of-concept stage. A further 103 are researching the idea. The Bank for International Settlements (BIS) website lists 20 CBDC research projects in which central banks have taken part since 2016. Just seven central banks have cancelled their CBDC projects. 

As a result of all this work, a great deal of knowledge about CBDCs has accumulated. It is now known that CBDCs are technically possible in terms of code, and in terms of security and resilience, though the range of designs is wide. It is also known that it is possible for central banks to distribute retail CBDCs to banks and make them available to retail consumers on multiple blockchains without compromising their privacy. 

In addition, the research projects have proved that wholesale CBDCs can be made available on third party platforms and be used to settle payment versus payment (PvP) and securities and funds transactions by delivery versus payment (DvP). CBDCs have proved interoperable with each other and with existing payment systems. Importantly, the experiments have also proved that CBDCs can make cross-border settlement cheaper and faster without undermining monetary sovereignty. 

Which explains why the BIS expects 15 retail and nine wholesale CBDCs to be circulating by 2030. However, only a CBDC in a major reserve currency such as US dollars, euros, Yen or Sterling would be a sufficient catalyst and at present it seems only the European Central Bank (ECB) is committed to issuing a CBDC. In the United States, the issue is (predictably) politically polarised with the House of Representatives passing a vectorially named "Anti-Surveillance State Bill" to block the Federal Reserve from issuing a CBDC as a case of government over-reach. 

The CBDCs launched so far do not seem to be getting traction. The Bahamian Sand Dollar, launched in 2020, has attracted less than 0.5 per cent of all cash in circulation. The eNaira in Nigeria accounts for less than 1 per cent of the currency in circulation. Even the Chinese digital yuan, now five years old, has not moved beyond the pilot stage. Nor has the Eastern Caribbean CBDC. The JAM-DEX CBDC in Jamaica has also failed to reach its targets. 

Neither merchants nor consumers are enthusiastic, despite promotional efforts by the central banks. There are many reasons for this, ranging from inadequate electrical and telecommunications infrastructure, through lack of effective marketing by banks, to distrust of the government. But the CBDCs in issue have also struggled to find compelling use-cases. Expectations that CBDCs can promote financial inclusion, for example, are being met but were overblown at the outset. 

Which has prompted a crucial question: CBDCs work but are they useful? Cross-border payments are the obvious answer, but this threatens the already fragile eco-system of correspondent banks. The tokenised asset markets, which would flourish if fiat currencies were available on-chain, offer another answer, but present a chicken-and-egg dilemma. If token markets scale, transactions will need to settle in central bank money, so central banks will issue CBDCs - but token markets cannot scale without a CBDC. An inadequate equilibrium prevails in CBDCs, and it is hard to foresee what will upset it. 

Benefits 

• When commerce is increasingly digital, the use of the only form of central bank money available to the public (cash) is declining, and private monies are proliferating, central banks must consider issuing central bank digital currencies (CBDCs) to maintain public confidence in the monetary system. 

• Financial inclusion is one of the benefits delivered by CBDCs and, despite disappointing results in the first markets where CBDCs were issued, an experiment with a retail CBDC in Ghana proved that the unbanked regard it as a secure alternative to holding physical cash. 

• The European Central Bank (ECB) sees a euro CBDC as a source of competition for incumbent payment service providers such as the international card networks, which it believes can play an important role in reducing the cost of cross-border payments within the eurozone. 

• Problems solved by CBDCs include reducing the cost to merchants (as opposed to consumers) of current retail payments arrangements, the lack of fiat currency on-chain to settle digital asset transactions and the high costs, slow speeds, lack of transparency and inaccessibility of cross-border payments. 

• If CBDCs can improve the connectivity of capital markets around the world, they could save commercial banks billions of dollars spent on maintaining cash buffers and sourcing eligible collateral, though these may be easier to deliver by means of synthetic CBDCs than actual CBDCs. 

Issues 

• A successful CBDC must be based on a cooperative and complementary relationship between central and commercial banks, because there is a risk that a CBDC will strip the commercial banks of their deposit funding and so undermine the credit offered by banks to businesses and households. 

• CBDC designs, including the euro CBDC being developed by the ECB, include features designed to mitigate the risks of a CBDC undermining the funding of commercial banks such as not paying interest on holdings of a CBDC and capping the amount that can be held by any one market participant. 

• In developed markets with sophisticated and well-entrenched digital payments systems in place already a CBDC must be highly innovative to succeed, whereas in less developed economies with unbanked populations a relatively simple CBDC can play a vital role in financial inclusion. 

• The limited success of the CBDCs issued so far reflects the difficulties of take-up in emerging markets with inadequate infrastructure and does not undermine the fact that a CBDC must be judged not by the rate of adoption but by its cash-like function of maintaining the singleness of money in digital form. 

• Despite the knowledge they have accumulated through multiple research projects that CBDCs will work, central banks are condemned to proceed cautiously because they need to be confident that the prerequisites for success are in place and the consequences are manageable. 

• Introducing a CBDC requires agreement on a design and then an execution process that imposes disruptive technological and operational changes not just on central banks operating the crucial settlement system in every jurisdiction but also on commercial banks and other firms active in making payments. 

• The singleness of money might not survive a surfeit of choice, in which cash pays no interest but suffers no caps, CBDCs pay no interest but holdings are capped and CBDCs are programmable, leading to different market values being attached to each, even though each is redeemable at par at the central bank. 

Regulation 

• The introduction by the Bank of England of an omnibus pooled account, by which private sector institutions can access central bank money without being deposit-taking institutions, suggests that central banks could offer market participants a choice of a CBDC or a synthetic CBDC. 

• The development of synthetic CBDCs is constrained by the fact that central banks need to be confident that service providers are operationally resilient and comply with the Principles for Financial Market Infrastructures published in April 2012 by securities and payments market regulators. 

• In developing a common platform, there is ample public-private cooperation to build on not only via BIS projects but in the collaboration between, for example, the Swiss National Bank and the Swiss stock exchange group and the Monetary Authority of Singapore (MAS) and numerous private sector actors in Singapore.