The Challenge of Achieving CBDC Objectives

Finextra has published an article highlighting different visions for Central Bank Digital Currencies (CBDCs).

Jon Cunliffe, Deputy Governor at the Bank of England, made a speech that said it was ‘probable’ that the ‘state will need to issue, public money’. It contrasted this with statements by the President of the Boston Federal Reserve, Eric Rosengren, who was more cautious, wanting to see ‘whether other technologies could more cheaply or efficiently address those problems’, the problems being reasons for issuing a CBDC.

Both these comments tie in with a paper written by Antonio Fatás at the Centre for Economic Policy Research (CEPR) – ‘The Conflict Between CBDC Goals and Design Choices’. While physical cash runs in parallel with private digital money, in many parts of the world physical cash is diminishing. In those areas a CBDC can be seen, as the ECB puts it, as the ‘natural transition from currency’, giving ‘people more choices about how to pay’.

In economic terms, if cash is not available, then the connection between value in a bank account and the unit of account managed by a central bank is broken. This has implications for financial stability and for the concept of sovereignty.

Clearly less cash is not the motivation for introducing a CBDC everywhere. The author also suggests resilience, financial inclusion and increasing payment competition as goals of CBDCs. The ECB's ‘Report on a Digital Euro’ of October 2020 said that a CBDC was needed ‘to cushion the impact of extreme events when traditional payment services may no longer function’. The Riksbank said that a CBDC was important to promote competition and to provide access to individuals struggling with digital payments.

The goal, of course, determines the design needs. Achieving the goals referred to by the ECB and Riksbank means that a CBDC will need to compete with private versions of digital money so that people choose to use it.

Unlike cash, which is relatively simple since cash issuance equals the creation of the payment technology, digital cash is more complex. For digital cash the asset, which is the digital repository of value, and the payment technology are separated.

Today making a payment with a bank account is likely to involve a card company, such as Visa and Mastercard, and a company managing the payment infrastructure, such as Stripe or PayPal.

The existence of an account at the central bank would be a digital record of value but its existence would not mean that the payment would be accepted everywhere or that it would be as efficient as alternative forms of payment.

The central bank may need, therefore, to control many or even all of the steps of the payment system. The CBDC design choices are key.

CBDC design options

The paper outlines three CBDC design options:

1. Direct CBDCs: an account at the central bank and the central bank controls the ledger and is involved in the execution of retail payments.

2. Hybrid or intermediate CBDCs: an account at the central bank with private intermediaries handling retail payments and, possibly, opening accounts. The difference between hybrid and intermediate CBDCs is whether the central bank keeps a central ledger of all transactions.

3. Synthetic CBDCs: accounts are not on the balance sheet of the central bank. Intermediaries hold the liability but are required to deposit 100% of the customers’ accounts at the central bank. These are not usually regarded as true CBDCs. (The People’s Bank of China requires Alipay and WeChat Pay to maintain customers’ funds at the central bank, so this approach is already in use for some forms of private digital money).

China, Sweden and the euro area are pursuing a hybrid model since they do not want to provide end user-facing services such as identifying customers or providing customer support.

Resilience

The ECB paper said that ‘a parallel infrastructure would also run counter to the aim of issuing a digital euro in order to improve the cost and environmental footprint of payments.’

If a digital euro runs on the same payment infrastructure, it is unclear how resilience is delivered.

For example, in September 2020 the Monetary Authority of Singapore ordered Wirecard, which provided payment services, to stop their payment services. Immediately merchants in Singapore could not accept regular credit card payments. Denying service was quick and easy.

Inclusion

Although ‘no cash’ signs exist in a minority of places, those apart cash is accepted everywhere. On the other hand, existing forms of private digital cash are not always widely accepted.

How, therefore, can a CBDC replicate the universal acceptance achieved by cash?

Competition

The challenge is to counter both the network effects of eco systems dominated by Big Tech companies and the interoperability of alternative payment systems.

It is not clear how CBDCs help achieve this and the paper even suggests it might reduce competition by helping existing players and technology companies who might use CBDCs as the digital assets backing the issue of their stablecoins. For example, Diem may choose to do this.

The author remarks on the significant work and progress made with introducing instant payment infrastructure around the world. This, along with open banking, perhaps reduces the benefit that CBDCs may bring to stream-lining back-office payment infrastructure.

Conclusion

The paper concludes by pointing out that the creation of an asset on a central bank balance sheet is not necessarily a solution.

The important requirement is to improve the digital infrastructure of payments and suggests putting regulations and interoperability standards for payment systems in place is the priority.

CBDCs may play a role in improving payments and it suggests that the challenge is working out how to ensure CBDCs are accepted as a means of payment.