Central Banks and the CBDC Conference

As noted in another article this month, the CBDC Conference took place in Istanbul 12-14 September. This article reports almost entirely on the central bank perspective on CBDCs, particularly the use cases justifying their use.

Maintaining the functional, economic and social role of cash

The Dutch National Bank (DNB) laid out, step by step, the current roles of central bank and private money and their interdependence. The public is not actually asking for CBDCs, so why is a digital euro in discussion? DNB laid out what is changing, and the promise of CBDCs, and then looked at the needs of all payment stakeholders.

Ultimately central banks tend to want payment choice for society, but only if the alternatives enable monetary and financial stability. The design of a CBDC needs to deliver this, along with a number of other policy objectives.

The description of these was heard frequently as the Bahamas, Jamaica, Nigeria, England and Norway described their work. In particular payment innovation, efficiency, resilience and financial inclusion, sometimes cross border payments as well.

In a panel discussion a rare dissenting view was put forward by the Central Bank of Chile. This bank is moving cautiously, questioning whether a CBDC is the best solution for the payment challenges. The central bank does not want a direct interaction with users. The trade-off between the payment system and innovation can be difficult. There is likely to be tension between participation and regulations. In addition, a Chilean state bank already provides free bank accounts to all, so the financial inclusion benefit of a CBDC is less.

Nigerian perspective

Nigeria is faced by a significant number of people holding crypto assets and a massive uptake in ecommerce participation. The Central Bank of Nigeria (CBN) is keen to offer an alternative. When the legislation enabling a CBDC was passed, it gave CBN the authority to decide the form and design of the CBDC. CBN mimicked the approval process used for banknotes to do this.

Now that the digital naira has been launched, CBN is focusing on increasing its adoption by the public. Its goal is to increase financial inclusion from around 60% of the population to 90% by 2024. It is working on sensitising the population to the eNaira and is using social welfare payments as part of this transition.

Live CBDCs in the Bahamas and Jamaica

The Central Bank of the Bahamas started its CBDC project in 2017 and launched this in 2020. 2021/22 has been about iterative upgrades to its CBDC and this continues in 2023 along with programme to increase adoption.

In a 12 month period from mid-2022 to mid-2023 the value of Sand Dollar transactions rose 210% and the number of merchant wallets increased 100%. At the same time the number of individual wallets only increased 24%.

To continue this increase, Wallet 2.0 is being launched which allows self-activation of wallets (no third party involvement) and self-help (making reactivation on new wallets) easier. Wallets can now be branded, and it is offering incentives to merchants and banks to increase adoption. The system is expensive for the bank to run, and it is working on introducing faster payments because it takes days for money transferred to CBDC wallets to be deposited.

In contrast, the Bank of Jamaica (BOJ) started its programme in May 2020 and went live in 2022. The BOJ laid out a list of lessons learned from the experience. For example:

It had to change six acts and one bill to get the right legal and regulatory framework in place. This took much longer than expected only being completed in June 2022.
It found that wallet providers were not as capable as expected and, again, it took longer and more work to build the necessary eco-system, develop wallets and overcome budget constraints. Start early and have a dedicated team.
Again, the BOJ had to get involved with the merchant base because the public wanted more choice and merchants were reluctant to get involved.
The communication effort was significant because a change of culture was needed. People were cash based and there was confusion and misinformation about the differences between CBDCs and crypto currencies.

Digital pound project

The Bank of England laid out its work, stressing the importance of the risks to the uniformity of money and to payment innovation that exist in this increasingly digital world. It wants to safeguard uniformity and lower the barriers to entry to payment to support innovation, choice and efficiency.

The Bank is going down the ‘platform’ model – ledger, API layer, intermediaries, users. It made the point that funds held on wallets will not sit on the balance sheet of the wallet providers, but on the Bank’s, which will reduce their regulatory burden and increase the range of businesses that might be interested. At the same time the Bank has to work out what is the business model that incentivises them.

The Bank’s analysis is that holdings of £10,000-20,000 will not jeopardise the financial model for commercial banks. It does not expect to pay interest to CBDCs. As with others, a digital pound would be private but not anonymous. The Bank and the government would not have access to personal data, wallet owners would be able to choose how data is used and a digital pound would not be programmable or restrict what can be bought.

The Bank will now enter its design phase through until 2025. If a build phase were approved, this would not be before 2025.

Norway’s motivation

The motivation for a CBDC in Norway is contingency and innovation. Increasing cyber risks, tokenisation and declining cash usage mean that Norges Bank wants to understand its options. It will shortly release a phase four report where it has been testing a hub and spoke approach. One area of work has been exploring whether interest rates or caps on CBDC holdings will mitigate against disintermediation.

It has also worked on cross-border payments in Project Icebreaker, working with Sveriges Riksbank and the Bank of Israel.

Kazakhstan looks at digital tenge

Kazakhstan is a huge, sparsely populated country. It is looking at introducing a digital tenge to make payments more accessible to those with limited internet access, to increase the efficiency of spending public funds without compromising anonymity and to encourage cross-border and wholesale payments. It is also preparing for new challenges such as distributed finance, tokenisation and distributed ledger technology.

The National Bank of Kazakhstan has proceeded by following IMF and World Economic Forum recommendations to look at technology advances and risk, economic effects and risk, possible market reactions, regulations and the costs and benefits of CBDCs.

It assumes that CBDCs will, in due course, reach 60% use. The most vulnerable are not ready to use CBDCs, but only 7% won’t use it.

The central bank intends to use conversion limits if and when short term shock scenarios occur in order to limit disintermediation.

In 2022 a pilot was carried out involving 3,594 end-to-end transactions over five days. This year the central bank will continue a pilot to test a future production grade platform for issuing social assistance and government procurement traceability. It is looking at 20 market scenarios where a smart contract might be useful, including testing the internet of things and machine-to-machine integration, pay per use and conditional payments.

Progress of HKMA

The Hong Kong Monetary Authority (HKMA) has been active on wholesale and retail CBDC projects. In 2017/18 it worked on Project Lionrock, in 2019/20 Project Inthanon Lionrock and since 2021 on Project m-Bridge. In 2021 it worked on Project Aurum, a retail CBDC project testing tiered distribution options, in May 2023 it launched its e-HKD project and in September 2023 Project Sela.

The e-HKD project is following a three rail approach: the development of a foundation layer, an independent pilot and iterative development and, finally, a full launch. A full legal review is also in process. The second rail will involve the examination of use cases and implementation. 16 use cases have been selected and HKMA is looking at pilot forms.

The use cases fall within six categories:

Fully fledged payments. Immediate settlement at a transaction level and lower transaction fees to than currently, 1.5% compared with the current 3%. This will be possible by fewer intermediaries being involved in the payment process.
Programmable. Generation of coupons automatically, making promotions for small and medium size enterprises easier. It should be possible to achieve pre-payment protection at a lower cost through the use of conditional payments. Government grant schemes should be possible to ring-fence recipients/projects and with better tracking of how funds are used. Interlink the movement of funds with investment subscriptions and remove the need for pre-funding.
Offline. No interest paid for offline settlements.
Tokenised deposits. Tokenised deposits will facilitate atomicity and cross-chain interoperability settlement.
Settlement for Web3. A settlement for Web3 will bridge fiat currency with virtual assets. This will allow lower thresholds for secured lending and mitigate credit risk.
Settlement of tokenised assets.

Digital shekel

In 2018 the Bank of Israel (BOI) began watching how CBDCs were evolving. In November 2020 it decided to start a CBDC project, and this led in May 2021 to five papers introducing a high level discussion about a digital shekel. In Summer 2022 it worked on Project Icebreaker with Norway and Sweden and is also working with Hong Kong on Project Sela.

In January 2023, it set itself a target of having a design document ready by December 2024. The design document needs to be sufficiently detailed to act as the basis for a Request For Information.

As with other countries, Israel is concerned about the reducing use of cash, stablecoins and competition in its domestic market by other digital payment options.

The design making process involves consultation between the government and regulators, end users and financial institutions. Design decisions have been made about:

Scheme management: the BOI will be the operator and regulator of the system, working with payment service providers and funding institutions. There will be mandated funding and defunding to ensure interoperability.
Cost structure: a CBDC is a public good and so BOI will cover its own costs. It will be a free basic service for individuals, but business will be charged, along with any advanced services offered to individuals.
Acceptance: money will need to flow in and out of government, the digital shekel will need to have the advantages of cash, encourage inclusion, work offline and be legal tender.
Privacy: the digital shekel will be private, but not anonymous. The BOI will not have access to identifiable data. There will be no monetisation of data without clear consent of the data owner.
End user participation: the digital shekel is intended for residents, businesses, children and foreigners. For children sub-accounts are allowed but 14 and 16 year olds will be allowed bank accounts which can hold CBDCs, with slightly different limits.
Legal aspects: the legal situation on issuance, the characteristics of a CBDC and an extension of existing cash law to include CBDCs, eg. that counterfeits are illegal, needs work.
Currently BOI is working on access to the technology, the logic architecture and immediacy and finality.

The list of future decisions is long – anti-money laundering, interoperability, security, inclusion and the role of intermediaries, data design, performance requirements, offline, holding limits, consumer protection, cross-border payments and programmability.

Web 3 and CBDCs: a game changer

nChain gave a useful primer on different generations of the web, web 1 being the internet (use a search engine, read), web 2 being the age of social media and of exchange dialogue (eg. Facebook: read, write) and web 3 being the exchange of value (read, write, verify, execute). Web 3 is the exchange of data without the involvement of unnecessary third parties and they see CBDCs sitting firmly in this space.

Web 3 combined with CBDCs should radically change payments. Micropayments (pay as you go for the smallest of activities), real-time compliance (for example the automatic collection of taxes at source), cross-border payments and fiscal payments (from government to people directly) will all be possible.