The Future of Money: Will Central Bank Digital Currencies reshape the payments industry?

Source: Bank for International Settlements

Key trends hint towards the likelihood of CBDC taking off and reshaping the payments industry. In this insight, we look at the case for CBDCs and some of the initiatives underway worldwide as part of our Future of Money series. For more detail on various CBDCs and pilots, see our global snapshot Around the World in CBDCs.

Before we launch into CBDCs, it’s important to note the crossover with bank-issued stablecoins as they evolve.  This is for a few key reasons:

• Conceptual, because both seek to enable fiat currency (or at least a representation of it) to operate in the digital economy and engage in atomic and other smart contract-enabled transactions
• Structural, because some CBDC projects are exploring bank-intermediated issuance and redemption
• Legal and regulatory, because several of the same legal considerations apply when determining the nature of the asset and related activities
• Practical, because CBDCs and bank-issued stablecoins are very likely to interact – we are already seeing this in pilot projects.

We focus on CBDCs in this insight, but we stress that these developments are happening in parallel and there is likely to be a strong interdependency between them.

In some cases, CBDCs are being used as part of stablecoin structures as well. Those developments are happening in parallel and the two may become interdependent.

No time for detail on the pros & cons of CBDCs, and how various jurisdictions are tracking? Jump to our quick tips on how businesses can respond by clicking here.

To CBDC or not to CBDC: a compelling case for wholesale, retail, neither or both?

Wholesale CBDCs – indicative success

A direct claim on the issuing central bank. Financial institutions only. Similar to traditional ‘balances’ held by commercial banks with central banks.

Many successful trials, internally and cross-border, across a range of countries have tested wholesale CBDCs. Strong interest in testing and developing wholesale CBDCs is likely to continue, with cross-border projects generally finding that a wholesale CBDC could enable cheaper, faster and safer cross-border payments.

Retail CBDCs – Australia, Mainland China and Hong Kong SAR test prevailing narrative

Issued to the public. Similar to cash – but digital.

Large economies including Australia, the US, the UK and Singapore are considering the options and functionality of these systems. Given the high functioning payments technology already available, these may not be as favourable. This is particularly in light of potential hurdles including:

• privacy implications
• the risk to economic stability
• the potential impact on commercial banks
• cybersecurity and technology risks, and
• technological capabilities. 

Countries that have introduced retail CBDCs tend to have less advanced infrastructure, citing financial inclusion and a more efficient payment system as the key reasons for launching a retail CBDC.

The major outliers in this conversation are Mainland China, and Hong Kong SAR when it launches its pilot e-HKD in late 2022. Since the start of research on e-CNY, the People’s Bank of China (PBOC) has paid close attention to the implications of retail CBDC for the monetary system and financial markets. It leverages on operational, technological and policy designs to minimise the impact of the e-CNY system on the existing monetary system, financial system and the real economy. For example:

1. e-CNY is a substitute for cash and pays no interest
2. it circulates in the same way as the physical RMB in a two-tier system under which commercial banks exchange e-CNY for the public
3. a tiered design of the e-CNY wallet with different caps on transactions and balances for different types of e-CNY wallets.

Central banks around the world will watch closely to see the impact that a retail CBDC can have on a large economy, which could change the current narrative on retail CBDCs altogether.

There is an undercurrent of sovereignty considerations provoking conversations. For example, one country may have concerns regarding another nation’s digital currency and its potential to become the dominant currency, particularly if it was the easiest to use.

The status of CBDCs worldwide

For more detail on various CBDCs and pilots, see our global snapshot Around the World in CBDCs. Below is a summary.

What does it all mean – and how can businesses respond?

The shifts under way highlight how financial infrastructure is changing in fundamental ways. The key points to consider are:

Experiments are important There are multiple proofs of concept underway in both regulator-led projects as well as by individual banks and other institutions. Testing ideas, collaborating with technology providers and trialling novel solutions are important to shape future business plans. BIS is one of the organisations most involved in the cross-border experimentation, which is consistent with its role historically in the movement of funds between jurisdictions.

Give considered feedback Consultations on significant topics need a high quality of considered feedback. Industry groups have an important role to play in gathering feedback, but these often rely on a small but pivotal group of engaged institutions.

Identify potential system upgrades early Technology build-outs are costly and have long lead times. They may also be run from head offices in other jurisdictions. There is value in the early identification of potential system upgrades and maintaining a watch list of potential changes.

Consider potential impacts to contracts early New technology may require new contracts. Particularly where consortia are involved, contractual arrangements which give effect to new payment systems and infrastructure can be critical. 

Creative partnerships in new economies Increased regulatory certainty in areas such as stablecoins and virtual / crypto assets provides a strong platform for more traditional institutions to consider involvement.

• We are already seeing joint ventures between banks and technology companies to serve the new economy, as well as banks leveraging aspects of decentralised finance in novel transactions.
• With advances in AML/CTF controls amongst virtual / crypto asset exchanges (including on-chain analytics) banking facilities are also increasingly common.

Identify and mitigate residual risks Identify & analyse risks and deploy targeted mitigation strategies. Innovation always carries risk. Engaging with regulators is a useful tool in appropriate scenarios.

Consider adjacent issues Data flows, customer expectations, tax implications, financial licensing, competition law and intellectual property are also important issues to evaluate.

There is a clear and present need to relieve one of the biggest pain points in cross-border projects: payments. The plethora of digital currency projects worldwide is set to take money’s journey to the next era.

As central banks implement and experiment, and cross-border collaboration grows, we are watching. To read more of our insights, subscribe here.

Thank you to Knowledge Consultant Emily Fox for research and drafting assistance.