DEVELOPMENT Oct 07, 2020

CBDC pioneers: which countries are currently effectively testing the retail Central Bank’s digital currency

Central bank digital currencies (CBDC) are currently a hot topic. A study conducted by the Bank for international settlements (BIS) in 2020 shows that 80% of the world’s Central banks participate in research

Retail CBDC projects in practice

The percentage of Central banks conducting experiments or confirming the concept is also growing, reaching almost 50%. 10% of Central banks surveyed plan to introduce public (retail) CBDCS in the next three years, and 20% in the next six years. Therefore, efforts are very dynamic and are expected to increase in the near future.

The analysis shows that China, Sweden, the Bahamas, the Eastern Caribbean monetary Union, and the Marshall Islands can now be seen as pioneers in this space.

  • China: DC / EP

The Central Bank of China (PBOC) was one of the first Central banks to focus on developing a CBDC, and formed a special WORKING group in 2014. In April 2020, the project gained momentum when testing of a CBDC prototype was announced. The prototype, dubbed DC / EP (digital currency / electronic payments), is currently being tested in both the private and public sectors. 50% of mobility grants for public sector employees are paid directly to the DC / EP digital wallet. It was announced that the entry is planned for the winter Olympic games in 2022.

The role of cash in China is declining. In 2016, only 40% of all payments were made in cash, and in 2018 – only 20%. In the Euro area, this share is 79%. Consequently, China is one of the few countries in the world where the share of currency in circulation (CIC) in gross domestic product (GDP) has decreased.

Less use of cash can bring risks, as Mu Changchun of the People’s Bank of China pointed out. Changchun points to a high reliance on private sector companies, with the risk of bankruptcy of private platforms offering widespread digital payment methods.

CBDC, which replaces cash, can support the development of a society less dependent on cash, without the risk of default, accompanied by private platforms, since it is issued and supported by the public sector.

In addition, the PBoC seeks to protect its monetary sovereignty by limiting demand for private cryptocurrencies, and by preventing Libra, a digital currency project initiated by Facebook, from taking root in China. Widespread acceptance of Libra by Chinese citizens could jeopardize the NBK’s sovereignty, since Libra will not be supported by the yuan.

China’s CBDC is also motivated by the internationalization of the yuan. Although efforts are already underway to internationalize the digital version, the US dollar remains dominant. By increasing the ability and convenience of cross-border payments and Renminbi payments abroad, CBDC can strengthen the international use of the Renminbi, and thus help internationalize it. If the digital yuan falls under capital controls, restrictions may prevent its successful internationalization. At the moment, it is unclear whether the NBK will focus on internationalizing the yuan or controlling capital.

An interest-free digital yuan will provide instant transactions, ease of offline use, and will not require a Bank account. It will be compatible with WeChat Pay and Alipay. It is reported that the NBK wants to implement a two-tier operating structure, in which the Central Bank will issue and buy digital yuan exclusively to selected firms. This applies to both banks and other large companies such as Alibaba and Tencent.

The PBoC can conduct transactions with these firms using distributed Ledger technology (DLT). Since firms should be able to achieve the goal of 300,000 processed transactions per second, they are unlikely to use the DLT infrastructure to conduct transactions with end users as well.

  • Sweden: e-krona

In March 2017, Swedish Riksbank launched its CBDC project, e-krona. The pilot project is planned from 2020 to February 2021. After that, Riksbank will decide whether to continue issuing it.

Initially, the pilot project will focus on interest-free CBDC, and is designed to provide instant payments at any time, as well as ease of use in offline mode. As for anonymity, Riksbank emphasizes that anonymous payments will only meet the standards if transactions in e-Krona occur in a peer-to-peer network. Riksbank is planning a two-tier operating structure for its pilot project.

The network consisting of Riksbank and selected banks is implemented on the permitted DLT. In addition, the “notary node” helps prevent double expenses. After activation, end users will manage their e-crown in digital wallets.

In addition to China, Sweden also has a low level of cash usage. In a survey of 50 countries, the majority of both industrialized and developing countries show an increase in the CIC-to-GDP ratio of 9% on average. In 2018, the Swedish CIC accounted for only 1.4% of GDP, the lowest in the world. Moreover, only 20% of all payments in Sweden are made in cash, and more merchants are expected to stop accepting cash in the future. Swedish businesses are not required to accept cash, and by 2023 there will be cashless payments in Sweden, according to forecasts by Riksbank Deputy Manager Cecilia Skingsley.

Faced with a reduction in the use of cash, the e-Krona could counter the negative effects of the unhindered marginalization of Central Bank money by offering permanent access to Central Bank digital money. If cash is accepted less and less often, the alternative to digital payments disappears. Network effects can easily lead to oligopolies that lack competition. In the case of marginalisation, cash cannot compete as a means of payment, resulting in higher fees for dominant suppliers. Alternatively, the e-crown may indirectly limit the maximum fee that private providers can charge.

The Riksbank also sees threats to financial stability in the form of less reliable payment systems, since profit-oriented private firms do not take such sophisticated measures to ensure the functionality of payment systems during crises as state institutions such as the Central Bank. CBDC can offer a reliable alternative in the event of a crisis or unrest among private payment service providers, ensuring the stability of the Swedish payment system.

Even if Swedes use fewer Fiats than any other country, there are parts of the population that struggle with technological innovation, and rely only on cash. If cash acceptance declines further, these people will be even more excluded from the system.

E-Krona can be targeted at people who usually refrain from digital payments, compensating for their financial alienation. Such an initiative is more likely to be expected from the public sector than from the profit-oriented private sector.

  • Bahamas: “Sand Dollar»

The Bahamian CBDC project is called the “Sand dollar” and its prototype was already launched in the Exuma area in December 2019, and two months later in the Abaco Islands. The Central Bank of the Bahamas (CBoB) plans to extend the project to all Islands in the second half of 2020. Currently, about 380,000 people live on the 700 Islands that make up the Bahamas. The national currency, the Bahamian dollar, is pegged to the us dollar 1: 1.

Although 80% of Bahamian adults have a Bank account – compared to the global average of 69% – there are significant gaps in access to financial services. Opening Bank branches on remote Islands is often inefficient for banks. In addition, stricter anti-money laundering (AML) and anti-terrorist financing (CFT) standards have made banking services more expensive, and led to a further reduction in the number of Bank branches.

Surprisingly, this reduction in the number of Bank branches has led not to a wider spread of electronic payments, but to an increase in the use of cash. Thus, one of the goals of Sand Dollar is to make digital payment services more attractive by improving the efficiency of the payment system.

Stricter AML and CFT standards also excluded certain groups from banking services, and led to self-exclusion of people due to new requirements. Therefore, access to financial services is the main goal of Sand Dollar. To achieve this goal, it is necessary to prevent unjustified exclusion and self-exclusion from banking services.

Finally, the economic supervision can be enhanced through the introduction of CBDC. As a digital medium, sand dollars allow tracking. With this information, the CBoB could learn more about the distribution of money, which would improve tax collection and policy-making.

Private use of Sand Dollars does not require a Bank account to reach the non-banking segment of the population. In addition, the card-based version, updated via POS devices, will allow you to use Sand Dollars without a mobile device. Sand Dollars will not generate interest, and there will be restrictions on the amount held. Transactions with sand dollars should be low, almost instant, and do not require an Internet connection. This is especially important in a region prone to hurricanes.

In addition, the Sand Dollar payment system will be compatible with other payment systems of classic financial intermediaries. Sand Dollar transactions will not be anonymous, but the CBoB emphasizes “strict attention to privacy.” The Central Bank is planning a two-tier operating structure for the sand dollar, where transactions will be restricted to internal use.

Since the sand dollar is an additional digital version of the Bahamian dollar, capital controls can be applied to it as well. This is necessary to maintain a fixed exchange rate, as well as to conduct an independent monetary policy.

As Fleming (1962) stated, it is not possible to allow additional free flow of capital. Since it is impossible to combine all three elements, namely a fixed exchange rate, sovereign monetary policy, and free capital flow, this concept is known as the impossible Trinity.

Conclusion

More and more Central banks are showing interest in CBDC. The presented innovative projects are motivated by several reasons. Interestingly, the overly dominant role of cash in the payment system, as well as the reduction in its use, are mentioned as motivating factors. On the one hand, CBoB and RMI eliminate inefficiencies due to the large use of cash and seek to promote financial inclusion through CBDC. China and Sweden, on the other hand, see the importance of reducing the use of cash, and emphasize the negative consequences of this reduction in use as a motivation for their CBDCS.

Other reasons are improved surveillance (CBoB), facilitated currency internationalization (PBoC), and the creation of an alternative revenue source (RMI). In terms of implementation design, CBDCS are very similar. With the exception of SOV, all projects will be based on a two-tier operating structure, and none of them are planned to generate interest. However, these initiatives follow different approaches to CBDC restrictions, anonymity, offline usability, international access, and technology.

Please note that the impact of CBDC on the financial system can only be analyzed theoretically so far. Thus, it remains to be seen how citizens will actually react to the specific introduction of the new Central Bank money option. Given the advanced status of the submitted projects, we may soon be able to observe this reaction.

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