Central Bank Digital Currencies to transform the financial landscape

Central Bank Digital Currencies (CBDCs) represent the digital form of a nation’s currency, issued and regulated by the central bank. Unlike cryptocurrencies, CBDCs maintain a stable value and do not replace cash, but rather complement it. Users can store CBDCs in digital wallets, enabling efficient, secure, and instantaneous transactions.

Types of CBDC

CBDCs are broadly categorised into retail and wholesale types:

• Retail CBDCs are available to the general public, enhancing cross-border payment efficiency, financial stability, and financial inclusion. Variants include:
  • Direct CBDC, which is managed directly by the central bank and available to everyone. A Direct CBDC represents a direct claim on the central bank; the central bank keeps a record of all balances and updates it with every transaction.
  • Indirect CBDC, when the central bank provides the direct CBDC but enlists the private sector to provide and maintain the accounts or wallets used for CBDC holdings.
  • Synthetic CBDC, stablecoin with the reserves backing its value held in a central bank master account.
  • Account-based CBDC, involves the use of a trusted third party to verify a user’s identity as the account holder and check their account balance before a payment is allowed. The accounts are then debited and credited accordingly.
  • Token-based CBDC, stored in digital wallets, a token-based CBDC uses blockchain technology to overcome the need to check a customer’s balance before allowing a transaction – as long as the customer can show that he is the token holder (e.g. using a private key, and meeting identity requirements at the appropriate level).
• Wholesale CBDCs, designed for interbank transactions, streamlining cross-border payments and securities transactions.

Both retail and wholesale CBDCs can be domestic and cross-border.

Global adoption of CBDCs

The first CBDC was the Sand Dollar of Bahamas in 2019. Since then, the area with the most CBDC pilot launches has been the Asia-Pacific region. The countries where these launches have taken place include Japan, South Korea, China, Hong Kong, India, Singapore, Thailand, Malaysia and Australia. Several countries are at various stages of CBDC development:

• Operational CBDCs: 11 countries are using CBDCs, including The Bahamas (Sand Dollar), Nigeria, the Eastern Caribbean Currency Union, and Switzerland (Swiss National Bank issued bonds that were settled with a wholesale CBDC).
• Pilot Programmes: China (e-CNY as retail CBDC), Japan, South Korea, India, and Australia.
• Research and testing phase: US (retail CBDC), Thailand (retail CBDC), and Canada (wholesale CBDC).

Digital Euro initiative

The European Central Bank (ECB) is progressing towards a digital euro, a retail account-based CBDC with legal tender status. The European Commission adopted a proposal for regulation on the establishment of the digital euro in 2023. Key points include:

• Issuance: By the ECB and authorised national central banks.
• Value: Parity with physical euros.
• Account Management: Through payment service providers.
• Mandatory Acceptance: Except for personal activities, microenterprises without comparable digital payments and certain non-profit entities, the digital euro must be accepted as a means of payment in the Euro zone.
• Payment Modes: Both online and offline.

Conclusion

CBDCs hold the potential to revolutionise the financial system, offering enhanced payment efficiency, financial stability, and inclusion. As various countries explore and implement CBDCs, the global financial landscape is set for a significant transformation.

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