Don’t dismiss CBDCs that quickly

CBDCs are rarely out of the news for long.

Because of the rapid pace of progress, not everyone has had the time to interact with CBDC research on a meaningful level. As a result, the CBDC landscape may appear to be confusing to navigate. 

The importance of engagement is underlined by some developments in the US political arena. A US presidential candidate is running with an agenda that makes fear-mongering over CBDCs an integral part of his campaign, Florida already passed legislation unanimously banning CBDCs last month, and crypto Twitter is often abuzz about the suggestion of “centralizing” the power of cryptocurrency in the hands of central banks.

But CBDCs are not a passing fad in the crypto ecosystem, doomed to disappear with the next bull market. Over 100 CBDC projects are currently at various stages of development across major jurisdictions such as the European Central Bank and Bank of England.

It’s important to actually understand the benefits that CBDCs may bring, the challenges that remain in adoption and how they might be used in real life rollout. CBDCs can’t be dismissed that easily.

The tension between technology and policy 

Policy will need to adjust to a CBDC issuance. This adaptation will need to cover everything from new legislation that allows a central bank to issue a digital currency to whether the CBDC should function as a new monetary tool. 

Different jurisdictions are moving at different paces in setting out what a CBDC regulatory framework might look like. In its consultation on a digital pound, for example, the Bank of England has stated that a CBDC would be “rigorously governed and regulated,” and that firms providing digital wallets would be regulated to ensure that payments using digital pounds are “resilient, reliable, and compatible with other payments.”

Most live rollouts have designed the issued CBDC to be like cash so as to limit the scope of legislative amendments that policy makers need to make. But programmability means the CBDC could potentially be used for many other functions. We can expect to see more complicated CBDC issuances in the next few years. 

Security and financial stability 

Because they are digital money, CBDCs will have the same potential for financial fraud as physical currency as well as additional concerns arising from their digital nature. 

These issues are particularly concerning for central banks following a rise in the number of high-profile technological failures and cyberattacks. The Eastern Caribbean Currency Union’s (ECCU) CBDC initiative, DCash, for instance, experienced a significant system-wide outage that took the entire system offline, indicating that this transition from checks (as the dispersion of the islands escalates the cost of physical cash) to digital currencies is not always free from bugs or glitches.

Similarly, major cyber breaches such as the Ion Markets hack mean that cybersecurity is now a top concern, as any asset that is digital can be vulnerable to hacking and other security breaches. 

When moving ahead with CBDC exploration, central banks will need to take increasingly great care to ensure that the underlying technology is thoroughly tested and designed to meet the most stringent security protocols. Additionally, the introduction of specific regulations should be embraced to ensure that user data is kept private, in line with existing banking regulation.

Understanding consumer behavior

Developing markets — where existing infrastructure is less complex — have generally moved faster in their CBDC exploration compared to more mature markets, where payment systems are already relatively efficient and consumers may be less likely to see the need for retail CBDCs.

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According to a report from the Official Monetary and Financial Institutions Forum, what consumers seem to want from digital currencies is universal acceptance, resilience, privacy, security and ease of use. These are, of course, the key characteristics of cash.

One of the biggest subsequent questions facing central banks is therefore: How cash-like should a CBDC be? Finding this balance will require close collaboration between the public and private sector, across all industry and market participants. 

What next?

The frontiers of research are moving outward with every research paper and pilot. In the space of just a few years, researchers have moved from the first definitions of CBDC to studying its effect on the financial system and working on design features. 

Central bank money has not changed much since the adoption of modern banknotes, and the introduction of CBDC would represent a considerable shift in how we send and receive payments. 

Research supporting better understanding of CBDC impacts will ensure that central banks undertake a comprehensive design process that delivers availability, security, resilience, interoperability and privacy.

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