Central Bank Digital Currencies (CBDCs) and other digital currencies – June 2023

It is becoming increasingly difficult to keep up with all of the announcements from a raft of central banks and think tanks but here are some that caught my attention:

• The minutes of the March meeting of the Bank of England’s CBDC Engagement Forum (the 5th) were released. Key discussion areas included:
  • Understanding how the digital pound work would fit alongside other initiatives in payments that are being built or explored, such as the New Payments Architecture, and noting that there could be efficiencies in working closely with industry.
  • Given the timeframe, the digital pound infrastructure would need to be extensible and built to accommodate future changes in technology and business models.
  • The Consultation Paper’s proposal to build the digital pound as a public platform to support private sector innovation. “Pass-through” wallets, which would not hold digital pounds on their balance sheets, opened the door for new business opportunities in the payments landscape, which could allow for new innovative solutions to emerge.
  • The proposed holding limit of £10,000 to £20,000 per individual described in the paper was higher than expected. Some thought this would be beneficial for innovation, while others questioned whether a relatively high limit could make digital pound wallets a direct competitor of traditional bank deposits, which could represent a risk to financial stability.

• The minutes of the March meeting of the Bank of England’s CBDC Technology Forum were released. The Bank presented a summary of the Consultation Paper and the accompanying Technology Working Paper, published on 7 February 2023. The presentation covered the proposed distribution model, technology design considerations and conceptual architecture for a UK CBDC, called the digital pound. Key discussion areas included:
  • Privacy, resilience and performance requirements set out in the Technology Working Paper.
  • With innovative offerings, like programmability features, the importance of ensuring that users have a common experience across PIPs (Payment Interface Providers).
  • The different business models (such as fee-based, data monetisation and cross-selling opportunities) for Payment Interface Providers (PIP).
  • The need to enable industry players to plug into the Bank of England’s API to interoperate with the digital pound system.

• The Bank for International Settlements (BIS) and the central banks of Canada, Japan, Sweden, Switzerland, Japan, the United Kingdom, the United States and the European Central Bank are working together to explore retail CBDCs. 

  The 3rd report noted that “Many of our jurisdictions are examining whether there is a need to ensure ongoing retail access to central bank money at a time of profound, ongoing changes across finance, technology and society. The motivation for introducing a retail CBDC may rest primarily on the role of central bank money as a public good. At the same time, the introduction of a CBDC could be an innovative opportunity for the monetary system.” 

  The report also noted that:

  • Development of CBDC work requires careful consideration and engagement with a wide range of stakeholders, including the private sector and legislators.
  • To successfully meet its public policy objectives, a CBDC ecosystem should allow a wide range of private and public stakeholders to participate and, in doing so, deliver services which benefit end users.
  • The complex design questions and the potential risks arising from the implementation of any CBDC require careful consideration.
  • The evolving payments landscape requires central banks to give some consideration to how CBDCs may be used for wholesale and cross-border use cases.
• The BIS issued a working paper on the economic impact of CBDC policies on open economies. It estimates that:
  • with a rate of issuance of 30% of GDP, a CBDC could add almost 6% to a country’s output and see welfare gains of over 2% by:
    • lowering real interest rates due to a reduction in the stock of defaultable debt (from 3% to 2.4%)
    • the funding cost advantage of CBDC over defaultable debt
    • lowering distortionary tax rates due to the budgetary space created by lower real interest rates
    • lowering monetary frictions due to a reduction in tax-like monetary wedges that represent a move of the economy towards the ideal of the Friedman (1969) rule
  • optimal policy outcomes come at an even higher rate of 40% of GDP.

    In addition the paper suggests that:

  • introducing a digital currency could enhance countries’ financial stability, with banks’ balance sheets growing in the long run and the average cost of funding remaining constant
  • CBDCs could complement existing monetary and fiscal policy rules, helping to stabilise inflation and output during financial shocks.

• A survey conducted by the BIS Innovation Hub Nordic Centre found that 49% of central banks consider offline payments with retail CBDC to be vital, while another 49% deemed it to be advantageous. In response, and as part of Project Polaris, it has published a comprehensive handbook exploring key aspects of how central bank digital currencies (CBDCs) could work for offline payments. 
• Australia successfully made its first foreign exchange transaction using eAUD as part of a live pilot for the country’s potential central bank digital currency. According to Blockchain infrastructure provider Canvas, crypto fund managers DigitalX and TAF Capital traded eAUD against the stablecoin USD Coin USDC and claimed that the transaction was settled instantly and touted it as a success over what it called the “slow, expensive and prone to errors” traditional FX and remittance networks.

  The FX trade was part of a series of tests currently underway as the country explores possible use cases for a CBDC. The pilot program was launched by the Reserve Bank of Australia (RBA) in conjunction with the financial research institute Digital Finance Cooperative Research Centre (DFCRC).

• Public sector employees in the Chinese city of Changshu will start receiving their salaries in full as digital yuan CBDC next month, as China’s rollout of the financial technology continues apace. The new initiative will impact employees like doctors, teachers, and journalists, according to the South China Morning Post. Located less than 100 miles from Shanghai, Changshu City is home to more than 1.5 million residents.
  • The IMF released a Working Paper that looked at “Perspectives on Jurisdictions with Conventional and Islamic Banking Systems”. It noted that issuing a CBDC in an Islamic setting raises several complex design issues:
  • Shariah principles prohibit interest payments, thus remunerated CBDCs are either not an option or the central banks have to design a CBDC that incorporates a profit-sharing mechanism. 
    The prohibition of speculation implies that CBDC cannot be used for foreign exchange derivatives transactions.

Naresh Aggarwal

12 June 2023