Central bank digital currency | Complete guide you need to know

CBDC has been a buzzword for the last few years and the whole world is shaking with this stormy concept. Digitization of payments around the world, the rise of cryptocurrencies, thoughts for speedy but cheap payment services, financial inclusion, etc. are some of the causes behind these concerns from almost all the central banks.

What is Central bank digital currency (CBDC)?

Central bank digital currency (CBDC) is a digital banknote. Like physical Taka/Dollar, a CBDC is a fiat currency. It may be used by individuals to pay businesses, shops or each other, or between financial institutions to settle trades.

A CBDC is digital money issued and regulated by the central bank, or national central monetary authority and serves the functions of money as the national unit of account (e.g., BDT in Bangladesh), medium of exchange and store of value.

CBDC is a digital version of a country’s legal tender issued by its central bank. In Bangladesh, a CBDC would be issued by the Bangladesh Bank and be equal in value to a physical BDT. 

On 20th October 2020, the Central Bank of The Bahamas launched the world’s first CBDC, Sand Dollar. At least nine countries have created their own CBDCs and more than other 95 countries are working on them.

So, as the name suggests, a CBDC is a digital currency working just like any physical fiat currency issued by the central bank.

Features of CBDC

CBDC is an alternative to the existing physical currency. It is gaining national and international interests worldwide. Based on the findings and suggestions from the practitioners, some of the features are expected in CBDC. They are listed below:

Instrument Features

• Convenience

• Low Cost

• Convertibility

• Recognition

System Features 

• Security

• Instant Settlement

• Resiliency

• Availability

• Interoperability

• Scalability

• Flexibility and Adaptability

Institutional Features

• Strong Legal Framework

• Standards

Functional Features

1. Unit of account 
2. Medium of exchange
3. Store of value.

Types of CBDC

In Wholesale CBDCs, the central bank grants institutions to deposit funds or use to settle interbank transfers. Central banks can then use monetary policy tools to influence lending and set interest rates.

In Retail CBDCs, state/government-backed digital currencies are used by consumers and businesses.

There are two types of retail CBDCs:

An account-based system requires verifying the identity of the payer, while a token-based system requires verifying the validity of the object used to pay.

class=”wp-block-heading”>Why CBDC?

The purposes for launching CBDC depend heavily on the status of the economy. The priority varies from country to country to a great extent. Some developed economies may seek to improve the efficiency and safety of the payment systems, while emerging economies may want to promote financial inclusion and financial stability. Some countries/regions may simply be following the trends in peer economies. Some of the reasons affecting the launching of CBDC are listed below:

•  Control on money (Payment systems, price stability, monetary policy)
• Financial inclusion
• Cryptocurrencies
• Digitization
• Decline in cash usage
• The surge in ecommerce and contactless payments
• Covid-19 Pandemic
• Cryptocurrency (Bitcoin for example) price instability
• Costs of printing, transporting, storing and managing cash

CBDC VS digital money

CBDCs would be “central bank money,” or a liability of the central bank. That’s what would make it different from current digital money, like money held in banks or payment apps, which are liabilities to commercial banks.

“The general public will be one of the biggest beneficiaries of CBDCs as it will give them access for the first time to a digital form of central bank money. And that is a big milestone in the evolution of money.” Henri Arslanian, Partner and Global Crypto Leader, PwC

“Central Bank Digital Currencies are direct alternative solutions to further financial inclusion efforts by public authorities. As sovereign digital cash, they can contribute to modernise the current monetary system but also help to bridge the gap with the unbanked.” Pauline Adam-Kalfon Partner, Financial Services and Blockchain Leader PwC France & Maghreb

BIS and CBDC

BIS Innovation Hub worked on central bank digital currency (CBDC) in a variety of manners and paved the way for the balanced development of CBDC.

The third BIS survey on central bank digital currency estimates that 86% of central banks are engaging in some form of CBDC work, 60% were experimenting with the technology and 14% were deploying pilot projects. This is a response to changing market and consumer needs, driven mainly by advances in technology. CBDC architecture has also been explained in detail.

SWIFT and CBDC

Recently On Oct 5, 2022, SWIFT has declared that it is ready to move CBDC on existing financial infrastructure – a major milestone towards enabling their smooth integration into the international financial ecosystem.

The trial, which for the last month has involved both France and Germany’s national central banks as well as global lenders like HSBC, Standard Chartered and UBS, looked at how CBDCs could be used internationally and even converted into fiat money if needed.

CBDCs and private cryptocurrencies

Cryptocurrencies such as  Bitcoin and Ethereum are privately issued virtual currencies that are secured by cryptography making it almost impossible to counterfeit or double-spend.  People use them to make payments, send money, as store of value and as investments. However, as they have no fundamental value, making them volatile.

Stablecoins are digital currencies /cryptocurrencies that attempt to peg their market value to some external reference. They are more useful as a medium of exchange as they are pegged to a fiat currency like the U.S. dollar or to the price of a commodity such as gold. For example, Tether claims that “Every Tether token is always backed by our reserves, which include traditional currency and cash equivalents.

CBDC Considerations for central banks:

1. What are the motivations and policy objectives for issuing a CBDC?
2. Who will have access to the CBDC?
3. Will it be available for cross-border payments?
4. Will the CBDC earn interest and what will be the implications of this on market participants and consumers?
5. What information will the regulator have access to?
6. How to balance AML/CFT compliance with preserving consumer privacy?
7. Will the CBDC be freely convertible to other forms of money?
8. How will the CBDC be distributed, will it be distributed through the direct model or the two-tier model?
9. How will this affect operational responsibilities such as account administration and customer due diligence?
10. Will the CBDC be token based or account based?
11. What are the advantages and risks of each choice?
12. Which ledger infrastructure will the CBDC use, centralized or distributed ledger technology?
13. What are the legal implications for issuing a CBDC?
14. Does the central bank have the legal authority to issue a CBDC as a legal tender?
15. Does the country have the enabling infrastructure and legislation to support implementing a CBDC project?
16. Should the CBDC be made legal tender and what are the implications for financial inclusion?
17. Should the CBDC be built on open source versus proprietary software?

Managing the Mandates

The central banks to explore CBDC and support innovation in line with their core mandates for monetary and financial stability. Central banks need to ensure that issuing a CBDC would support and not compromise monetary and financial stability.

How should central banks explore CBDCs?

1. As Central banks respond to the changing market needs and technological developments, they still need to maintain their primary mandate of monetary and financial stability.
2. They need to respond quickly and decisively to create a highly efficient payment infrastructure for the digital economy.
3. CBDC could also drive effective competition as central banks open the national payment systems to non-bank financial players, enabling a platform that private companies can use to serve private customers.  Additionally, there is an opportunity for embedded supervision which could lower the cost of compliance and supervision.  There is also the question of how to regulate crypto, and create public infrastructure that will support interoperability, thereby reducing the risk of walled gardens. Embedded supervision is a framework that lets compliance with regulatory goals be automatically monitored by reading the market’s ledger, thus reducing the need for firms to collect, verify and deliver data.
4. If central banks do not act quickly and decisively, the rise of private stablecoins and crypto could result in negative implication for monetary and financial stability. 

CBDCs present an opportunity for central banks in developing and emerging economies to modernize their payment infrastructure and make central bank money available to retail users,taking advantage of advances in technology such as distributed ledger technologies such as blockchain. Depending on the design choices, CBDCs have the potential to improve efficiency and the cost of remittances and enhance financial inclusion.

However, CBDCs also come with risks. If not carefully designed to fit a country’s specific needs, CBDCs could result in reputational risks for the central bank.

CBDCs could also have negative implications for bank intermediation and financial stability. It is, therefore, important for central banks to not only set country-specific objectives but to also analyze the implications of CBDC in the local context. There is no one size fits all. Central banks also need to weigh in on the design options and technical considerations before committing resources and to a particular solution.

CBDC and the consumer

Bringing attention to the consumer who, in the end, should be at the center of the CBDC conversation. Retail CBDCs have the potential to modernize payment systems and enhance financial inclusion. However, as central banks research and experiment with CBDCs, they need to be creative and offer options that are designed for the people they serve (human-centered innovation). Central banks will need to contextualize CBDCs and understand what solution or design choice best fits their jurisdiction.

They need to ask the question, “what pain points do consumers have and how will a CBDC address these?” Also, is a CBDC the best solution given the local context, including access to digital infrastructures such as internet connectivity and smartphones?

As result of increased digitization, consumer increasingly prefer digital means of payments over the use of cash. This makes for a good motivation for issuing a CBDC to ensure that consumers have access to digital central bank money. But adoption will depend on more than changing consumer behaviors. A CBDC should be backed by strong data privacy laws to preserve consumer confidence. But the question remains, do consumer trust their central banks and governments? As Ms. Nolwazi put it, “who polices the police?”

The importance of collaboration which becomes even more important when we talk about cross-border CBDC. Central banks need to make use of regional forums to drive collaboration and take a long-term strategic view. Collaboration could lead to harmonization, especially around governance, laws, and standards. The collaboration will also foster peer learning and support capacity building around the different elements of CBDC.

•So, the keys are:

Central Banks should not just replicate what other countries are doing. They need to contextualize their CBDC projects.

Collaboration is very important, especially when we talk about cross-border CBDC.

Proponents of CBDCs believe that, among other things, they can:

1. alleviate the problem of concentration of the payments infrastructure;
2. discourage illicit activity and rein in the shadow economy;
3. spur competition in the payment industry;
4. reduce the problem of banks being ‘too big to fail’;
5. contribute to financial stability;
6. help facilitate monetary policy

CBDC Potentials

1. Spurring innovation
2. Cross-border payments.
3. Financial inclusion.
4. CBDC would be the safest type of digital money.
5. A CBDC could lead to transactions that are much faster, cheaper
6. Extend public access to safe central bank money.
7. It would have no credit or liquidity risk and require no deposit insurance
8. Many countries have large unbanked populations, and CBDCs could help solve this problem.
9. Consumers wouldn’t need to risk storing their money with a commercial bank that could potentially collapse.
10. Shifting from SWIFT

Challenges

CBDCs could have unintended implications for central banks, banks, consumers, financial markets, and the international monetary system. •Negative implications include:

1.  cybersecurity and data privacy risks,
2. vendor lock-in risks,
3. fraud,
4. Apps-related risk,
5. and financial stability risks.
6. Therefore, it is important for Central banks to conduct in-depth research and experimentation based on their needs and the local context.
7. It is not enough for central banks to rely on data and research from other central banks. The implications will also depend on the technical design choices and the type of CBDC.
8. A country’s central bank would have full control over its CBDC.
9. The central bank would have data on every transaction and at least some data on the CBDC’s users, there’s the potential for privacy issues.
10. Some people won’t have the means to access digital currencies. Others may be reluctant because they don’t trust digital currencies.
11. Commercial banks could lose a significant portion of their business. It could also impact the stock market since bank stocks could drop in value.
12. Possible competition between central and commercial banks.

  Critics of CBDCs range from those who question the need for such currencies altogether, to those who point out the risks, including the possibility that CBDCs could:

1. amplify the international spillover effects of shocks;

2. curtail the autonomy of less powerful economies in their monetary policy, and even substitute their domestic currency;

3. facilitate tax avoidance or a loss of domestic oversight capabilities;

4. put at risk the variety of payment instruments available to households;

5. create undesired volatility in exchange rates;

6. put banks’ deposit bases under threat

CBDC around the world

The whole world is now heavily engaged with CBDC. A report shows around 105 countries are working on CBDC while a recent BIS report (BIS Papers No 125 Gaining momentum – Results of the 2021 BIS survey on central bank digital currencies ) says 9 out of every 10 central banks are working on it.

CBDC in China

China is the pioneering country to work on CBDC. It Is also the first major economy to roll out CBDC in reality though not nationwide yet. Its central bank, the People’s Bank of China (PBOC), began research on the digital currency in 2014 under the leadership of Governor Zhou Xiaochuan.

In 2016, Fan Yifei, a deputy governor of the PBOC, wrote that “the conditions are ripe for digital currencies, which can reduce operating costs, increase efficiency and enable a wide range of new applications”. 

In 2017, the State Council approved the development of the digital Yuan, in partnership with commercial banks and other organizations. Chinese technology firms such as Alibaba (through its affiliate Ant Group), Tencent (which owns WeChat), Huawei, JD.com and UnionPay were invited to cooperate with the central bank in developing and testing digital RMB(Yuan).

China CBDC Timeline

1. In October 2019, the PBOC announced that a digital renminbi would be released after years of preparation. DCEP (Digital Currency Electronic Payment) requires an account with a commercial bank.
2. In April 2020, testing began in four cities around China -Shenzhen, Suzhou, Chengdu and Xiong’an
3. By April 2021, more than 100,000 have downloaded apps. The digital currency could be spent in stores like Starbucks and McDonald’s in China, and online shopping platforms like JD.com. 
4. Local governments have distributed more than 150 million RMB as incentive to attract test users.
5. As of April 2021, testing expanded to six additional regions.
6. By the end of 2021 there were 261 million users in the extended trial who had made US$13.8 billion of transactions. It also rolled out for foreign attendees at the 2022 Winter Olympics in Beijing.
7. On March 31, 2022, PBOC expanded testing to six additional regions and six cities in the province of Zhejiang that are hosting the 2022 Asian Games (Hangzhou, Ningbo, Wenzhou, Huzhou, Shaoxing, and Jinhua). The city of Beijing and Zhangjiakou were included on the list of testing after the 2022 Winter Olympics.

eYuan Objectives

China has been on the CBDC initiatives for some solid short-term and long-run goals in mind. Local as well as international aspects have propelled the creation. Some strategic issues have encouraged it to be the first mover in the full-fledged CBDC roll-out. The major eYuan Objectives for China are listed below:

• First, the digital currency will enable the Chinese government to better track the flow of money through its economy and make better planning decisions.
• Second, a digital yuan will enable China to bring its unbanked population into the mainstream economy.
• A third benefit of the digital yuan is that it might help propel the Yuan to international reserve status.

U.S. digital currency

“My Administration places the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC,” Biden said in his executive order on March 09, 2022 regarding CBDC in the US. 

According to the Fed, “a CBDC would be the safest digital asset available to the general public, with no associated credit or liquidity risk.”

 While the Federal Reserve has made no decisions on whether to pursue or implement a CBDC, the potential benefits and risks of CBDCs from a variety of angles, including through technological research and experimentation are under consideration. Key focus is on whether and how a CBDC could improve on an already safe and efficient U.S. domestic payments system.

The Federal Reserve Board has issued a discussion paper that examines the pros and cons of a potential U.S. CBDC and sought public feedback on a range of topics related to CBDC. The Federal Reserve is committed to hearing a wide range of voices on these topics. Find more on the FACT SHEET.

Why would the U.S. want a digital dollar? 

According to Biden’s executive order, a digital dollar could be useful for

• reducing the cross-border transaction fees,
• expanding financial services to unbanked people, and
• supporting the dollar’s role as the world’s most traded currency in the coming days of digital currency. 

But critics argue that a U.S. CBDC could put people’s savings at risk of being hacked and could give the government increased control over a citizen’s finances.

U.S. Rep. Tom Emmer, a Republican from Minnesota, said in January that, “Requiring users to open up an account at the Fed to access a U.S. CBDC would put the Fed on an insidious path akin to China’s digital authoritarianism.” Earlier this year, Emmer introduced a bill to prevent the Federal Reserve from issuing a CBDC directly to individuals.

CBDC in India

The Reserve Bank has been exploring the pros and cons of the introduction of CBDC in India. The design of CBDC needs to be in conformity with the stated objectives of monetary policy, financial stability, and efficient operations of currency and payment systems.

The introduction of CBDC has been announced in the Union Budget 2022-23 and an appropriate amendment to the RBI Act, 1934 has been included in the Finance Bill, 2022. The Finance Bill, 2022 has been enacted, providing a legal framework for the launch of CBDC. (Page-138)

The Reserve Bank is engaged in the introduction of a central bank digital currency (CBDC) in India. The design of CBDC needs to be in conformity with the stated objectives of monetary policy, financial stability, and efficient operations of currency and payment systems. The Reserve Bank proposes to adopt a graded approach to the introduction of CBDC, going step by step through stages of Proof of Concept, pilots, and the launch.(Page-12)

Recently, RBI has expressed its CBDC trial rollout by December, 2022.

What is the need for a CBDC in India?

1.  Helps in becoming more globalized
2. Shifting from SWIFT
3. Helps in domestic digitalization
4. Cashless economy
5. Secure and risk-free and boost the digital economy
6. Revolutionise the fintech sector •prevent counterfeiting of currency
7. Accelerate financial inclusion •Reduce volatility
8. Negative interest rate

Sand Dollar: The first CBDC

The Central Bank of The Bahamas launched Sand Dollar as the first central bank digital currency available to the general public. With their launch, the world has practically found the CBDC nationwide. It is a great milestone for digital finance practitioners and professionals.

Sand Dollar Timeline

Selecting a Technology Partner
In March 2019, NZIA Limited was selected as the preferred solutions provider.

Drive Toward The Pilot

In November 2019, a special session of the National Payments Council (NPC) convened with key stakeholders to reaffirm the approach to the project. On 27th December 2019 the Exuma pilot launched, with an expansion to Abaco on 28th February 2020.

In the Summer of 2019, a targeted baseline survey on financial inclusion and access for Exuma, alongside new data for the rest of The Bahamas initiated.

Pilot – Abaco Expansion

February 2020 with an expansion of the Sand Dollar pilot.

Nationwide Launch

On 20th October 2020, the Central Bank of The Bahamas launched Sand Dollar as the first central bank digital currency available to the general public. 

eNaira: Same Naira, More Possibilities.

The eNaira is the Nigerian digital currency issued and regulated by the Central Bank of Nigeria. Its functionality delivers speedy, safe, and simple trading and transactional opportunities to customers and end-users for:

• Inclusive and sustainable economy.
• Very very low cost and fast remittance
• seamless digital payments

Nigeria’s President Muhammadu Buhari (L) and the governor of the Central Bank of Nigeria Godwin Emefuele at the launch of the eNaira in Abuja on Monday, October 25, 2021.

“We have become the first country in Africa and one of the first in the world to introduce a digital currency to our citizens,” Buhari said at the official launch.

The Central Bank of Nigeria (CBN) engaged a Barbados-based digital financial technology firm, Bitt Inc, as a technical partner to develop the e-Naira. Nigeria has so far launched two mobile applications – eNaira speed wallet and eNaira merchant wallet – on Google playstore and Apple store for the usage of digital currency.

CBN governor Godwin Emefiele in August listed the benefits of the e-Naira to include increased cross-border trade and accelerated financial inclusion. He hinted that 500 million eNaira ($1.21 million) has already been minted.

The eNaira Journey

eNaira Features

1. Unified Payment System: Customers can now move money from their bank account to their eNaira wallet with ease.
2. Contactless Payment: Customers can make in-store payments using their eNaira wallet by scanning QR codes.
3. Bank Account Management: Customers can monitor their eNaira wallet, check balances, and view transaction history.
4. Peer-to-Peer Payment: Allows users to send money to one another through a linked bank account or card.

eNaira Benefits

1. Growth: eNaira fosters Economic Growth by offering easier access to capital and financial services thereby increasing economic activities at low/no interest transaction rate.
2. Remittance: eNaira provides a secure and cheaper diaspora Remittance option and increase in the speed of such transactions.
3. Monitoring: eNaira’s traceability limits its use for illicit or fraudulent purposes.
4. Welfare: eNaira enables the effective, equitable, and faster distribution of cash assistance to •
5. Inclusion: eNaira provides Financial Inclusion by making financial services available to people or communities who do not have (enough) banking opportunities.
6. Trade: eNaira increases Local and International Trade by making transactions cheap, safe, quick, and better.
7. Security: eNaira has stronger security because it cannot be forged or counterfeited as a result of its unique identity and security structure.
8. Revenue: eNaira aids revenue collection by reducing cash handling costs.

CBDC in Bangladesh

National Budget Speech 2022-2023, Page-123, point 213 cited by the Finance Minister AHM Mustafa Kamal on 9 June in parliament on Conducting Feasibility Study of Launching Central Bank Digital Currency.

“As the risky use of virtual currencies such as Crypto Currencies continues to grow worldwide, many central banks around the world are working to launch digital versions of their currencies as an alternative to Crypto Currencies. The main purpose of launching Central Bank Digital Currency (CBDC) is to facilitate currency in virtual transactions and to encourage startups and e-commerce businesses. As a result of the time-befitting steps of the present government, the coverage of the internet and e-commerce in the country has increased tremendously. In this context, Bangladesh Bank will conduct a feasibility study on the possibility of introducing CDBC in Bangladesh.“

• BB(PSD) is in the initial stage with CBDC. It is working on the international best practices and case studies for countries where launched.
• It has presented the ideas on various occasions.

Ground works

1. Digital Bangladesh
2. Digital Factoring
3. Digital Nano loan
4. Interoperability
5. Digital/Neo Bank

CBDC FAQs

Will digital currency replace paper money?

CBDC does not intend to reduce or replace paper money; it strives to ensure safe payments with less time and costs. However, with the advent of CBDC, paper money usage will reduce to some extent.

Will CBDC replace Bitcoin?

CBDC will reduce the usage and influence of Bitcoin but it is unlikely that it can replace it altogether.

Who controls central bank digital currency?

CBDCs are controlled by the central banks of the respective countries.

Will the the world go cashless?

Cash will be less used in the days ahead but will not go away.

Can you invest in CBDC?

As CBDCs are an alternative to an existing physical currency, investing in them offers no particular investment value. However, you can take advantage of differences in interest rates between different countries.

Is CBDC a cryptocurrency?

No, CBDC is not a cryptocurrency.

Will CBDC be on a blockchain?

CBDC will be on a digital ledger but not necessarily that it will be on the blockchain.