Central bank digital currency (CBDC) is essentially a virtual token that’s the equivalent to a country’s existing fiat currency.
In this article:
- Retail and wholesale CBDCs
- Real ground for innovation
- Minimising risks in the financial system
- Central banks exploring retail CBDCs
- RBA’s work on CBDC
- Project Dunbar
The advantage of a digital currency transaction is that it is often quicker than a traditional bank transfer because there aren’t any intermediaries.
This means users can transact across international borders without paying exorbitant charges or waiting for days for the money to reach its destination.
Retail and wholesale CBDCs
A retail CBDC would be like a digital version of cash that is universally accessible, including via wallets on phones or purpose-built devices like smart cards.
There could also be wholesale CBDC, which – like settlement accounts at central banks – would be accessible only to a more limited range of participants.
Similar to cash and settlement account balances, the unit of account of the CBDC would be the sovereign currency (also known as fiat currency).
The CBDC would be convertible at par (ie one for one) with other forms of money, and would also be specified to serve as legal tender.
Real ground for innovation
CBDC wouldn’t make much difference at the wholesale level, given that money in this segment is mostly digital.
“The new technology does not fundamentally change the nature of the asset, as it is already digital, but enables banks to use it more efficiently and cheaply," says Eswar S Prasad in The Future of Money — How the Digital Revolution is Transforming Currencies and Finance.
The real ground for innovation is the retail segment where a significant portion of money is still in cash.
Retail CBDCs will be digital currency issued by the central bank which will exist alongside physical cash.
A Bank of England discussion paper notes that the retail CBDC would be “denominated in pounds sterling, just like banknotes".
Minimising risks in the financial system
CBDCs are different in the sense that the payment infrastructure is created and managed by the central bank and payments are made using central bank money and not the money created by the banking system.
There are strategic advantages of CBDCs from a central bank’s perspective.
D Priyadarshini and Sabyasachi Kar noted in a working paper titled 'Central Bank Digital Currency: Critical Issues and the Indian Perspective': “China, for example, has seen near-universal adoption of digital payments, with nearly 94% of mobile transactions supported by Tencent or Alibaba.
“Both entities have also combined several other financial services with their social media apps."
This level of dependence increases the overall risk in the financial system, with the entire digital payment infrastructure being dominated by a few private companies.
As Priyadarshini and Kar write, this poses risks “of monopolies, high entry barriers, potential misuse of data, safety and security of technology".
Central banks exploring retail CBDCs
According to cbdctracker.org, at least 64 central banks are exploring retail CBDCs, of which 20 have been launched or tested or are in the very advanced exploration stages.
There are six jurisdictions that have either fully launched (Bahamas) or have initiated pilot programs (China, Eastern Caribbean Central Bank, Nigeria, Jamaica and Uruguay).
Fourteen jurisdictions are in the advanced stages of retail CBDC research, of which six have started or soon will start proofs of concept (Bhutan, Ghana, Japan, Korea, Sweden and Ukraine).
For emerging economies, some of the main motivations for launching or testing a retail CBDC are payment system efficiency and financial inclusion, including reducing the costs of managing physical cash.
Protecting monetary sovereignty and pushing back on the encroachment of private digital currencies are also important objectives of both emerging and advanced economies.
RBA’s work on CBDC
Given the possibility that the balance could shift towards a case for issuance of retail CBDCs, the RBA has been stepping up its CBDC research.
In his address to the Australian Corporate Treasury Association in November 2021, RBA head of payments policy Tony Richards noted that ‘Supporting the evolution of payments’ is one of the six strategic focus areas in the RBA’s strategic plan, and research on CBDC is a key element of this.
The RBA is looking to do experiments around retail CBDC and is engaging with the new Digital Finance Cooperative Research Centre (CRC) on possible projects; the RBA is one of the 29 founding entities that will work through the CRC to explore the opportunities arising from the digitisation of assets.
Regarding wholesale CBDC, RBA has been conducting research on the technological and policy implications for several years, based on a view that it was more likely that a case for issuance could emerge.
RBA’s first project, completed in 2019 in conjunction with its in-house Innovation Lab, developed a proof-of-concept of a DLT (distributed ledger technology)-based interbank payment system using a tokenised form of CBDC backed by exchange settlement account balances held at RBA.
Project Dunbar
Currently, RBA is working on Project Dunbar, together with the BIS Innovation Hub and the central banks of Malaysia, Singapore and South Africa.
This project aims to develop prototype shared platforms for cross-border transactions using CBDCs of many different jurisdictions.
Such platforms could allow financial institutions to transact directly with each other in CBDCs, eliminating the need for intermediaries and potentially improving the speed, cost and transparency of wholesale cross-border transactions.