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Central Bank Digital Currencies: a new frontier in digital payments

With 80% of central banks world-wide exploring the use of CBDCs, get ready for it to go mainstream.

The regulatory recap

Majority of world’s central banks working on digital currencies

The Bank for International Settlements (BIS), says 80 per cent of central banks are engaging in investigating central bank digital currency (CBDC).1 A CBDC is state-backed digital or electronic form of central bank money. A CBDC could be used as a means of payment, a unit of account and storage of value. Fifty per cent of central banks have progressed from ‘conceptual’ to proofs of concept and have developed pilot projects. A number of the central banks that have progressed to development or a pilot project are based in emerging market economies. One of the most advanced is The People’s Bank of China, the central bank of China, which began testing its digital currency in selected cities this year and plans to launch it nationwide though a firm date has yet to be set.2

The Covid-19 pandemic presented challenges to central banks as they sought to support monetary policy, particularly the disbursement of payments to citizens. The BIS observed that the pandemic has acted as a catalyst to the further development of CBDCs, particularly in the retail payments sector.3

There are main two types of central bank digital currency (CBDC): general purpose (ie. retail) and wholesale. The latter is a token-based digital currency that is a restricted-access digital token for interbank payments and securities settlement. The former is retail payments focused akin to a digital form of cash and can be based on tokens or accounts.

Motivations to develop CBDCs include improvement of domestic payments efficiency, payments safety and diversity, and financial stability (particularly important in emerging markets). In more advanced economies, central banks see CBDCs as a route to increased cross-border payments efficiency. There are also expected benefits in transparency, which will help fight financial crime as CBDCs will be easier to trace than physical money. Policy consideration of a direct (full retail) CBDC should take into account the possible concentration of risk, disintermediation of financial institutions and excessive government control of credit allocation.

Scope, scale, and structure

Various distribution models under examination

To date, no commercial CBDCs have been issued in any major economies. However, as the BIS found, central banks are intensifying their efforts to develop CBDC. In Europe, Banque de France has selected eight firms with which it will work on its wholesale CBDC.4 The work will cover:

  • new ways of exchanging financial instruments (including crypto-assets for central bank money
  • testing settlement in CBDC to improve execution conditions for cross-border payments
  • revising the arrangements for making central bank money available.

The Bank of Thailand has also taken a collaborative approach with its Project Inthanon.5 With eight commercial banks and technology partner R3 it has conducted a proof of concept of a decentralised real-time gross settlement system using a wholesale CBDC.

Central banks in the Caribbean are also exploring digital currencies to improve financial inclusion and explore the benefits including lower cost of cash and know your customer controls 6. Indeed, the first nationwide CBDC in the world has been launched by The Central Bank of The Bahamas after a successful 2019 pilot.7

There are three distribution models for CBDCs: direct, indirect and hybrid.

Under the direct model, all parties wishing to transact with the digital currency will hold an account at the central bank. Payments will simply be a transfer from one account to the other and the claim will be on the central bank. The central bank will issue the currency and manage a permission system to clear transactions. Know your customer (KYC) and anti-money laundering (AML) compliance requirements will be met by the central bank.

In the indirect model, the central bank will pass the digital currency token to the commercial bank, which will then distribute the currency and also handle KYC and AML requirements. The claim for the currency will be on the commercial bank, not the central bank.

The hybrid model – on which most central banks are working – is based on the central bank distributing the digital currency to a commercial bank, which handles the transaction and the KYC and AML requirements. However, the claim is on the central bank.

Building the blueprint for your firm

Digital assets will require CBDCs

At present, many firms are readying their systems for the issuance and management of digital assets. A CBDC or Stablecoin (digital currencies designed to maintain a stable value relative to another asset that are issued by commercially-run entities) enables settlement of digital asset transactions in near real-time This will significantly improve settlement times in the securities industry.

To prepare, firms should:

  • ensure back-end payment and settlement systems can interoperate with the imminent CBDC networks by running tests and proofs of concept
  • consider whether they may retain some liquidity in CBDCs if – based on the distribution model – the currency is interest-bearing. There is potential for CBDCs to change the way firms invest; if the CBDC is interest-bearing and the rate is good enough, some firms may opt to keep more of their assets in the digital currency to gain better liquidity
  • recruit and retain the right skills and talents for the new digital business model
  • ensure senior levels of the firm understand that CBDCs are a ‘when’ not ‘if’ and thus get management buy-in to support CBDC projects and ensure adequate resources are provided.

Building the blueprint for the industry

Private sector has a role to play

As CBDCs gain mainstream interest, financial institutions and market participants should ensure that they are engaging with central banks to help in the development of CBDCs. A plethora of surveys have been issued by central banks, seeking the views of industry participants. It is important that the industry gets involved at this early stage of development to help frame the wider CBDC environment. Central banks are cognisant that they are policy makers and should not dictate the technologies required to make CBDCs a success.

In addition to consultation, regulatory sandboxes and innovation hubs have been set up by central banks to enable technology firms, financial technology companies, and financial institutions to experiment with various options.

The industry should also collaborate on and agree CBDC-related standards, especially for cross-border transactions.

There is potential for disruption to the custody model as CBDCs will have full traceability, removing the need for a clearing houses, for example. To stay relevant, custodians could offer safe-keeping and asset servicing of CBDCs and cryptocurrencies.

Championing change with Standard Chartered

Connecting clients and central banks in the new digital journey

As a global custodian with a strong presence in emerging markets, Standard Chartered Securities Services is well-placed to help clients make the most of the opportunities CBDCs will provide. We are providing education to ensure clients are ready for CBDCs and digital assets.

CBDCs will inevitably become the new landscape for payments, and we at Standard Chartered are making sure that we – and our clients – will be prepared and ready as CBDC become more widely used.

1 CBDC, Central Bank Digital Currencies : foundational principles and core features, BIS (October 2020) https://www.bis.org/publ/othp33.pdf

2 One day everyone will use China's digital currency, BBC News (September 2020)  https://www.bbc.com/news/business-54261382

3 Pandemic pushes central bank digital currencies into top gear, Reuters (11 June 2020) https://www.reuters.com/article/us-health-coronavirus-britain-crypto/pandemic-pushes-central-bank-digital-currencies-into-top-gear-idUSKBN23I2HO

4 https://www.banque-france.fr/en/communique-de-presse/banque-de-france-press-release-20-july-2020

5 https://www.bot.or.th/English/PressandSpeeches/Press/2019/Pages/n3962.aspx

6 https://www.bis.org/publ/bppdf/bispap107.pdf

7 Central Bank Digital Currency: The first nationwide CBDC in the world has been launched by The Bahamas, Forbes, (October 2020)

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