Partially inspired by the concept of Bitcoin, Central Bank Digital Currency (CBDC) has been ringing in with research studies and experiments in over 85% of economies around the globe including China, Japan, US, UK, Russia, Malaysia, Sweden, etc. for a few years now. With China leading the road with its digital yuan or e-CNY, central banks around the globe are either in conflict or under the process to substitute publicly issued digital currency for the bank-issued digital money in everyday use. However, as of now, no country has officially launched its CBDC, although there are several pilot projects and research studies in progress to determine their viability and usability.
The past couple of years has seen a massive surge in the digital economy, along with rising demand for online financial services. Consequently, virtual currencies or cryptocurrencies like Bitcoin and Ethereum have gained heavy traction in the private sector, resulting in thousands of cryptocurrencies serving various industries. However, price fluctuations, instability, high energy consumption, association with illegal activities, etc. have kept these currencies from being suitable for everyday use.
Thus, CBDCs hope to integrate the efficiency, ease, and security of digital currencies like cryptocurrencies with the regulated and reserve-backed circulation in traditional banking systems. Easier said than done though! Even though meant to accelerate the growth and efficiency of the payment and banking systems, CBDCs come with their own set of challenges considering user privacy, current financial system & intermediaries (commercial banks, payment operators, etc.), or even their need altogether. Nevertheless, countries are approaching these concerns at their own pace.
One of the most engaged and growing markets in digital currencies, the US administration has been speculative of the growing attraction towards cryptocurrencies. Addressing the skepticism on the matter, Federal Reserve Chair Jerome Powell, during a congressional hearing on Wednesday, supported the role of US central bank digital currency in undermining the need for cryptocurrencies and stablecoins. Powell stated before the U.S. House of Representatives Financial Services Committee-
"That, in particular, you wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency - I think that’s one of the stronger arguments in its favor."
Although Powell sees stablecoins have scope for gaining more attraction over time, he also mentions a possible launch of a report by the Federal Reserve in early September to address digital payment methods including cryptocurrencies, stablecoins, and CBDC. Putting faith in the power of public consultations regarding CBDCs and crypto assets, Powell also said:
“We want to begin a major public consultation across many different groups, including Congress of course, on a CBDC. And also on stable coins and crypto.”
Powell made it very clear that the Fed is more focused on doing it right and with substance instead of falling into the rat race with the rest of the economies just for the sake of coming first.
In order to align with the growing pace of private innovation, the Bank of Japan launched the first phase of its CBDC experiment in April. However, Japan won’t move onto the second phase until next year. According to Hideki Murai, head of the ruling Liberal Democratic Party’s panel, remarks on digital currencies:
"By around the end of next year, we'll have a clearer view of what Japan's CBDC would look like."
In his interview with Reuters early in July, Murai clarified that there would be no rush to make a decision on issuing a CBDC, taking time to debate details over the effect of its issuance on financial institutions and to lay out the key functions of a digital yen. Moreover, Murai extended his concerns over the design of CBDC. If focused on making commercial banks key intermediaries, CBDC would result in a shift in business along with pulling the data back to the banks.
Furthermore, the Bank of Japan also needs to consider the digital yen’s compatibility with CBDCs developed by other nations to counter the aggressive growth in the issuance of China’s digital yuan. On that note, Murai expressed:
"If a digital yuan becomes so convenient it's frequently used by tourists or becomes a main settlement means for trade, the relationship between the yen and yuan could change and erode the yen's status as a safe-haven currency”
Japan has been marked in crypto history for being the first nation to mark “crypto-assets” as a legal term in law. Not to mention, the Bank of Japan falls among the group of seven major central banks that are jointly looking into core features of CBDCs. Stepping up their extensive research and coordination on digital currency to understand the prospects for issuing a CBDC, Japan’s Financial Services Agency (FSA) recently established a new unit that would supervise digital currency and decentralized finance.
One of the biggest challenges in designing CBDC to truly match cash’s viability is maintaining the sanctity of the framework, offering seamless transactions while preserving user privacy and identity. Cash holds its almighty stance for anonymity against centralized figures. However, since CBDCs and legal compliance are pursued hand-in-hand, user identity verification becomes inevitable to avoid illicit transactions and activities, further compromising user’s privacy.
Addressing the same concern in its paper in 2019, European Central Bank explored anonymity in CBDCs, noting-
“The ongoing digitalization of the economy represents a major challenge for the payments ecosystem, requiring that a balance be struck between allowing a certain degree of privacy in electronic payments and ensuring compliance with regulations aimed at tackling money laundering and the financing of terrorism.”
Currently looking into a possible CBDC for the UK, the Bank of England isn’t exactly inclining towards the use of distributed ledger. Instead, the BOE believes using conventional centralized technology comes as a strong possibility if they actually do go on to issue a CBDC. It's still unsure, unlike China.
Walking miles ahead and fueling the race, China is currently leading in issuing a central bank digital currency. The People’s Bank of China recently published a whitepaper on e-CNY or digital yuan, addressing some previously raised issues. For instance, the paper corrects a statement made earlier by the former central bank governor about state banks issuing e-CNY against central banks deposits. The paper now clarifies that the CBDC is issued by the central bank and the commercial banks are just distributors.
Carrying the status of a legal tender, e-CNY supports offline payment without a bank account along with managed anonymity-
“The e-CNY system collects less transaction information than traditional electronic payment and does not provide information to third parties or other government agencies unless stipulated otherwise in laws and regulations.”
Where e-CNY managed anonymity can hint towards surveillance over transaction history, Chinese authorities have previously reported having admitted that they can already track payment history.
Central Banks Digital Currency is still a work in progress project while leading economies try to grasp the idea behind the inspiration. Despite the concept of CBDCs being strung from a decentralized currency, central banks are not necessarily considering blockchain as a viable option to power their digital currencies. While countries like the US, Japan, and even India are still exploring the space to address the current concerns, China is pulling the strings on countries, striking their fear of lagging.
As of now, CBDCs still have a long way to go in building a secure, convenient digital instrument with the qualities of regulated and reserve-backed circulation. Japan’s inclination towards investing and exploring decentralized finance with its new FSA unit shows potential for better and reliable alternatives to cash and traditional digital money. Moreover, the increasing demand for online financial services and boost in the development of the digital economy in lieu of the pandemic has created a higher demand for new technology integrations and services, offering an opportunity for nations to ascend into true financial digitization.