Advances in Blockchain Technology Are Driving Development of Central Bank Digital Currencies

Central banks are asking themselves a key question: “Are we ready for a Central Bank Digital Currency?”

A Central Bank Digital Currency (CBDC) is drawing closer for many nations: In a Bank for International Settlements (BIS) survey, 70% of responding banks said they are engaged in, or planning to begin, work on a CBDC.

Central banks that adopt a CBDC will enable individuals to have a direct account with their central bank, from which it can issue new money that is equivalent to and redeemable for its domestic currency. In the “retail” scenario, a CBDC can be issued for general use, enabling peer-to-peer and consumer-to-merchant payments. It can also be applied to a “wholesale” use by commercial banks and clearinghouses for more efficient interbank payments.

CBDCs can address several key gaps in traditional finance today, including those of access, speed, cost, transparency, and security.  A CBDC best prepares the burgeoning digital economy to meet its payment needs as cash use gradually declines. It can also help modernize the transfer of financial value, such as cross-border payments. 

Most CBDC models are designed using blockchain technology, with the unique capabilities of Distributed Ledger Technology (DLT) at its core. Blockchain-based currencies make online transactions like money transfers and payments easier and more transparent; cross-border currency exchange becomes a level playing field for smaller economies via a simpler, more standardized online exchange; and the drive to cashless status can accelerate as mobile and online payments increase

International Initiatives

CBDCs are quickly picking up steam, with serious studies and pilot projects underway worldwide.

Interest in CBDC adoption is blossoming throughout Asia. Masayoshi Amamiya, Deputy Governor of the Bank of Japan, said in a March 2020 speech to the BIS, “To support economic activities, it is essential to have payment instruments that are safe, reliable, cheap and universal to everyone. Most would agree that the central bank should play the role of provider of such instruments even in the digital society. CBDC is expected to play a part in this.” He goes on to note that the Bank of Japan has established a research team on CBDC within its Payment and Settlement Systems Department.

Other countries exploring CBDC include Cambodia with its Project Bakong, South Korea, and Malaysia among others. Thailand’s Project Inthanon Proof of Concept (PoC) study for a wholesale CBDC was conducted with eight banks. Pimolpa Suntichok, Senior EVP Commercial Banking Solutions, Siam Commercial Bank stated, “The outcome of Project Inthanon has demonstrated that DLT has not only increased efficiency but also reduced risks and overall costs in the financial ecosystem.”

China appears to be the major economy furthest along on their journey, announcing recently that trials of the digital yuan will commence at McDonald's, Starbucks, and Subway restaurants in Beijing. This represents a significant step, even though an official start date has not been set. 

CBDC Comes with Questions

There are obvious benefits to developing a CBDC, but also many challenges. Mistakes are inevitable on the way to a frictionless digital currency, which could prove costly in both time and money. Nations that choose to wait may enjoy an easier path to their own high-functioning CBDC.

Launching a CBDC, however, requires technical mastery of many moving parts. A functioning CBDC successfully balances diverse considerations, including privacy, resilience, business partners, cost model, user experience, and security.

From there, more key questions unfold for central bank decision-makers. How best to achieve universal access? Should core architecture be fully centralized, or should some components be decentralized and built on a blockchain? How many transactions per second (TPS) must our network infrastructure support, and how will it scale up? How is settlement finality defined, and how can transactions be revoked if necessary? Is the model interest-bearing? How do we integrate this seamlessly with our nation’s existing retail payment system and banking ecosystem?

Help Is On the Way

Such considerations are only the start in executing a CBDC, which are extremely challenging mechanisms to design. The officials and administrators steering a CBDC’s development have a responsibility to scan the horizon.

New platforms and protocols are constantly being developed in the private sector, which sees a growing opportunity to support countries and central banks on their way to deploying a CBDC. Identifying and incorporating the right innovations can be key to maximizing cost efficiencies.

One innovative solution gaining traction is that of an instant global settlement network for banks, central banks, and other ecosystem partners. Just as DTCC provides settlement for US equities, for example, a blockchain-based settlement network has the potential to provide near-instant settlement for global fiat currencies and digital assets. Entirely new remittance and payment products can be developed for a country’s CBDC to work seamlessly with other participants in the network.

In this model, a country’s central bank can join the network as a settlement node. The network can then help to establish a digital currency for the native fiat currency that is usable for instant settlement of financial transactions. As trade volumes rise, the country would see an increase in fiscal revenues. 

A nation’s benefits from an early CBDC deployment could multiply from there, including attracting top talent and emerging as a technology resource. It also demonstrates a country’s fiscal adaptability, a key trait as global partners battered by COVID-19 reassess their supply chains and look to identify nations that can withstand a sudden crash. Each country in the network would be established as a digital financial hub, helping to promote employment and increase its tax revenue.

Committing to a CBDC program requires resolve. Central banks must brave a minefield of choices, carefully weighing high-stake trade-offs with every step. Fortunately, nations are no longer alone in the quest for a CBDC, with an ever-widening knowledge base of blockchain use cases and rapidly growing resources to assist them. The newly interconnected world of CBDCs is developing quickly, and early movers may soon go live. It adds up to very intriguing times for the world of central bank digital currencies, where timing could be everything.