Are CBDCs a question without an answer?

The Singapore Fintech Festival takes place next week with central bank digital currencies (CBDCs) one of the hot topics on the agenda. Questions should raise be raised about what role such currencies would in fact play in financial systems. Singapore would appear to be an ideal market for the use of a CBDC, with its dense population, universal internet and smartphone penetration with propensity of digital payments at the expense of cash.

Indeed, the Monetary Authority of Singapore (MAS)’s chief fintech officer, Sopendu Mohanty, said earlier this year that Singapore’s financial sector has the technology in place to use a digital currency, with a decision by the central bank the only thing holding it back.

“What we’re missing is the decision of a central bank to issue a digital currency into the network,” Mohanty said on a R3 webinar.

“I think it will take some time, but hopefully as soon as possible.”

Singapore has the infrastructure in place, given the MAS’ work in Project Ubin, which aims to use blockchain technology in the clearing and settlement process between the central bank and commercial banks or corporates.

"Project Ubin has worked with the financial industry and blockchain community on a journey of experimentation, prototyping and learning,” Mohanty said after the MAS successfully completed Project Ubin’s final phase of testing in July.

“This has built a strong foundation of knowledge, expertise and experience, and paved a path towards commercial adoption. Following the successful experimentation over five phases, we look forward to greater adoption and live deployment of blockchain technology.”

Central banks’ priorities

However, a central bank using blockchain technology for clearing and settlement between institutions does not necessarily amount to a CBDC.

“Distributed ledger technology can certainly make clearing and settlement between central banks, commercial banks and corporates more cost-effective, efficient and transparent,” Taimur Baig, chief economist at DBS, tells Finextra Research.

“However, I haven’t really seen anything from the MAS that makes me think a CBDC is just around the corner.”

There is a conversation to be had about the extent that Singapore or other developed economies requires a central bank digital currency.

One of the dominant concerns of central banks is losing control of the monetary system, either through a decline in the use of cash or through companies developing tokens or other instruments for use on their platforms.

“There is no such urgency in Singapore because it’s not like there’s been a fintech revolution that has completely overtaken the conventional monetary system,” Baig says.

“So, I struggle to understand what problems Singapore needs to solve in the near term that a digital currency would be the solution.”

One of the most common reasons put forward for a CBDC circulated direct to the public – the retail model as it is known – is to address the decline in the use of cash.

However, this need not be a problem in developed countries with sophisticated payment systems and small unbanked populations. It is certainly not significant enough that it is worth risking the tension that may be provoked between central banks and commercial banks if they end up in competition for consumer’s deposits.

The evolution that is taking place in the way businesses, consumers and banks transact are likely to take place and gain speed independent of any initiatives in CBDCs, so they may lack a unique use case.

Like China

China has been developing a digital currency for a number of years and appears to be very close to fruition. The latest trials saw 50,000 residents of Shenzhen received an amount equivalent to $30 in the form of ‘e-renmibi’ (e-RMB) as part of a city-wide lotterty. This could then be spent at more than 3000 designated retailers across the city.

Given China’s dominance of the APAC region, it makes sense for countries in its orbit to at least have preliminary plans in the area of CBDCs to avoid falling under a Chinese digital economic hegemony. Japan is drafting a plan to test a digital yen as early as next year. The Reserve Bank of Australia meanwhile announced in November that it will be exploring the development of a digital dollar with a number of partners, including Commbank, NAB and software company, Consensys.

However, according to Baig, there is a debate to be had over the extent to which China’s e-RMB is even a CBDC, much less if they intend to use it as instrument for a greater stake in the world’s financial system.

He argues that the Chinese state is merely looking for greater visibility over the creation of digital money.

“So, anything that is happening on the platforms of Alibaba or Tencent, China’s central bank wants to have greater oversight and visibility by creating some sort of e-RMB clearing house.

“That’s my understanding of what the Chinese are doing now.”

Cross-border interoperability

Where there is broader consent over the use cases for CBDCs is in making cross-border payments faster, cheaper and more efficient. This would certainly appear to be the intent of the MAS with Project Ubin.

“The MAS has been an enabler of clearing and automation for over a decade and it is no surprise that it is working in conjunction with central banks in the region and around the world to enable more efficient processing of cross border clearing and settlement,” says Sankar Krishnan, executive vice president of banking and capital markets at Capgemini.

Whether this is the intent or not, a world of several different CBDCs would cast into doubt the need for bodies like SWIFT, a point that was made by David Birch of Consult Hyperion recently.

"In a world of CBDCs, I am not sure what Swift would do," the director of Consult Hyperion said at Sibos in October

"It involves an awful lot of messing around to do with settlement, reconciliation, clearing and so on."

Taimur Baig echoes this, saying that “correspondent bank accounts and using SWIFT numbers to send payments across borders becomes moot”, with central banks and other institutions instead able to carry out cross-border, FX payments among themselves through a digital platform.

This though presents the challenge of developing said platforms and payment systems that can support multiple CBDCs.

Krishnan believes that the MAS can be seen as a “gold standard in how clearing and settlement operates” and should pave the way for other central banks to join their initiatives to improve speed, cost and transparency in the movement of central bank money.

However, there is sure to be a proliferation in such initiatives designed to increase interoperability between CBDCs, stablecoins and other cryptocurrencies.

“Initial challenges will include the multiple initiatives around the World that banks are part of and how they will be able to collaborate across consortiums,” he says.

“The MAS is working with R3, so if you are on a platform that is operated by Hyperledger, Ethereum, Ripple or Bitfinex, how would you then partner with an MAS CBDC?” he says.

This could well be addressed in time, but in the face of real-time payment schemes buoyed by initiatives like P27, the CBDC advocates will need to present a more compelling use case other than addressing inefficiencies in cross-border payments.