Central Bank Digital Currency, Design Choices, and Impacts on Currency Internationalization
Over the past decade, digital currencies and payment instruments—including cryptocurrencies, global stablecoins, and central bank digital currency (CBDC)—have emerged as important innovations with potentially large impacts on the international monetary and financial system. While there are a range of factors that will impact the pace and shape of digital transformation in the financial sector, this paper focuses primarily on CBDC, given recent attention on digital fiat currency and its potential to promote currency internationalization.
CBDC promises increased efficiency and lower costs, improved access to financial services, and greater transparency and accountability in payment systems and financial flows. It also raises new risks and greater technical and regulatory complexity. CBDC’s future will depend, first and foremost, on national authorities’ ambitions and assessments of benefits and risks. CBDC design elements can address individual country preferences, while international cooperation—for instance, on data frameworks, privacy protections, and technical interoperability—will be necessary to fully realize the benefits of CBDC, especially for cross-border payments. Multilateral agreement and CDBC standards will take time, but national authorities can act now to ensure an enabling domestic environment for CBDC and other digital currency developments.
Digital Currency Evolution: Cryptocurrency, Stablecoin, and CBDC
The concept of digital currency dates back decades, but Bitcoin, launched in 2009, is recognized as the first privately issued, decentralized (ledger-based), and encrypted digital currency or cryptocurrency. Today, there are an estimated 7,000 distinct cryptocurrencies, with a combined market value in the hundreds of billions of dollars. Since their introduction, cryptocurrencies have been characterized by extreme price volatility, limiting their use as a store of value and unit of account, two key functions of money. As a result, cryptocurrency has primarily served as a speculative investment, with more limited use as a medium of exchange.
Stablecoins—private sector digital tokens backed by fiat (government-issued) currency held in physical reserves—were first introduced in 2014 and designed to address the extreme volatility of ledger-based cryptocurrency. However, like cryptocurrency, stablecoins are privately issued and neither regulated nor backstopped by a monetary authority, raising questions about how their adoption might impact monetary policy transmission, visibility into economic and financial activity, and financial stability. Policymakers, and monetary authorities, in particular, have greeted announcements of new global stablecoins with caution. In October 2020, the Financial Stability Board (FSB) warned that the emergence of global stablecoin (GSC) arrangements may “challenge the comprehensiveness and effectiveness of existing regulatory and supervisory oversight” and put forth recommendations to address associated financial stability risks. Leaders from the world’s 20 largest economies (G20) welcomed the FSB’s work and agreed that “no so-called ‘global stablecoins’ should commence operation until all relevant legal, regulatory and oversight requirements are adequately addressed through appropriate design and by adhering to applicable standards.”1
The emergence of stablecoins is widely seen as spurring work already underway in many central banks on a third category of digital currency: central bank digital currency or CBDC. Unlike private digital currencies, CBDC or “digital cash” is a liability of the central bank, and the holder of CBDC has a direct claim on the state. This feature of CBDC preserves the concept of money as a public good and makes CBDC a safe store of value, but it also has the potential to disintermediate banks and undermine financial sector stability if individuals and companies are able to hold accounts directly at the central bank.
CBDC, Digital Payments, and Currency Usage
For many of the world’s central banks, discussion of CBDCs has shifted from “if” they will be developed to “when” they will be introduced and widely used. According to the Bank for International Settlements (BIS), over 80 percent of the world’s central banks, including the U.S. Federal Reserve, are now conducting research on CBDCs, with the majority of these already progressing to the experimental or pilot development phase. The case for CBDC is based in large part on the underlying technology’s potential to improve payments efficiency and lower transaction costs, particularly for cross-border payments, as well as to bolster system integrity, spur financial innovation, and improve access to financial services. Some central banks are also motivated to pursue CBDCs in order to counter the declining use of physical cash and potential risks to payment system resilience and monetary policy transmission.
Early experiments with CBDC focused on possible applications of digital ledger technology (DLT) to digital currency to improve the efficiency and security of interbank and cross-border payments. Recently, the chairman of the U.S. Federal Reserve indicated that the main motivation for U.S. interest in CBDC, in fact, lies in its potential to improve payment systems.2 While digital currency and digital payments are not synonymous, the two are closely related, and digital currency can only fulfill its function as a medium of exchange if its design is compatible with the underlying payments infrastructure.3
For many of the world’s central banks, discussion of CBDCs has shifted from “if” they will be developed to “when” they will be introduced and widely used.
In no country is experimentation with CBDC more developed, or the link between currency and payments more explicit, than in China. The People’s Bank of China (PBOC) has been working on its “digital currency electronic payment” (DCEP) program since 2014, and in April 2020, it launched a DCEP pilot program in four Chinese cities: Shenzhen, Suzhou, Chengdu, and Beijing’s satellite city Xiong’an. PBOC governor Yi Gang has said China’s DCEP aims to “partially digitize” China’s existing monetary base, boosting both efficiency and data collection. It has also been reported that China’s DCEP program is motivated by concern that private digital payment platforms could displace traditional banks—posing a threat to financial stability and official sector oversight of economic and financial activity in China.
Despite domestic considerations that have driven China’s CBDC efforts to date, DCEP has also been linked to efforts to expand renminbi (RMB) use outside China’s borders, along with China’s Cross-border Interbank Payments System (CIPS). Many factors influence the attractiveness of a sovereign currency outside its national borders, including the infrastructure and technology of cross-border payments. Other factors, such as capital account convertibility, deep and liquid financial markets, and established property protections and rule of law, also matter.
China is not alone in seeing CBDC as supporting currency internationalization. An October 2020 report from the European Central Bank (ECB) noted that a digital euro “could be issued to foster the international role of the euro,” and the Federal Reserve chairman has said that the United States is “committed to carefully and thoughtfully evaluating the potential costs and benefits of a central bank digital currency for the U.S. economy and payment systems, as well as for its international implications.”
CBDC Design Considerations
It is clear that CBDC has captured the attention of policymakers around the world. However, they rightfully approach the issue with a high degree of caution, reflecting the challenges associated with a major technological change to the so-called “plumbing” of the international financial and monetary system. A recent working paper on policy and technical considerations from the Brookings Institution acknowledged the experimental nature of CBDC, underscoring information security risks and the potential for fundamental design mistakes. Apart from prioritizing risk management and mitigation, CBDC design will depend on specific objectives and priorities and will entail certain trade-offs. In October 2020, a joint report from the BIS and seven central banks outlined foundational principles and core features of an effective CBDC, including resilience and security, convenience and low cost, a clear legal framework, and a role for the private sector.
However, different jurisdictions will have different priorities, and there remains a wide range in design features, which could have implications for interoperability and cross-border payments in particular. For example, U.S. officials have articulated their intent to evaluate CBDC on its ability to “improv(e) an already safe and active dynamic domestic payment system.” The ECB has emphasized the potential for a digital euro to enable the digital economy and support European sovereignty and stability. The ECB also raises the prospect of declining cash use, highlighting the need for low-cost, low-risk, and efficient cash-like CBDC design, a priority echoed by the Bank of Japan, Bank of Canada, and Sveriges Riksbank. Japan also emphasizes the stability and efficiency of payment and settlement systems, along with universal access, instant payment capability, and interoperability, as requirements of CBDC.
Against this backdrop of multiple and sometimes competing priorities, an August 2020 working paper from the BIS identifies a short list of foundational design choices for CBDC:
- The most fundamental choice is that of CBDC architecture, which refers to the operational role and division of responsibilities between the central bank and private intermediaries;
- Next is CBDC infrastructure, which refers to the technical design and choice between a centralized database or decentralized DLT for recording transactions in CBDC; and
- Then there is the question of access to CBDC and whether its use is based on individual identity or anonymous, for instance, through digital tokens.
There is not a right or wrong choice for each design element, rather a preference based on objectives and priorities. On the question of architecture, a “two-tier” or “wholesale” model in which CBDC is issued by central banks through commercial banks to end users could prevent some of the more disruptive impacts of CBDC on the financial sector but may limit efficiency gains and broad access to CBDC relative to a retail model. On the other hand, a “general purpose” or “retail” CBDC could lower barriers to financial inclusion but would also compete with traditional deposit-taking institutions, limit the financial intermediation role currently played by banks, and concentrate credit allocation decisions with the state. Differences between countries in the architecture of CBDC are likely to impact the competitive landscape for financial services as well as currencies.4
The infrastructure of CBDC will have to support choices regarding who has access to CBDC and under what conditions. The underlying technology and design, in turn, will influence the payment and settlement platforms on which a CBDC can operate and whether these platforms are interoperable with one another and with legacy systems. In particular, the record-keeping structure (token- or account-based) will determine who records and stores transaction data. While a decentralized digital token would allow for greater anonymity and arguably be more resilient to infrastructure outages and cyberattacks, a centralized ledger could promote greater transparency and facilitate compliance with anti-money laundering and countering the financing of terrorism (AML-CFT) and know-your-customer (KYC) frameworks.5
Differences between countries in the architecture of CBDC are likely to impact the competitive landscape for financial services as well as currencies.
Global Cooperation and the Path Forward
For some country authorities, among the most compelling reasons to move ahead urgently with CBDC development may be the possibility that failing to do so could undermine the home currency’s position or result in the diminution of reserve currency status. To the extent there is a “first-mover advantage” in arriving at a viable CBDC, those countries that have a CBDC in advanced development could also be setting the standard for cross-border CBDC use. Some industry participants have even pointed out that first-mover advantage could translate into a strong network effect, which historically has been a determinant of reserve currency status. While central bankers are aware of first-mover considerations, the chair of the Federal Reserve recently stated, “[i]t’s more important for the United States to get it right than to be the first.”
Central banks will need to weigh the trade-offs inherent in CBDC design choices and find solutions that take domestic interests into account while forging new international standards.
A number of central banks have published research and views on various considerations, along with requests for public input, at times in collaboration with other central banks. In addition, numerous international organizations are working to understand the implications of design choices, with an eye to defining international standards for cross-border payment interoperability and standardized communication channels among central banks. The FSB, in coordination with the BIS’s CPMI, has taken a leadership role in coordinating next steps, including with other multilateral institutions and intergovernmental bodies such as the International Monetary Fund (IMF), World Bank, and the Financial Action Task Force (FATF). The FSB, currently chaired by the vice chair of the U.S. Federal Reserve and whose membership includes monetary and fiscal authorities from 24 countries, has published a “roadmap” to enhance cross-border payments, including on new payment infrastructures and arrangements such as CBDC and GSC. This roadmap was endorsed by G20 leaders in November, and the FSB will continue to report on an annual basis to the G20 on implementation of the road map, a process that can serve to promote public buy-in and political accountability.
While these broad international efforts provide a platform for collaborative approaches to improving cross-border payments, smaller country groupings may also expedite progress, at least on high-level standards. In October, finance ministers and central bank governors from the Group of Seven (G7) industrialized democracies issued a statement on digital payments linking confidence in the stability of domestic payment systems and the international monetary system to “longstanding public sector commitments to transparency, the rule of law, and sound economic governance.” Critically, action on the part of national authorities will be required to align regulatory, supervisory, and oversight frameworks and provide the regulatory clarity required by private sector participants. This is especially true in the areas of data frameworks, customer due diligence, and digital unique identifiers.
Consensus on standards will be challenging, given the range of policy objectives across jurisdictions. Without alignment, however, the efficiency gains of digital currency and digital payments may be lost on cross-border flows. According to the FSB’s roadmap, by July 2021, the CPMI, IMF, and World Bank will “take stock of multilateral platforms for cross-border payments and analyze pros and cons, demand, design features, risks and challenges to establishing such platforms,” a useful step toward building international consensus. At the same time, individual central banks with interest in CBDC cannot wait until all policy questions are answered to make progress. In the U.S. context, national legislation on data privacy and digital identity—the implications of which extend well beyond the scope of CBDC—may well be complementary to efforts at developing a digital dollar.
There is a solid use case for CBDC that justifies the intense interest across multiple jurisdictions. At the same time, establishing the architecture, infrastructure, and rules for access to CBDC will entail design choices that are not without trade-offs. Tough choices, however, should not stymie progress, especially given the rapid pace of innovation and the fact that developments in one jurisdiction can have impacts beyond national borders, including for currency internationalization. Near-term priorities for national authorities should include data frameworks as well as digital identity, given their centrality to CBDC design and digital currencies and payments more generally. Policymakers should make these issues central to consultations with stakeholders and in outreach with the public.
Stephanie Segal is a senior fellow with the Economics Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Pearl Risberg is a research associate with the Economics Program at CSIS.
This brief is made possible through the generous support of the Ministry of Finance, Japan.
CSIS Briefs are produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
© 2020 by the Center for Strategic and International Studies. All rights reserved.