CBDC, the central banks are going digital

Jan 6, 2021

In 2008, the first crypto-currency made its appearance and aimed to provide an alternative independent of the classic banking system, shaken by the financial crisis of that same year. Bitcoin is launched and will be a model for future crypto-currencies, which will multiply from then on, with varying degrees of success. This still unstable model, characterized by its high volatility, will nevertheless push Central Banks around the world to study the possibility of a digital central bank and digital currency.

Digital coins in the age of time

In a context marked by the acceleration of digital adoption, the digitalization of payments has become a major concern, in order to adapt to increasingly dematerialized uses. Traditional means of payment (cash, payment cards, checks) are no longer the only way to pay for purchases and, with the rise of Open Banking, many players are appearing in the financial ecosystem, offering digital alternatives. Financial flows are therefore no longer managed solely by banks, allowing Fintechs to propose new concepts: among them, some have looked at crypto-currency as an alternative to traditional monetary systems, allowing them to be used as investment supports, or even as payment instruments.

It is partly from this observation that the world’s major central banks have understood the need to adapt to the evolution of the sector in order to rethink the digitization of traditional monetary systems. The emergence and attractiveness of all these innovative means of payment has prompted them to accelerate their thinking on the subject. It’s now very real: Central Banks are setting up what are called CBDCs (Central Bank Digital Currencies), not wanting to be overtaken by the growing competition from private companies, which are themselves beginning to offer this type of digital currency. This is the case of Facebook with Diem (formerly Libra) whose crypto-money is planned to be launched at the beginning of this year. Facebook undoubtedly served as a gas pedal for the emergence of CBDCs, given the risk of destabilization of the monetary system that the authorities perceived in this alternative project, on the part of an actor of such magnitude. This danger in terms of stability had been noted in particular by the G7, which last October published a forum strongly opposing the authorization of projects such as Libra in the absence of an appropriate regulatory framework.

One of the first CBDCs to be effectively implemented was the Digital Yuan in October 2020. Tested since last April in 4 cities in China, it was launched in Shenzhen. 10 million “digital” Yuan (50,000 200 Yuan vouchers) were paid into the electronic wallets (mobile wallets) of the city’s inhabitants, with the aim of testing the solution.

The European Central Bank has also accelerated its reflection in order to quickly study the opportunity to propose an CBDC. The “digital euro” should therefore enter the test phase in the coming months: the ECB has launched a public consultation to measure the expectations around this digital euro. These full-scale tests will make it possible to assess the risks and benefits of implementing a digital currency. Indeed, many doubts remain about the effectiveness of this new system, especially in terms of the security of the currency. The blockchain principle applied in cryptocurrency has its advantages as well as its disadvantages and some start-ups offering cryptocurrency have been victims of large-scale computer attacks. The objective for the Central Banks will be to avoid reproducing these errors, the stakes being all the more important on their scale than on that of a company.

The different applications of CBDCs

Reflections are therefore focused on the creation of two distinct types of CBDC: one called “wholesale” and the other “retail”.

The role of the “wholesale” CBDC will be to facilitate interbank transactions, in particular by creating a blockchain listing all the exchanges concerned in a digital way. This information would be shared transparently by all financial players, in order to reduce the interbank payment system breakdowns that have set the pace in 2020.

Image source : Code Theorem agency

The “retail” CBDC will be the one that will concern the largest world, since it will theoretically be usable by all economic agents, from individuals to companies. It will aim to replace paper money, for example by offering digital bills and digital vouchers. This tokenization of financial assets aims to bring more transparency and efficiency to the model, by reducing the number of intermediaries involved in the process. The automation of certain transfers is also possible, as in the case of “smart-contracts”: these autonomous APIs/programs automatically apply instructions present in the blockchain concerned. This retail CBDC is also a response to the decline in cash usage, which seems inevitable in some economies. In Sweden, for example, the Swish mobile application has become highly democratized. Launched in 2012 thanks to the cooperation of 6 major Swedish banks and the Swedish Central Bank, this application is used by nearly 7 million Swedes (out of a total population of 10 million!) to pay for their purchases, from donations to the local church to everyday shopping. Their Danish neighbors have the same vision regarding digital payments and especially the abandonment of cash, with the decision of the Danish Central Bank to completely stop printing banknotes at the end of 2016. This decision is due in particular to the relative advance Denmark had regarding instant payments and transfers, which have been common practice in Denmark since 2014. Nevertheless, one must remain cautious about the general implementation of Digital Currencies, especially on a global scale. The examples given above remain a minority and technological and behavioral constraints still hinder the more global use of these digital payment systems. Some parts of the population refuse to link their banking activity with smartphone applications, or simply do not have access to this technology. It is therefore not possible for the various Central Banks to impose a digital currency overnight. It will probably have to be implemented gradually, taking into account the constraints mentioned above. Once these issues have been resolved, digitalized means of payment could become the standard for payments.