The Green Sheet Online Edition
March 3, 2025 • 25:03:02
Central bank digital currency: promise, challenges, unanswered questions - Part 2
This is the second in a two-part series on central bank digital currency (CBDC). Part 1 explored its purpose and benefits; this article explores its real-world feasibility and how CBDC can work in practice. Various attempts to model how a CBDC could operate in the real world have been made by central banks such as those of Canada and the UK.
Many people associate CBDC erroneously with crypto and blockchain as if they were the same thing. While using a distributed ledger (blockchain) is one possibility, the alternative – and for many in the payments world the more likely and more realistic model – is to allow the core ledger, the platform that stores the currency securely, to be provided and maintained by the central bank itself or a regulated entity under its control.
So, the dream for some of a decentralized currency may well end up back in the center (even if it does repose on some form of distributed ledger technology). It's not for nothing that it is called a central bank digital currency, and the fact that it is the central bank that issues and maintains the currency is fundamental.
Central banks are there to control the money supply, and it is unlikely they will want to leave the management of that to others. But after that, everything is up for grabs.
Canada posited three models which should be taken as examples rather than an exhaustive list:
- Model 1: The central bank provides the network infrastructure. Intermediaries provide end-user services such as a wallet and the means of acceptance/authorization.
- Model 2: The central bank provides the network infrastructure and a basic wallet for end users, and intermediaries provide all other end-user services.
- Model 3: A regulated entity provides the network infrastructure, and intermediaries provide end-user services.
Canada's work is noteworthy because it recognizes the need for practical uses and an ecosystem that benefits everyone. "[T]he chosen model must deliver value to all participants of the ecosystem: end users should find it worthwhile to adopt and use it, intermediaries should find it profitable to participate in the ecosystem, and the central bank should be able to advance its chosen public policy objectives."
- End users should find the CBDC convenient and beneficial to adopt.
- Intermediaries should see a return on their investment as an incentive to participate.
- Central banks should be able to advance public policy objectives, such as cost control, risk management and financial inclusion.
This last point is crucial. Central banks will not want to issue digital currency just for the sake of it, and their objectives are multiple. (See Youming Liu, Francisco Rivadeneyra, Edona Reshidi, Oleksandr Shcherbakov and André Stenzel, Ecosystem Models for a Central Bank Digital Currency: Analysis Framework and Potential Models, Bank of Canada, Staff Discussion Paper 2024-13, P.2.)
The European Central Bank is very active in the area of CBDC and has published numerous studies and position papers on the topic, seeing it as a way of ensuring the euro "continues to play a key role" in Europeans' lives, promoting financial inclusion and, most consequentially, as the foundation for a European "scheme" as an alternative to Visa and MasterCard. The objective is to propose an open framework that will encourage innovation and enable the fintech sector to allow use cases to emerge over time.
The Bank of England commissioned a study that was even more operationally focused. It examined whether existing POS terminals could accept payments of a digital currency. (See Bank of England, Point-of-sale proof of concept, Digital Pound Experiment report, May 2024 [Consult Hyperion])
The answer is yes, at least for terminals with real-time access and provided these use existing EMV protocols, but accepting payments without an online connection was likely to be more problematic. This leads to the very real question of whether offline payment is a prerequisite for a CBDC to work. (If the objective is for CBDC to be identical to cash, the answer is probably yes.)
And in real life?
There is a real risk that CBDC becomes a solution looking for a problem. Like any technology, usage will depend on how value is perceived, and adoption will follow a traditional pattern from rejectors to early-adopters to late-adopters, and everything in between.
But that adoption will depend on there being a reason to use it, and central banks are looking to build into their models reasons for CBDC to be of interest to consumers. Indeed, Canada has put CBDC on hold, having not found a compelling case for it in the short term. And the old adage, "if it ain't broke, don't fix it" applies here too.
So, in many countries, where minimum banking facilities are mandatory and digital payments already widespread and relatively cheap, there is a risk that a digital currency is an answer to a problem that doesn't exist.
There is also the impact of a digital currency on existing retail banking, which, while it may pay scant attention to payments, are nevertheless happy to hold the monies they process. All of these are reasons why progress remains at the experimental stage, and no one is in a hurry to upset the payments applecart.
Nevertheless, independently of policy objectives, advantages emerge at this stage, which may encourage adoption and which could cause the usually glacial pace of change in payments technology to advance just that bit faster.
- Financial inclusion: As we move away from notes and coins, there is a risk that some people lose out if the system relies too much on the banking system. A CBDC could go some of the way toward mitigating that, but there will still be a need for some form of digital support – a telephone, a card – which could exclude some people.
- Innovation: The Bank of England sees a CBDC as having the characteristics of a "general purpose technology" that would accelerate innovation in ways we cannot yet imagine, over time, boosting entrepreneurship and new market models. (See Rachel Greener, Enabling innovation through a digital pound, Bank of England Quarterly Bulletin, August 2023
- Costs: Lower overall cost of transactions through competition and innovation.
None of these are overwhelming arguments in favor of CBDC. They are at best optimistic, and at worst nebulous. The innovation argument appears to be the strongest. The pace of innovation has been relatively slow in payments compared to other sectors, and evolutions for users have tended to be incremental and based on existing technologies. CBDC could be a catalyst for innovation.
Because of the political backing that a central bank sponsored digital currency has by definition, a CBDC could change what is possible, and at scale, in a way that traditional payment schemes cannot. This could explain the European Central Bank's enthusiasm for the topic as it seeks to develop a strategic autonomy in transnational payments with the EU area. But once again this brings us back as much to the realm of public policy as it does to that of financial innovation.
Going forward
The decision to launch a CBDC is necessarily a political one. Management of its currency – like control of its armed forces – is a core attribute of an independent state, and a CBDC is, in effect, a new form of a state currency.
It is encouraging to see the effort being made to identify what would be needed to ensure mass adoption prior to any rollout. Conceptually, it is important to highlight how a CBDC is fully assimilable to cash and not just another means of payment akin to a user's payment card. An understanding by the general public of this essential difference could be an important factor in its adoption, but the full implications on banking remain to be understood.
The risk of CBDC becoming a solution in search of a problem is a real one, as is the age-old question of disruptive technologies – will the dogs eat the dog food? No one has a clear answer yet to this, which is why there appears to be a consensus among central banks that it is important to make haste slowly.
For these reasons, CBDCs are likely to remain a topic of interest and discussion for some time, and it is likely to be several years before we are using digital currency in the same way as we use cash today. But it is not too soon to start thinking about the implications now.
Mark Dillon is solutions marketing director at Ingenico, https://ingenico.com/us-en, a global leader in payment acceptance and service with advanced integrated solutions and a network of partnerships that simplify the world of payments and bring value added services to move commerce forward. Contact Mark on LinkedIn at linkedin.com/in/markodillon.
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