If you haven’t heard of the term “CBDC” yet, you will soon. What this term stands for is Central Bank Digital Currency, and banks from all over the world are experimenting with them as we speak. In order to help you better understand what this means for you and your money, think about the fact that many world banks and governments may soon make the move towards offering a more digital form of currency than ever before. According to a discussion paper written by a group of some of the central banks throughout the world, about 80% of the world’s central banks have engaged in some form of research with Central Bank Digital Currencies and half of them have progressed to experimenting and running pilot programs to some degree. With that said, what would be some of the core features of a CBDC.
source: Boar et al (2020) [1]
The Big 3 Principles of CBDCs
Since every country and/or jurisdiction is different to some degree, the needs they would need to fulfill by implementing a CBDC are going to be different, therefore, the characteristics and core features of said currency will most likely be different across a variety of use cases. However, there are a set of common objectives that a CBDC must fulfill for its consideration to be worthwhile. There are three main principles of CBDCs that central banks are attempting to follow when they create this new form of money, and a look at each of these principles in depth will allow for a better understanding of their meaning.
Principle 1: Do No Harm
You can be forgiven if the first thing that comes to mind when you hear “do no harm” is the Hippocratic Oath that doctors take when they first sign on to this profession. However, in this case, the central banks are actually referring to their desire not to harm their own ability to carry out their function and mandate as a central bank. Not necessarily the route that individuals would most likely prefer, but it probably isn’t a surprise that your best interests are not the main concern of central banks with respect to CBDCs.
Principle 2: Coexistence
The Central Banks are required to enter into new markets very carefully and precisely, and this means that they must approach the world of digital currencies with a lot of caution. They are also tasked with making sure they are able to allow their digital currencies to coexist with the monetary policies and structures that are already in existence. Put another way, they don’t want to rock the boat too much because if they were, it would be like a tsunami broadsiding a dingy, and not a rogue wave hitting an aircraft carrier. Must different outcome.
Principle 3: Innovation and Efficiency
The concepts of innovation and efficiency seem extremely important to central banks. However, we should be careful to make sure that we don’t push these concepts to the point where they can potentially do harm to consumers. When consumers adopt products that are highly efficient and innovative, they sometimes accept that with the trade-off being that they get involved with something that is riskier than what they realized. Thus, it is important to include this principle as part of the central bank’s mandate when it comes to new digital currencies.
In other words, the CBDC ecosystem, even if central banks outsourced much of the services required for its functioning, would require oversight and regulation similar to what we see in traditional finance to prevent end users from falling prey to any malfeasance committed by intermediaries.
Core Features of a CBDC
The principles that central banks are putting in place when they develop CBDCs are interesting without a doubt, but the even more important element of the work that they do has to do with the core features of a CBDC. We want to take a look at some of those as well.
Instrument Core Features of a CBDC
The instrument in this case if the actual currency itself. These are the features of the CBDC “tokens” that will allow it to function parallel to options already available in the traditional financial system.
Accepted and Available
It is incredibly important that any CBDC created by a central bank have features that make it easy to be accepted and available across a large portion of the economy. Put another way, it is a good idea to have a CBDC that can be transacted for real-world goods both online and in the physical world. Another way to say accepted, is “adopted”, and user adoption of a new form of currency is pivotal to its long-term usage in the economy.
Convertible
The CBDC that a central bank creates needs to be convertible into physical cash, commercial bank deposit or some other store of value representative in a currency. This should be easy to do, and there should be plenty of liquidity in the currency market to convert one to the other.
Low Cost
In order for a potential CBDC to be adopted by end users, it must have little to no cost to said end users. This is both from a cost of transaction point of view and that of the services required for a financial system to function (i.e., customer service, billing, etc.).
System Core Features of a CBDC
The system of a potential CBDC will most likely be two-tiered, where the central bank controls the instrument and its core rulebook for possible use cases and then the services require for the systems functioning are outsourced to intermediaries.
Instant
The platforms where transactions happen in CBDCs should be instant or near instant when it comes to how long it takes for a transaction to go through. Someone who is transacting in this currency should have no trouble at all getting the money that they need from the account to wherever it needs to go.
Available
The system needs to be all systems go 24/7/365. A lack of availability in the system is not acceptable in any way, and it is very important to ensure that all users of the system have access to it as needed. People that are in different time zones and need to be able to transact with a currency when they want. Regardless of the time of their transactional counterparty.
Secure
The infrastructure that the CBDC is built around needs to be secure from cyberattacks to make it as resilient as possible against the possibility that someone with malicious intent may come along and take advantage of the system. Unfortunately, this happens all too often, and it is often the case that these new currencies are the target of cyber criminals. This also includes to disadvantage that a CBDC system would create, meaning more end points vulnerable to these types of attacks, which is something that must be monitored closely in order to ensure the system’s proper functioning.
Institutional Core Features of a CBDC
The institutions involved in a CBDC system must have certain features. This includes defining who has legal authority to do what and what regulations they must follow.
Legal Framework
The central bank needs to have clear authority to handle disputes that could arise over any CBDC that they may put out into the world. It is not acceptable to have anything less than full legal control over what happens within the legal framework of a CBDC as there are bound to be disputes.
Regulatory Standards
It is also completely necessary for the central bank to have regulatory standards over the CBDC that exists in the world. Failure to hold on to controls like this means that it all becomes a free-for-all for everyone, and that is just not acceptable. Instead, there needs to be clear boundaries of authority that everyone can agree to so that there aren’t any major disputes that come up between the different entities of the CBDC infrastructure.
The CBDC Explosion is Just Beginning
The talk of central bank digital currencies is becoming more prevalent and more frequent. Seemingly in ever speech from certain members of the Federal Reserve Board of Governors there is some mention of a CBDC being implemented by the Fed. Now, most of this is research, but with it brought up more and more frequently, it is something that must be understood and monitored. This means a deep understand of the possible core features of a CBDC and their costs and benefits for a future system.
For more of Central Bank Digital Currencies
https://jamesdforsythe.com/why-is-a-cbdc-such-a-big-deal/
https://jamesdforsythe.com/united-states-central-bank-digital-currency-on-the-horizon/
https://www.bis.org/search/index.htm?globalset_q=central+bank+digital+currencies
References
[1] Group of Central Banks, “Central bank digital currencies: foundational principles and core features”, BIS (2020) Pg. 3 https://www.bis.org/publ/othp33.pdf
