19.2 Central Bank Digital Currencies (CBDCs)

Central Bank Digital Currencies (CBDCs) are the next big thing in money. They're digital versions of regular cash, backed by central banks. CBDCs aim to make payments faster, safer, and more convenient in our increasingly digital world.

There are two main types: retail CBDCs for everyday use and wholesale CBDCs for banks. Their design impacts how they work and who can use them. CBDCs could change how we handle money, affecting everything from monetary policy to financial inclusion.

Types of CBDCs

Central Bank Digital Currency (CBDC)

• Digital form of a country's fiat currency issued and backed by the central bank
• Represents a claim on the central bank, similar to physical cash
• Aims to provide a safe, efficient, and convenient means of payment in the digital era
• Can be designed as a retail or wholesale CBDC depending on the intended use case and target users

Retail and Wholesale CBDCs

• Retail CBDC is designed for use by the general public in everyday transactions
  • Accessible to households and businesses through digital wallets or accounts
  • Can be used for peer-to-peer transactions, retail purchases, and bill payments
  • Examples: China's Digital Yuan project and Sweden's e-krona pilot
• Wholesale CBDC is intended for use by financial institutions for interbank settlements and large-value transactions
  • Facilitates more efficient and secure settlement of wholesale payments
  • Can streamline cross-border transactions and reduce settlement risks
  • Examples: Project Jasper (Canada) and Project Ubin (Singapore)

CBDC Design Choices

• Central banks must make key design decisions when developing a CBDC
  • Account-based vs. token-based: Account-based requires identity verification, while token-based allows for greater anonymity
  • Interest-bearing vs. non-interest-bearing: Interest-bearing CBDCs can be used as a monetary policy tool
  • Centralized vs. decentralized infrastructure: Centralized allows for greater control, while decentralized offers increased resilience
• Design choices impact the CBDC's functionality, accessibility, and potential implications for the financial system

Technical Aspects

Distributed Ledger Technology (DLT)

• Many CBDC projects explore the use of DLT, such as blockchain, for the underlying infrastructure
• DLT offers benefits such as increased transparency, immutability, and resilience through decentralization
• Permissioned DLT networks, where access is restricted to authorized participants, are often favored by central banks
  • Allows for greater control and compliance with regulatory requirements
  • Examples: R3's Corda and Hyperledger Fabric
• Central banks may also consider hybrid architectures that combine DLT with traditional centralized systems
  • Balances the benefits of DLT with the need for central bank oversight and control

Economic and Social Implications

Monetary Policy Implications

• CBDCs can potentially enhance the transmission and effectiveness of monetary policy
  • Interest-bearing CBDCs can serve as a direct tool for influencing spending and saving behavior
  • Can enable more targeted and real-time policy interventions during economic crises
• CBDCs may impact the demand for cash and bank deposits, affecting the banking system's funding and lending activities

Financial Inclusion and Cross-border Payments

• CBDCs can promote financial inclusion by providing access to digital payments for unbanked and underbanked populations
  • Lowers barriers to entry and reduces reliance on traditional financial intermediaries
  • Enables more efficient and affordable cross-border payments, especially for remittances
• Improved cross-border payments through CBDCs can foster international trade and economic integration

Privacy Concerns and Disintermediation of Banks

• CBDCs raise privacy concerns as they may enable greater financial surveillance by central banks and governments
  • Need for robust data protection measures and privacy-preserving technologies
  • Balancing the trade-off between privacy and prevention of illicit activities
• Widespread adoption of CBDCs could lead to disintermediation of banks
  • Reduced demand for bank deposits may impact banks' funding and lending capabilities
  • Potential shifts in the role and business models of commercial banks in the financial system