As Central Bank Digital Currency (CBDC) exploration and development accelerates across the globe, Alisa DiCaprio, Chief Economist at R3, discusses the key topics at the frontier of the CBDC research agenda.
With the blistering pace of CBDC announcements, it can be difficult to figure out what we know and what is still conjecture. There are four major themes in the CBDC research agenda. These themes – policy, security, monetary tools, and consumer behaviour – indicate the frontiers of our understanding about CBDCs.
Establishing the frontier of evidence is important to interpret how much disruption we should expect from over 100 CBDC projects in various stages of development. Some of these projects are still investigative, like those of the European Central Bank and Bank of England. Others are already issued and circulating, such as Nigeria and China.
Tension between technology and policy
The first research theme is how policy will need to adjust to a CBDC issuance. This covers everything from new legislation that allows a central bank to issue a digital currency, to whether the CBDC should function as a new monetary tool.
Different jurisdictions are moving at different paces in setting out what a CBDC regulatory framework may look like. In its consultation on a digital pound, the Bank of England has stated that a CBDC would be “rigorously governed and regulated”, and that firms providing digital wallets would be regulated to ensure that payments using digital pounds are “resilient, reliable, and compatible with other payments”.
Most live roll outs have designed the issued CBDC to be cash-like to limit the scope of legislative amendments that policy makers need to make. But programmability means that there are many other functions that the CBDC could potentially be used for.
Security and financial stability
Security concerns are another key theme as central banks are tasked with ensuring financial stability. Because they are digital money, CBDCs will have the same potential for financial fraud as physical currency, as well as additional concerns arising from their digital nature.
These issues are particularly concerning following a rise in the number of high-profile technological failures and cyberattacks. The Eastern Caribbean Currency Union’s (ECCU) CBDC initiative, DCash, for instance, experienced a significant system-wide outage that took the entire system offline, indicating that this transition from cheques, as the dispersion of the islands escalates the cost of physical cash, to digital currencies is not always free from bugs or glitches.
Similarly, major cyberbreaches such as the Ion Markets hack mean that cybersecurity is now of top concern.
When moving ahead with CBDC exploration, central banks will need to take increasingly great care to ensure that the underlying technology is thoroughly tested and designed to meet the most stringent security protocols. Additionally, the introduction of specific regulations should be embraced to ensure that user data is kept private, in line with existing banking regulation.
New tools for monetary policy management?
There is a great deal of discussion about the potential for CBDCs to be used as new monetary tools. Much of this discussion is around the ability to put an interest rate on the CBDC. Central banks occasionally adjust their toolkits to address new economic conditions, and a CBDC could fall in line with this.
An interesting counterpoint is that while the research describes the benefits of CBDC as a monetary tool, all issuances to date have rolled out with a zero percent interest rate.
A unique approach, however, has been adopted by the Bank of Jamaica for its CBDC, JAM-DEX. Despite the theoretical zero remuneration on JAM-DEX, the Bank of Jamaica is running several promotions to encourage adoption. On the retail side, beginning April 2023, users receive 2% cash back on transactions up to a maximum of JMD “5000 spent monthly”.
Additionally, there is also a payment to the first 10,000 businesses that receive five JAM-DEX payments after 31 March 2023 of JMD 25,000, or a one time payment to businesses who upgrade, of JMD 25,000 (equivalent to approximately US$150). This method could be viewed as a form of interest rate.
For JAM-DEX, the CBDC is distributed through an e-money wallet, credit card network, or other digital options in a hybrid model. It does not rely on DLT technology, instead using the existing centralised payment system, JamClear. Despite these measures, adoption has been slow due to challenges such as application and onboarding issues, availability of the payment gateway.
We might see more action in this area once central banks are comfortable that the CBDC will not destabilise the domestic economy. We don’t yet have a good view into this impact since existing issuances have very low uptake – for nearly all of them is less than 0.2% of cash in circulation.
Consumer behaviour
Developing markets – where existing infrastructure is less comprehensive – have generally moved faster in their CBDC exploration compared to more mature markets.
According to a report from the Official Monetary and Financial Institutions Forum, what consumers seem to want from digital currencies is universal acceptance, resilience, privacy, security and ease of use. These are, of course, the key characteristics of cash.
One of the biggest subsequent questions facing central banks is therefore: how cash-like should a CBDC be? Finding this balance will require close collaboration between the public and private sector, across all industry and market participants.
What next?
The frontiers of research are moving outward with every research paper and live pilot. In the space of just a few years, researchers have moved from the first definitions of CBDC, to studying its effect on the financial system and working on design features.
Central bank money has not changed much since the adoption of modern banknotes, and the introduction of CBDC would represent a huge shift in how we send and receive payments. Research around the above topics will ensure central banks undertake a solid design process that delivers availability, security, resilience, interoperability and privacy.
