Many central banks around the world are now pursuing projects of central bank digital currencies (CBDC), digital tokens backed and issued by monetary regulators. According to the latest
evaluation by the economists at the
Bank of International Settlements (BIS), four monetary authorities – those of Nigeria, the Bahamas, the Eastern Caribbean, and Jamaica – have already launched CBDCs, while 37 jurisdictions are running pilots. The Atlantic council’s
CDBC tracker further reveals that over 70 other jurisdictions are either in the development or research phases.
Some major central banks are taking a cautious approach. The
Bank of England is “looking at the case for issuing the digital pound” and is now at the
design phase. The
ECB is
looking “into the possible issuance of a digital euro”. The
Federal Reserve has not taken a definitive stance on a CBDC yet, but it has “been
exploring the potential benefits and risks of CBDCs”.
Other regulators are further ahead in the development process. In November 2023, the
Swiss National Bank
announced plans to start a pilot project of a wholesale CBDC with six commercial banks, which will run until the summer of 2024. China
launched trials of its own e-CNY and reached an agreement with the Monetary Authority of Singapore to enable tourists
from both countries to use e-CNY, even though for now the share of the digital yuan in China’s money supply is still rather
negligible.
China is also one of the key members of the
mBridge initiative, a wholesale CBDC platform for cross-border payments, which, apart from the PBC, involves the Bank of International Settlements and the central banks of Hong Kong,
Thailand, and the UAE (a minimum viable product is set to appear in mid-2024).
Other countries are collaborating on CBDCs too, as is the case, for example, with Hong-Kong and Thailand jointly developing Inthanon-LionRock, or France and Tunisia having joined forces on an experimental Project Prosperus, which was focused on real-time
remittance transfers.
What CBDC development is currently underway?
CBDC development is driven by a number of considerations, including digitalisation and efficiency enhancement. These digital currencies could also compete with cryptocurrencies, and the latter, if adopted on a sufficiently broad scale, could pose potential
problems for monetary authorities: in particular, the
BIS warned that cryptoisation (substitution of local currencies with crypto-based means of payments) driven by macroeconomic instability in a country might put excessive pressure on its local currency and, ultimately, lead to the loss of monetary sovereignty
for the domestic central bank.
In the face of possible financial fragmentation some central banks might see CBDCs as alternatives to the existing payment processing solutions, namely Swift. So, at this point the version of the future where central bank digital currencies do not become
a part of the financial system seems rather unlikely. For fintech companies this poses the question of whether CBDCs would create a new market opportunity for them or if these digital tokens will disrupt fintech operations.
CBDCs can be designed to be a wholesale (accessible only for financial institutions, basically a substitute for reserves) or a retail (available to the population and businesses, such as an equivalent of cash and bank deposits) digital form of money.
In principle, retail CBDCs could be regarded as a solution competing with fintech ones, fast payments in particular, as CBDCs could solve the interoperability problem. This could present a challenge for card issuers and acquirers, as CBDC payments are meant
to be faster and cheaper than those processed via standard gateways. In particular, it would not come as a surprise if CBDCs became the preferred payment method for merchants, since it could be designed to be free of all the hidden customer fees charged by
card schemes and acquirers.
This would also be important in cross-border payments. Some peer-to-peer payment systems might, in theory, have to look into new use cases to stay in the business. The bigger ones are way ahead of the curve: they provide lending services, insurance, and
incorporate marketplaces into their business models (think Chinese giants like Alipay). At the end of the day, though, CBDCs and fintech payment solutions could turn out to be complementary.
For one, fintechs might become the entities that provide access to CBDC transactions for the broader public. Some central banks, the Bank of England in particular, are considering relying on private digital wallet and payment interface providers.
According to the BoE, this structure is intended, in particular, to limit the central bank’s access to personal data and thus to boost the public’s confidence in the CBDC.
Then there is the question of market barriers: if the existing money infrastructure is replaced with CBDCs, especially with the retail varieties, for fintech service providers this would essentially mean less dependence on incumbent financial institutions,
as the latter would lose the role of gatekeepers in the payments market. This problem has been addressed in some jurisdictions, albeit to a different extent, by open banking, the use of application programming interfaces (APIs) to allow access to users’ financial
data for third party developers.
What CBDC regulations are in place?
In the EU it was the second Payment Services Directive (PSD2) that
laid out the regulatory framework for open banking and obliged banks to offer APIs to fintech firms if those were registered as the so called account information service providers
(AISP) or payment initiation service providers (PISP).
In the UK, initially the nine largest banks
were mandated to have a common standard for sharing their data with authorised financial service providers. However, since then quite a few
other banks have followed suit. Now
over 7 million consumers and businesses use financial services enabled by open banking. Open Banking payments
have more than doubled in 2022 reaching 68 million.
PSD2, even though it did set a legal framework for open banking, does not impose a specific open standard on financial institutions. Operating within a framework of a CBDC, on the other hand, could facilitate uniformity in the sector, and fintech service
providers, as well as their potential customers, might well benefit from it. The
ECB is only at the
preparation stage with its Digital Euro, but it indeed
envisions it as a platform for developing pan-European services that would increase efficiency, reduce costs, and foster
competition in the European payments sector.
Breakthroughs in CBDC API research
Moreover, a CBDC could make the compliance problem obsolete. Back in 2020,
Salt Edge, a UK-based developer of API platforms,
made a research-backed claim that European banks having APIs largely did not translate into these APIs responding to requests from other financial service providers. Salt Edge estimated that on average, half of the banks did not respond to connection requests,
while 38% of all bank APIs did not meet regulatory standards. APIs on a CBDC basis would eliminate these issues.
Focusing on an API system is the road the Bank of England has
taken with
Project Rosalind, its joint initiative with the Bank for International Settlements. The idea of the project, albeit experimental in nature, was to run a system that would enable a broad spectrum of financial service providers to support consumer access
to a retail CBDC.
In early 2023 the BIS collected applications from those willing to develop use cases on the basis of the API prototype, and the international organisation was aiming at developing applications that would offer users “something entirely new”.
In the summer, the BIS Innovation Hub and the BoE published the
final report on the project. According to the report, they ended up with 33 API endpoints in 6 functional categories including account management, payments, and offline operations, and tested them on 30 use cases. The developers concluded that a set of
simple and standardised API functionalities could indeed support a variety of use cases, not least the programmability of payments, such as transactions being executed under a particular set of conditions.
There were caveats too. What turned out to be a challenge is processing offline payments in CBDC. Then there is the trade-off in terms of extensibility and consistency: simplifying the APIs and allowing for more flexibility for fintech service providers
to build their use cases is beneficial when it comes to extensibility, but it might be detrimental for the consistency of user experience.
Can CBDCs promote financial inclusion?
One more idea behind CBDCs which is often voiced, is the fact that they can increase financial inclusion, as transacting with them might be carried out without bank accounts. This is particularly important in those developing countries where access to traditional
banking is limited, but mobile internet is widely available. In this vein, the Nigerian retail CBDC e-Naira
supports transactions with text messages, which should enable low-income people with feature phones to access this digital payments ecosystem.
If countries adopted CBDC models compatible with third-party fintech solutions, for fintech companies that would mean a broader potential customer base, and for customers – a broader potential choice of services.