Central banks around the world are experimenting with digital currency to boost efficiency and achieve greater financial inclusion.
Central banks around the world are experimenting with so-called Central Bank Digital Currency (CBDC). But what is it and why does it matter?
CBDC is a digitized version of domestic currency where the central bank issues new money equivalent to – and redeemable for – its domestic currency, often removing the equivalent amount of currency from the money supply.
It could be issued using distributed ledger technology, where transactions would operate and settle on a peer-to-peer basis.
While it may seem far-fetched, at least 44 central banks, according to survey research by the BIS, are currently or will soon be researching and experimenting with CBDC.
The fact that dozens of central banks are exploring, and in some cases implementing, CBDC based on blockchain technology is significant, and is an early indicator of the potential use of this emerging technology across financial and monetary systems.
The two types of CBDC
Wholesale CBDC – The leading cases for wholesale CBDC, which is made available only to commercial banks and clearing houses for use in the wholesale interbank market, consist of increasing efficiency in domestic or cross-border interbank payments. Today, these processes in some countries can be inefficient and entail costs, time, and counterparty risks to banks.
Most early-stage CBDC central bank pilots thus far have focused on wholesale CBDC for domestic use. By employing this type of digital currency, central banks hope to achieve increased efficiency in interbank payments and in interbank securities trading and settlement. Central banks from several countries are experimenting with this version of CBDC, including those from South Africa, Canada, Japan, Thailand, Saudi Arabia, Singapore, and Cambodia.
Retail CBDC – The leading cases for retail CBDC, which is made widely available to the public, relate to the ability to potentially increase financial inclusion, or to serve as a strategic alternative to physical cash in economies where cash dwindles.
CBDC acts as a substitute or complement for cash and an alternative to traditional bank deposits. For some countries, this form of digital currency could have the potential to incentivize participation in the banking sector for the under-banked, improve peer-to-peer and overseas payments, and potentially improve KYC/AML functionalities or curb illicit activities. In regions with decreasing use of cash, it could serve as an important counterweight to retail payment applications developed by the private sector.
Central banks from several countries are experimenting with this form of CBDC, including those from the Eastern Caribbean, the Bahamas and Cambodia. Importantly, CBDC can also be issued in a centralized manner without blockchain technology. Sweden has been evaluating both forms of CBDC.