Written evidence submitted by The Digital FMI Consortium
Introduction
The Digital FMI Consortium welcomes the opportunity to contribute to the Treasury Committee’s crypto asset industry inquiry. The Consortium’s response contained within this paper reflects views expressed by its advisors and members, who combine cross-industry expertise.
The Digital Financial Market Infrastructure (DFMI) Consortium is a cross-industry initiative recently launched in the UK to reimagine and test new payment rails for the global financial system. The new group is the body behind Project New Era, the UK's first privately-led Digital Sterling (‘dSterling’) pilot, set to launch in the autumn.
The Consortium will issue a pre-CBDC UK asset known as ‘dSterling’, with collateral held at a one-to-one ratio in a Bank of England reserve account to reduce asset insolvency risks and to validate use cases. The pilot will also consider options for the use of commercial bank liability to examine the role of banks in a CBDC environment, withdrawal limits and other disincentives to mitigate any future risks to the supply of credit in the market.
The Digital FMI Consortium is made up of leading financial institutions, including commercial banks, payment providers, telecommunications providers, FinTechs, NFT ecosytems and digital currency exchanges. To date members include IBM, Finastra, FinClusive, Ibanera, paywith.glass, Mattereum, Trust Payments and Accomplish Financial, with further members set to be announced upon the launch of the pilot in the autumn.
The industry initiative is founded by leaders of the global financial services industry, under the coordination of Dutch financial infrastructure group paywith.glass Special Interest Group (SIG), with Boston Consulting Group as its official consulting partner, and supported by The Payments Association in the UK. Official global advisors to the project include Rosa & Roubini Associates as Macroeconomic Advisors, Simmons & Simmons as legal counsel and Farrant Group providing strategic communications.
The group will focus on real-world testing to evaluate a future digital currency ecosystem, environment and economy that includes the coexistence of current forms of money, regulated digital assets (including cryptocurrencies and stablecoins) and Central Bank Digital Currencies (CBDC).
In light of its mandate, the Digital FMI Consortium is offering its views in response to the inquiry’s call for evidence relating to Crypto-Assets including Central Bank Digital Currencies (CBDCs).
Contents
Summary of Contents
In the below submission The Digital FMI Consortium focuses on the opportunities and risks associated with the prospective implementation of a Central Bank Digital Currency (CBDC), the potential for crypto-assets to boost digital financial inclusion, and how other Governments and regulators around the world are approaching the adoption and regulation of digital assets.
In terms of opportunities presented by CBDCs, the Consortium highlights that thanks to Distributed Ledger Technology (DLT), of which blockchain is one example, CBDCs have the power to revolutionise the domestic and international money transfer system by accelerating payment settlement time and reducing transaction costs. Cross-border payments are highlighted as the use case which best which exemplifies this key transformative benefit. CBDCs can also enable the novel function of payment programmability, which refers to the ability to govern the behaviour of a digital asset. This automation is usually done through ‘smart contracts’, which enable pre-agreed transactions that remove intermediaries, enhance trust and minimise the risk of delays or defaults.
There is also a macro-case for CBDCs. Economic systems have shifted towards a full digitalisation of their activities. In the future, some of these activities, including crucial interactions with the banking system, will occur in the so-called metaverse. Electronic forms of payments will not be sufficient to keep the pace of economic transformations; a fully digital form of payment will be needed. The private sector has introduced its own means of transaction, in the form of crypto-currencies or stablecoins. The public sector will need to introduce a foundation layer in this new system of payments, in which the public will be able to place its trust. This will be the function of CBDCs in the pyramid of means of payment.
In the face of these inevitable and irreversible macro-trends, the United Kingdom has the historic opportunity to lead. Exploring and implementing best practice in the digital assets space could help the UK secure its leading global position in financial services and payments by designing digital financial market infrastructure (Digital FMI) that caters for the practical benefits and high-potential uses cases outlined below while mitigating against the risks also discussed.
In terms of risk areas, the most commonly cited concerns relate to privacy and security. The privacy concern surrounding CBDCs relates to the potential for states to design digital payment systems as engines of state surveillance. With regards to security, there are concerns that CBDCs will be susceptible to data breaches and cyber-crime, representing significant threats to both national security and the security of citizens’ assets.
However, there are a variety of safeguards that can be implemented to mitigate these risks, namely data encryption, avoiding the construction of single points of failure, decentralizing the data and transaction processing, constant threat monitoring and AI-pattern recognition of on-chain data.
With regards to financial inclusion, the Consortium notes that, according to the FCA, as of 2020 up to 1.2 million adults in the UK are ‘unbanked’, meaning they do not have a current or e-money account. Being unbanked poses obstacles to everyday life, as individuals are unable to safely access essential services including savings, pensions, loans and insurance. Concerningly, the majority of the world’s unbanked population are from low-income backgrounds. The proposed infrastructure of crypto-assets like CBDCs would include digital identity components to enable people to break the cycle of financial exclusion, to access digital banking and payments systems without bank accounts and to build a credit score without the barriers of traditional institutions.
Lastly, with regards to the international implementation of CBDCs, the Consortium notes that the distribution of CBDC in live implementations and pilots (including The Bahamas, Nigeria, and China, with an Indian pilot due later in 2022) is through a ‘two-tier’, indirect approach. A two-tier model distributes CBDC to citizens through commercial banks and non-banks in an open market model. The central bank oversees management of the central ledger, including net settlement. Commercial banks and non-banks are responsible for wallet issuing and the provision of financial services.
Opportunities
The implementation of a Central Bank Digital Currency (CBDC) in the UK could represent both economic and geopolitical opportunities. Economic opportunities reside in the wide range of practical benefits which CBDCs can bring about for consumers and businesses alike. Geopolitically, by designing the right kind of CBDC infrastructure, the UK has the opportunity to gain early mover advantage and position itself as a global leader in the race for the future of money, the pace of which is rapidly accelerating across the globe. Some of these economic and geopolitical opportunities are outlined below.
CBDCs accelerate payment settlement time and reduce transaction costs
CBDCs have the power to revolutionise the domestic and international money transfer system. The payments industry is still reliant on infrastructure dating back to the 1960s, and currently requires high levels of physical and human capital. In an era of instant messaging and mass media, we can do better.
This is where technologies such as Distributed Ledger Technology (DLT), Artificial Intelligence and Cloud Computing can facilitate transformative change. In combination, these tools can enable settlement in near real-time, removing the need for both pre-funding and overnight settlement. This would mean that both transaction and settlement costs, on the local and international level, can be significantly reduced. While DLT, which consists of a distributed database that is automatically updated at the point of payment, may be limited in scalability, it is the belief of the Digital FMI Consortium that enhancement of this breakthrough technology through the use of Artificial Intelligence (A.I.) and Cloud Computing, with an architecture built around telecommunications principles of scalability, resilience and cyber security can lead to truly fit for purpose Financial Market Infrastructure, suitable for the needs of today’s economy and those of generations to come.
DLT is a relatively new technology. The basis consists of a distributed database system that enhances resilience and reliability. Even if one or a few of the databases are infringed upon, the network of databases ensures that these databases are updated with the correct information. The implementation that we recommend is to use this distributed model using centralized control. With the correct credentials users can inspect the system and run updates, but cannot tamper with the system due to its immutable nature. In addition to DLT, reliable high-speed data transfer systems can be effected by the integration of AI and Cloud computing to optimize processing speed. In this manner a complete transaction, including settlement, can take as little as a few seconds, or instantaneously by human perception.
Given the radical changes digital asset transactions could bring to the current payments value chain, the cost of end-to-end transactions could be significantly reduced while providing near-instant settlement features.
As such, the benefits to merchants and consumers could be immense in terms of both reduced settlement speed and reduced settlement costs. In the cost-of-living crisis which the world currently faces, starting at home in the UK, SMEs in particular would benefit from reduced settlement costs. As it stands, these enterprises pay high fees to their payment providers. Merchants could also reduce their overall cost of payment acceptance, the benefits of which could be passed on to the consumers in the form of lower prices of goods on the shelf. This could represent a preferable alternative to mark-ups on goods to account for payment costs.
There is also the opportunity to synchronise business and low-cost payment processes in real-time. The current, outdated infrastructure means that micropayments have always been challenged by transaction costs, which can often be larger than the value of the payment itself. The cash flow and margin benefits of these pay-per-use micropayment use cases will be transformative.
CBDCs, just as importantly, are widely recognised to have the potential to revolutionise cross-border payments – the European Central Bank itself has described CBDCs as the ‘holy grail’ in this regard. Yet, while improvements to existing payment infrastructure and networks like SWIFT are ongoing, a second stream of research has appeared, the multi-jurisdictional CBDC (mCBDC).
An mCBDC implementation can take multiple forms but the most commonly explored is the linking together of domestic CBDC systems in different jurisdictions to facilitate cross-border trade and payments. This method of facilitating cross-border payments has the potential to radically simplify payment streams and can lead to faster settlement, reduced transaction costs and less liquidity trapped in the correspondent banking system.
It is however, not without compromise nor risks. The linking together of multiple, naturally incompatible domestic CBDC systems bears the inherent risks of complexity within record reconciliation, risks of data leakage and therefore privacy infringement of citizens of one or more jurisdictions and the incompatibility of regulatory standards, which will lead to an environment rich in opportunities of regulatory arbitrage at worst and at best, inefficiencies in settlement systems, thereby negating any performance gains of the use of digital assets such as CBDCs in this context.
It is the view of this Consortium that a standardization of the infrastructure, its supported ruleset and standards would provide the optimum operating environment for an mCBDC implementation. The opportunity then for the UK to test, deploy and standardize such an environment for the rest of the world, is immense and should not be missed.
CBDCs can enable payment programmability
CBDCs also offer the potential for programmable payments. Programmability refers to the ability to govern the behaviour of a digital asset, primarily one residing on a distributed ledger. This automation is usually done through ‘smart contracts’, which enable pre-agreed transactions that remove intermediaries, enhance trust and minimise the risk of delays or defaults. Terms and conditions are coded into said software smart contract, which are then self-executed without the need for any manual intervention. A simple real-world example would be that in an environment where government fiscal relief is made available to a population, smart contract based programmability could be applied exclusively to those funds earmarked for this particular purpose, ensuring their appropriate use and reducing the less effective human capital and oversight required to police their disbursement and use. Under other circumstance, commercial application of this technology in a private-sector led application, could see the deployment of savings smart contracts within a financial services offering of an FSI, whereby a percentage of one’s income could be automatically allocated on one’s savings account, adjustable automatically to conditions such as time of year or other pending financial obligations which would see the availability of disposable income limited from time to time.
Ultimately, programmability will serve to boost efficiencies for government, consumers and businesses alike. Much like the revolution brought about by mobile apps, programmability could be applied in ways that are still today difficult to conceive. Machine-to-machine payment applications, for example, are another area that harbours enormous potential. Driverless vehicles could negotiate directly with charging points, pay for the electricity used and drive away without any human intervention.
With pandemic-led e-commerce intensification, a recent report suggested merchants surveyed experienced a 25% increase in chargebacks post COVID-19 on average. The growth is driven partly by the increase in Card-not-Present transactions, where the payment is made without the physical presence of the card or customer. For merchants, this leads to lost revenue, increased costs and wasted effort.
The pre-CBDC asset could make a material difference in addressing some of the underlying causes. Programmable payments could, for example, allow funds to only be released if goods are physically received by consumers (Delivery vs Payment). The use of cryptography and avoidance of exposure of card details also significantly reduces the risk of fraud.
Additionally, supply chain financing could be much more effective through effective information exchange of goods in transit and associated payments, which could in turn support cash flows for businesses and also provide transparency for financial services providers to extend lending facilities to businesses.
When transactions can be automatically settled, huge cost and time savings can be made.
The Macroeconomic Case for CBDCs
Economic systems have shifted towards a full digitalisation of their activities. In the future, some of these activities, including crucial interactions with the banking system, will occur in the so-called metaverse. Electronic forms of payments will not be sufficient to keep the pace of economic transformations; a fully digital form of payment will be needed. The private sector has introduced its own means of transaction, in the form of crypto-currencies or stablecoins. The public sector will need to introduce a foundation layer in this new system of payments, on which the public will be able to place its unconditional trust. This will be the function of CBDCs in the pyramid of means of payment.
Together with a more targeted implementation of fiscal policy (discussed below), CBDCs will also allow a more effective implementation of monetary policy. While potentially carrying a positive rate of interested in “normal” times, CBDCs may also be able to carry a severely negative interest rate, when monetary authorities will want to discourage savings and the hoarding of “cash,” while encouraging consumption and investment. In a totally cash-less economy (or in an initially “less-cash” economy), central banks will be able to impose a negative rate to CBDC holdings, so to stimulate the circulation of money via increased consumer spending and business investment.
In the interim, as central banks reduce their balance sheets to combat rampant inflation, they may need to increase them again by purchasing government bonds (on the asset side) to compensate (on the liability side) the issuance of CBDCs, when this will occur. This will have important implication for the implementation of monetary policy, when the so-called “floor system” to remunerate bank reserves will finish.
CBDCs can help to fight against fraud and financial crime
CBDCs can be programmed to track and trace sources of funding when illicit financial activity is suspected, which can create opportunities for anti-fraud, anti-money laundering (AML) and counterterrorist financing (CTF) professionals to investigate suspected criminal activity.
Fighting financial crime with non-digital currencies has been challenging to say the least and in some circles it is perceived as a losing battle, racing against time. With digital currencies, ‘chainalysis’ enables money trails to be tracked with much greater visibility, allowing authorities to track, trace and quarantine assets. This however is still a reactive approach to the fight against financial crime.
The design of a universal Digital Financial Market Infrastructure solution which supports the co-existence of CBDCs and other digital assets, could drive the transition from a ‘blacklisting’ reactive approach when it comes to financial crime to a more proactive ‘whitelisting’ approach, saving valuable time, effort and resources and providing a much more effective AML and Anti CTF environment by default. Existing compliance systems check each transaction against a blacklist of banned individuals and organisations prior to transaction execution. This approach is inefficient and often mistakenly implicates non-criminals by misleading association. By contrast, the CBDC infrastructure could use real-time automated whitelisting, permits every legitimate transaction. Illicit activities are identified instantaneously, at which point wallets are and tokens are frozen and unable to initiate a transaction to begin with. Correctly designed, the proposed approach by the Digital FMI Consortium would see these checks become a real-time automated process embedded into the transaction initiation and execution steps, allowing real-time processes that do not impact settlement time or transaction finality.
A CBDC could additionally help prevent friendly fraud, sometimes called chargeback fraud, which would vastly improve merchants’ online payments operations by lowering the cost of payments acceptance and diminish any potential fraud related losses. Consumers will also benefit from reduced fraud given the control that can be exercised over programmable payments.
Designing the payments journeys would also permit better consumer control over payments authorisations, providing more security over transactions.
CBDCs can enable a range of G2C (government to consumer) disbursements and other monetary benefits
Alongside the scope for application in the B2C (business to consumer), B2B (business to business), and P2P (Peer-to-Peer) spheres, CBDCs would offer near-instant payments, low transaction costs, and programmable payments in the Government-to-Consumer (G2C) context.
CBDCs could be leveraged to streamline social welfare payments, for example, allowing for instant, low-cost transactions to citizens in the face of an economic crisis or any other response-worthy event. In addition to these event-based payments, CBDCs could also be programmed to have a conditional function, limiting the use of social welfare funds where applicable.
Furthermore, minimising any inefficiencies in payment systems would help avoid needless waste, saving governments considerable public funds whilst creating far more efficient G2C systems.
The opportunity to lead
On 4th April this year, the UK government announced moves that will see stablecoins recognised as a valid form of payment as part of wider plans to make Britain a global hub for crypto-asset technology and investment.
Under new Prime Minister Liz Truss, the United Kingdom has an historic opportunity to secure its leading global position in financial services and payments by designing digital financial market infrastructure that caters for the practical benefits and high-potential uses cases outlined above while mitigating against the risks also discussed.
By taking advantage of regulatory divergence from the European Union, the UK can be a early-mover amongst leading Western economies to shape a global digital currency ecosystem. Our Green Paper encourages government and central banks to drive the process and seize this unique opportunity via an active public-private partnership.
Early mover advantage
Currently, 105 countries (representing over 95 percent of global GDP) are exploring paths towards a CBDC, while 10 countries have now fully launched a digital currency. The market continues to develop at a tremendous pace, with the ECB declaring recently that CBDCs could be the 'Holy Grail' of cross-border payments, and the Fed exploring a digital dollar with increasing urgency.
Early adopters of CBDC are proactively shaping the role of digital money in their economies to unlock payment efficiencies, drive innovation and protect the sovereignty of national currencies. China’s vastly expanding e-CNY is the most developed CBDC initiative in the world, with ~260m wallets now registered and set to transform domestic retail payments following adoption at the Winter Olympics. Full CBDC implementations also exist in The Bahamas and Nigeria, while Russia and India have both confirmed CBDC trials in 2022.
Exploring and implementing best practice in the UK will foster a market environment that attracts future investment and drives cutting-edge innovation. This will include coexistence between existing and new forms of money, interoperability between existing and future payments and financial market infrastructure, all enabled through careful tech choices including a hybrid model of Distributed Ledger Technology (DLT) and traditional finance (TradFi).
Together with ongoing advancements to existing payments systems, a future-proof financial technology landscape would confer a significant competitive advantage to the UK’s financial market and payments infrastructure globally, a critical enabler to power economic growth in the coming decades.
A proud history of innovation
The United Kingdom has a proud history of invention and innovation. When Tim Berners-Lee invented the World Wide Web in 1989 to meet the demand for automated information-sharing between scientists in universities and institutes around the world, he did not anticipate that his creation would profoundly and permanently change the way we live and interact to this day.
The emergence of digital currencies represents the biggest technological revolution since then, the final step in the full digital transformation of the global financial system and the biggest transformation the industry has faced in more than 300 years. Today, the global race for the future of money is well underway, and the UK should be striving to set the pace.
Risks
Project New Era will examine the digital currency landscape, detail core design considerations and propose closer public-private collaboration in order to address key challenges and open questions. The challenges and questions surrounding CBDC development are significant, and the pilot is designed to understand these challenges at a fundamental level and answer these questions in a transparent manner.
The pilot will seek to discover and promote design considerations that harness the technology’s practical benefits to maximum effect while catering to consumer privacy and safety. Outlined below are mitigation strategies for a number of widespread concerns surrounding CBDCs in the UK.
Security
Cybersecurity is a key design consideration that needs to be addressed from the outset in the design, just as with the current payment infrastructure of today. There are concerns that CBDCs will be susceptible to data breaches and cyber-crime, representing significant threats to both national security and the security of citizens’ assets.
Possible scenarios of concern include the corruption of the Distributed Ledger Technology (DLT) or blockchain on which CBDCs are reliant, or the threat of hacking via quantum computing which could represent a single point of failure for entire financial systems and the associated national economy. But even if the infrastructure were to be built with Trad-Fi instruments, the centralisation of the management of transactions implicit in the adoption of a CBDC may create a single point of failure, which needs to be protected. The near instant speed of transactions could also potentially facilitate fraud in which consumer wallets are drained without time for law enforcement to react.
For example, a centralised ledger or permissioned Distributed Ledger Technology (DLT) would enable central control over issuance, participation, and party rights. Bad actor wallets could also be blacklisted and the continuous deployment of new node and wallet software from multiple providers could spread risks and reduce single points of failure. Strong, reliable, and trusted backup systems would also be implemented to ensure the technology is able to return to a “restore” point in the event of a cyber-attack.
Privacy
A primary area of concern surrounding CBDCs relates to the potential for states to design digital payment systems as engines of state surveillance. Naturally, surveillance efforts that are effective in preventing criminal activity (such as monitoring transactions and wavering sender and receiver anonymity) are a blow to confidentiality. A precedent has also been set in some jurisdictions for the partial monitoring of transactions. Moreover, sovereign CBDCs are likely to be subject to extensive international cooperation, with concerns that transnational agreements will override privacy concerns.
This pilot’s overriding objective is to discover and recommend design infrastructure that is fully compatible with the standards of privacy upheld under the Bank of England’s existing data policies. In other words, the government should not be able to see individual spending or interfere with the expression of financial preferences, without limitation on the ability to effectively meet and manage AML and anti-CTF obligations. While these two objectives may seem opposing in mandate, it is the belief of the Consortium that an effective design can be demonstrated which supports both mandates in a new digital financial market infrastructure design, with zero compromise to one or the other.
One method of enforcing such standards might be the adoption of a ‘two-tier’ model that can be implemented to ensure the privacy of compliance and account operations. For example, certified wallet issuers would authenticate the identities of all users, whilst only allowing central banks, regulators, AML and CTF access to pseudonymous data, with access privileges elevated under strict and legal supervision, to aid in any investigation into suspected financial crime.
These privacy measures also answer concerns relating to the possible social control impact of CBDCs, such as the possibility of spending data being used to implement a social credit score system or to block payments from targeted individuals. A two-tier system would ensure clear and provable limits to central bank or government oversight of CBDC transactions.
Potential Impact on the Traditional Banking System
There are concerns that CBDCs could undermine the role and credit-allocating functions of the retail and commercial banking sectors, leading to bank disintermediation and credit crunches. However, there are numerous options that can be explored to mitigate this risk, such as CBDCs acting as on-balance sheet liabilities for commercial banks and limits on deposit outflows to ensure a phased transition.
Clearly the introduction of CBDCs would need to be made compatible with existing incentive structures on which commercial banks rely, or else they will risk becoming net negatives for the private sector. Moreover, should commercial banks be required perform Know Your Customer (KYC), Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) activities within their remit in a two-tier system, they should also be remunerated for performing such tasks.
The important point presently missing from discussions is whether commercial banks will be able to issue other digital currencies as their own liabilities, or alternatively lend out the Central Bank Digital Currency (or at least lend out against the CBDC held as collateral) on their own balance sheet. One potential solution might be to allow banks to create stablecoins backed by their own deposits in CBDCs. This stablecoin might either be lent out or used with all the potential benefits of programmable money while falling under the same operational and regulatory classification and environment as today’ s e-money/commercial bank money. The proposal would protect the current economic models while adding a facility for real-time amendment to the distribution ratios of M0 and commercial bank money as and when needed for responsible fiscal activities in a digital asset environment, such as more effective quantitative easing or other monetary policy initiatives.
Currency Substitution
Concerns have also been raised that a perceived trustworthiness of a foreign CBDC could become widespread amongst UK consumers, leading to the replacement of the pound sterling as the dominant currency. This could be in the form of a “friendly” currency such as the USD, or a “rival” currency like the e-CNY. In both cases the risk is that the GBP (and its digital sister d-sterling) becomes crowded out by alternative currencies for everyday transactions, leading to diminished monetary sovereignty.
Currency substitution is more likely to be an issue of concern in economies which have less stable currencies than GBP, or face other macro-economic and political challenges in their domestic markets. However, the design of digital currency financial market infrastructure proposed by this consortium supports a robust payment system design which could ensure that domestic transactions only take place in a specified currency. Furthermore, with the co-existence of other forms of digital currency, including foreign CBDCs in a single infrastructure under real-time enforceable domestic regulation and a single Financial Market Infrastructure, a government with such a robust toolset would be much better enabled to manage and reduce the risks associated with currency substitution in a future digital currency economy. It must be noted that such infrastructure would provide real-time support for the implementation of fine-grain and real-time implementation of restrictions on non-resident cross-border transactions in its own sovereign currency, with grounds for supporting domestic and international legislation.
The FCA reveals that, as of 2020, 1.2 million adults in the UK are ‘unbanked’, meaning they do not have a current or e-money account. Being unbanked poses obstacles to everyday life, as individuals are unable to safely access essential services including savings, pensions, loans and insurance. Concerningly, the majority of the world’s unbanked population are from low-income backgrounds. The proposed infrastructure which includes digital identity components will allow crypto-assets, like CBDCs to enable people to break the cycle of financial exclusion, to access digital banking and payments systems without bank accounts and to build a credit score without the barriers of traditional institutions.
Secondly, CBDCs can expedite the delivery of welfare or economic recovery programmes. In the case of the United States’ Covid-19 stimulus payment, millions of Americans faced months-long waits to receive their allowance, despite living in one of the most developed financial markets in the world. CBDCs can resolve these issues, providing an instantaneous, cost-saving, regulated and secure method of delivering stimulus payments to the intended recipient in need. CBDC technology would be similarly useful for the UK, whether for benefits plans or one-off stimulus packages.
Lastly, digital financial exclusion extends beyond just the banking system. Not all people have access to smartphones and high-speed broadband, which are necessary for traditional online banking services and mainstream digital payment methods. Ofcom has estimated that 1.5 million households still lack internet access. Well-designed CBDC infrastructure that operates on low-tech devices or features offline payments is well positioned to solve this problem.
The distribution of CBDC in live implementations and pilots (including The Bahamas, Nigeria, and China, with an Indian pilot due later in 2022) is through a ‘two-tier’, indirect approach. A two-tier model distributes CBDC to citizens through commercial banks and non-banks in an open market model. The central bank oversees management of the central ledger, including net settlement. Commercial banks and non-banks are responsible for wallet issuing and the provision of financial services.
China’s e-CNY is divided in tiers between the PBoC and state-owned commercial banks, with the PBoC maintaining the core ledger and technology, and banks holding the e-CNY on their balance sheets.
Developing economy progress is generally more advanced than developed economies, with three full implementations currently live in the Bahamas, Cambodia and Nigeria. The East Caribbean Currency Union’s DCash pilot and China’s expanding e-CNY are in close pursuit. The Reserve Bank of India has also announced the trialling of a Digital Rupee later in 2022. In the most prominent initiatives, central banks are typically supported by private sector players.
In developing economies, financial inclusion and payments efficiencies are at the forefront of publicly stated ambitions.
In developed economies, where financial inclusion is higher and domestic payments are more efficient, these drivers can be less relevant. In such nations, CBDCs are considered by some to be, as a recent UK report quipped: “A solution in search of a problem?” Larger economies appear to view CBDC more as a counter to the rise of unregulated, privately issued digital currency. For example, Fabio Panetta, a Member of the Executive Board of the ECB said: “... different forms of private money coexisting in the absence of sovereign money leads to crises. The primary policy objective of a digital euro would be to pre-empt such a situation.” Additionally, the People’s Bank of China is supplementing the ban on the sector by rapidly scaling the e-CNY pilot, which has now been adopted by >140m users.
Developing markets are overwhelmingly focused on retail CBDC applications (92%), developed markets have a far higher share of wholesale CBDC projects (38%). In many developed economies, considerable ambiguity remains regarding the direction of central bank plans for digital currencies. The current discourse is dominated by debates focused on issues rather than collaborative initiatives looking for constructive solutions.
Developed economies are less incentivised to develop mCBDC architecture from scratch given existing efficiencies. However, developing nations with lower financial inclusion and in search of payment efficiencies, may be more willing to adopt an mCBDC approach. This split can be seen in the development of multi-jurisdictional mCBDCs across the world in exhibit twenty three. The major mCBDC projects currently live, mCBDC Bridge, project Dunbar and the DCash currency union largely involve developing economies. The US and the UK, which together clear 45% of international trade, have no such initiatives.
Our research suggests there are broadly two groups of nations. The first group is openly opposed to the adoption of digital currencies by its citizens, advocating blanket cryptocurrency bans that include stablecoins. We note nations in this group often have advanced CBDC initiatives and include the likes of China and Turkey.
The second group, while clearly expressing concerns, also accept a level of coexistence which enables innovation, but also introduces safeguards for financial stability risks. Regulators in these states, which include the UK, EU, and US, are finalising stablecoin regulation and appear to be moving relatively slowly on CBDC implementation. In our view, this divergence points to a future where privately issued digital currencies, including stablecoins and cryptocurrencies, can coexist with CBDCs to varying degrees around the world.
The volume and progress of CBDC projects have accelerated over 2020-21, with full implementations live in The Bahamas (Sand Dollar), Cambodia (Bakong) and now Nigeria (e-Naira). China’s e-CNY pilot has been recently expanded and adopted by >140m users. The Reserve Bank of India has also announced the trialling of a Digital Rupee later in 2022.
As outlined above, currently 105 countries (representing over 95 percent of global GDP) are exploring paths towards a CBDC, while 10 countries have now fully launched a digital currency. The market continues to develop at a tremendous pace, with the ECB declaring recently that CBDCs could be the 'Holy Grail' of cross-border payments, and the Fed exploring a digital dollar with increasing urgency.
If the new British Government is to deliver on its ambition to make the UK a global crypto hub, the time for action is now, and action starts with greater public-private collaboration.
4. Next Steps & Recommendations
In light of the opportunities and risks outlined above, the Digital FMI Consortium proposes the following steps are followed to help the UK explore best practice in the CBDC space, which should constitute a core component of its ambitions to become a global crypto hub:
September 2022
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