Hazem Danny Nakib[1] I Geoffrey Goodell[2] I D. R. Toliver

Q1.What are the main issues driving central banks to explore CBDCs?


  1. There are several issues driving the exploration of CBDC. First, the secular decline in the use of cash as a means of payment, particularly in industrialised economies, over the last decade as consumers move to internet payments, including debit and credit cards. This is not a worldwide generalisation; the use of cash has, in some locations, increased. However, the combination of the increasing popularity of electronic payment options and the high fixed costs of cash infrastructure point to an economic reason for cash use to decline overall.  The decline of the use of cash is fundamental because the properties of cash, in particular privacy and choice, have been essential and expected by the public. In fact, these properties of cash have been enjoyed for as long as people have used fungible coins and notes to transact.  Absent the privacy-preserving properties of cash, users are at consistent risk of being profiled by various parties. This is especially true where CBDC infrastructure will rely on the private sector to operate.


  1. The second issue that is driving the exploration of CBDC in our view is not getting left behind, given that many other countries are very quickly developing their own CBDC solutions with more than 10 countries conducting pilots including Singapore, France, and China.[3] If a central bank and government does not explore this area, they would be left behind, both from the standpoint of what they offer their citizens, the public as well as technologically. It has become, very clearly, a race.


Q2. What are the main benefits and risks of a CBDC?


  1. The value of CBDC relative to other forms of central bank money lies in its suitability for conducting payments.  Payments can be broken down into two categories, namely cash and electronic payment systems.


  1. The use cases for cash often require low latency, low transaction overhead, and unlinked transactions (consumer privacy by design).  A good CBDC can meet these requirements, and can also extend the benefits of digital transfers into the cash domain, so that those same properties will become available in the digital realm. As the digital economy continues to skyrocket and expand, we must ensure that those rights and benefits enjoyed in the physical realm are similarly enjoyed digitally.


  1. Existing electronic payment systems often rely on implicit credit, particularly when transactions are expected to complete in real-time.  A good CBDC that can meet the use cases of cash and potentially mitigate the costs and risks of that underlying implicit credit.


  1. Bad CBDCs pose two main classes of risk, primarily on the continuum involving privacy and regulation, because they compromise one or both of the requirements: first, true privacy for consumers, and second, regulatory oversight of all transactions.  CBDC proposals that compromise the first (privacy) requirement have good regulatory capabilities, but fail to provide basic consumer protections, such as protection against profiling and discrimination.  CBDC proposals that compromise the second requirement have good privacy properties, but fail to provide essential regulatory oversight of transactions.


  1. A good CBDC proposal must address (not compromise) both concerns, and must also provide latency, costs, and energy usage that is appropriate for the use cases to which it will be applied. This is possible, and no CBDC should be launched and offered to the public before this has been met. If not, the game is over before it has begun. This is because it is incumbent on central banks to offer the public access to the economy, whether physical or digital, and that access should be safe, unfettered and inclusive. Cash did this, and CBDC should be digital cash, maintaining the beneficial properties of cash.


Q3. Could the proposed benefits of a CBDC be achieved through improvements to existing payment systems?


  1. No.  As a physical mechanism, cash incurs high fixed costs, and the proliferation of electronic alternatives means that nation-scale cash infrastructure is economically untenable in the long run.  Meanwhile, existing electronic payment systems are based on accounts and are therefore intrinsically bound to the identities of their account-holders, meaning that their account-holders will always be subject to the risk of profiling or discrimination.


  1. A key benefit of a good CBDC is to eliminate that risk of profiling and discrimination while also eliminating the high fixed costs associated with cash.  The existing payment systems cannot provide this benefit in any way.


Q4. How should the Bank of England and HM Treasury address concerns over privacy and traceability of payments when exploring CBDC design?


  1. A good CBDC proposal must incorporate privacy into its design. Traceability of payments from sender to recipient is not necessary for appropriate regulatory oversight, and the ability to trace payments inherently compromises the ability of that system to efficiently meet the demands of cash-like use cases.


  1. We note in particular that it is not necessary for regulators to know both counterparties to every transaction.  What is important is that transactions take place under regulatory control.  It should be sufficient to know that both parties have received CBDC legitimately via regulated financial institutions that comply with appropriate AML/KYC requirements and that at least one party to every transaction is engaging with a regulated financial institution. We must resist seeing CBDC as a panacea for financial inclusion, regulatory compliance, the business interests of private organisations, or even as strengthening the central banks monetary policy transmission channels. We need not be fancy, the question is simple: What is CBDC for? It is for users, the public, to be able to conduct payments digitally, while maintaining the choice and affordances available to them with physical cash. Anything that compromises this very tenet has lost the objective of a CBDC from the start.


  1. Central banks must have the ingenuity and fortitude to develop a CBDC policy that guarantees four key principles: first, accessibility, to ensure that nearly everyone can use it; second, non-discrimination, to ensure that any one person's money is as good as everyone else's; third, privacy, to ensure that no user would fear that he or she would be profiled on the basis of his or her transactions; and, finally, ownership, to ensure that CBDC can be owned by its bearer, just as cash is owned, and used without the risk of being blocked by a custodian or other third-party actor.


Q5. What effects might a CBDC have on the financial sector?


  1. If CBDC is designed to be cash-like, then its effects on the financial sector should be benign.  Neither consumers nor banks would have an incentive to hold CBDC on their balance sheets over long periods.  Consumers and retail businesses would withdraw CBDC from bank accounts or receive it via money services businesses, and recipients of CBDC would generally deposit it into bank accounts or have it be processed by regulated financial institutions, just as they do with cash.  The withdrawals and deposits of CBDC into the system would be subject to limits and controls just as cash is.  The main differences relative to cash would (and should) be that the digital infrastructure significantly reduces the fixed overhead costs of cash and that the regulator gains a view into all transactions (although generally not the identities of both counterparties).


Q6. What effect might a CBDC have on competition and innovation in the payments and fintech sectors?


  1. A good CBDC proposal, i.e. one that satisfies the above requirements we have highlighted, will create innovation opportunities both for existing actors in the payments and fintech sectors as well as for new entrants. This is catalysed by the privacy protections that prevent tracking, profiling, and discrimination, which allows actors to enter these sectors with lightweight solutions that do not need the same protections for confidential information, because that personally identifiable information is absent, by design, from the assets and the transactions.


Q8. How might a CBDC change the Bank of England’s role and responsibilities?

  1. The decline in the use of cash means that retail money issued by central banks might require stewardship to be successful.  The Bank of England could be that steward.


15 October 2021

[1] Honorary Researcher, University College London; Member, Digital Strategic Advisory Board, British Standards Institute.

[2] Senior Researcher, University College London; Associate, London School of Economics Systemic Risk Centre.

[3] Atlantic Council, CBDC Tracker, available at: https://www.atlanticcouncil.org/cbdctracker/