THE ATLANTIC COUNCIL GEOECONOMICS CENTER - WRITTEN EVIDENCE (CDC0041) - CENTRAL BANK DIGITAL CURRENCY INQUIRY
Author: Nitya Biyani
Co-author: William Howlett
Contributions from Ole Moehr, Niels Graham, Julia Friedlander, and Josh Lipsky
- The Atlantic Council GeoEconomics Center appreciates the opportunity to respond to the House of Lords Economic Affairs inquiry into Central Bank Digital Currencies (CBDCs). After reading the other submissions and based on our relevant expertise, we have chosen to reply to questions 5, 6, 7 and 10. At the intersection of economics, finance, and foreign policy, the GeoEconomics Center at the Atlantic Council is a translation hub with the goal of helping shape a better global economic future.
In this submission, we provide an overview of our Central Bank Digital Currency Tracker (link) and its key findings. The newly updated database features 90 countries—around triple the number of countries we identified as being active in CBDC development one year ago. These countries account for over 90% of global GDP. The United Kingdom, as a leading economic and financial power in the world, is in a unique position to shape the course of CBDC adoption through its G7 presidency, the G20, the Bank of International Settlements, and the Financial Action Task Force. The reasons for adopting a CBDC span from financial inclusion to cybersecurity, but without new standards and international coordination the financial system may be headed for significant interoperability problems in the future.
CBDC Tracker and Insights
- We begin with an overview of our new research project, the Central Bank Digital Currency (CBDC) Tracker. The full database is available online at www.atlanticcouncil.org/cbdctracker and is the product of months of research from our entire team. Our global database shows the progress 90 countries and/or currency unions are making on central bank digital currencies. To make these assessments, the team conducted original research on every central bank in the world.
- Based on our public and private survey of central banks, it is evident that COVID-19 has played an outsized role in spurring countries to act. The need to deliver an unprecedented fiscal and monetary stimulus with rapid speed led central bankers to explore new avenues for innovation in payment systems. This has made CBDC exploration a viable option for many countries. In addition, the increased usage of cryptocurrencies and stablecoins has been the major motivating factor for central banks as they look to ensure monetary sovereignty in their countries.
- Seven countries have now fully launched a digital currency, the first of which was the Bahamian Sand Dollar and the latest being Nigeria's e-Naira. The Sand Dollar has much to teach other countries about financial innovation and the way a CBDC can work with the private banking system. 16 other countries, including Sweden and South Korea, are now in the pilot stage and preparing a possible full launch. This means that all of the G20, with the exception of Mexico and Argentina, is in some stage of CBDC development.
- Retail CBDCs, available to the general public, are being developed by more central banks than wholesale CBDCs, which can be used for bank to bank transactions and cross-border settlements. Wholesale projects are more common in developed economies, whereas retail CBDC projects are more widespread in developing economies, which see clear financial inclusion benefits. Currently 45 countries are exploring retail CBDCs, 7 wholesale CBDCs and 20 are exploring both.
- Finally, our database explains the design and security choices made by countries developing CBDCs. Our research indicates that without governing standards and international coordination, the financial system may be headed for a significant currency interoperability problem in the near future. In our research process we have heard a clear message from other central banks: they are eager for leadership on digital currencies. Why would there be an interoperability problem? Right now most countries, with notable exceptions such as Thailand, are overly focused on their own domestic use cases for CBDCs and therefore are choosing individual technology systems and security systems that work for them. However, these systems may encounter problems when users try to use digital currency overseas or exchange it for other digital currency. In the absence of leadership, a fragmented system could have serious consequences for financial stability - as well as national security.
5. What effects might a CBDC have on the financial sector?
- As our research demonstrates, CBDC projects are rapidly advancing globally. London has been a global financial and trading hub for centuries. The openness of trade, transparency of transactions and the access to capital have facilitated this status. Issuing a CBDC, and playing a leading role in international standard-setting, will be crucial to secure London’s vitality to the global financial infrastructure and maintain its supremacy in transaction settlement and clearing.
- Design choices will determine the impact on the financial sector. For example, a direct CBDC architecture wherein consumers would hold accounts directly with the Central Bank could adversely affect the financial sector. However, as our research shows, no current CBDC projects feature this type of architecture, arguably in part due to its adverse impact on the private sector. So while a direct to consumer retail CBDC is technologically possible, it is not the preferred avenue of any country seriously considering CBDC adoption. Even China issues its CBDC pilot through private banks and private payment providers like Alipay and WeChat Pay. A hybrid architecture would rely heavily on the private sector to manage and maintain consumer accounts, ensure KYC and AML/CFT compliance, and provide wallet technology. Essentially, a CBDC would be issued by the Bank of England, but the accounts and transaction settlement would be maintained by the private sector and a similar ledger would be kept by the Bank of England as well. A viable CBDC would bolster the financial sector and reduce their transaction settlement costs by providing an open payment platform. The proposed benefits of CBDCs, such increased speed and efficiency of payments, are not hampered even if they are processed through the traditional payment infrastructure.
- Our research shows that countries are currently split in their security choices for CBDCs. Seventeen, including South Korea, have chosen a form of permissioned Distributed Ledger Technology (DLT), which enables trusted partners to verify transactions. Seven others, like China, have chosen a fully centralized conventional system. Another ten countries are using both, while fifty-four are undecided. CBDCs that rely on conventional CBDC databases, which share many of the technical features of traditional central bank databases, and DLT-based systems are both susceptible to large-scale attacks. However, the 2016 Bank of Bangladesh hack and consequent Fedwire transactions are evidence that the current system also has vulnerabilities.
6. What effect might a CBDC have on competition and innovation in the payments and fintech sectors?
- We believe CBDCs, with the appropriate regulatory framework, are likely to stimulate further innovation and lead to a more competitive payments sector. Our research has shown that most of the technology solutions partners of various CBDC projects did not exist 10 years ago. The use of new technology to create an open payment platform would level the playing field for new players and reduce the barriers to entry in the financial sector. As mentioned above, a hybrid approach would require the private sector to conduct consumer facing operations and continue its current operational and compliance tasks. Firms can compete to provide various services for consumers, from P2P payment solutions to wallet solutions. A CBDC would only create further avenues for engagement and innovation in the fintech sector, while reducing the costs associated with the traditional payment infrastructure. Furthermore, a CBDC should not be intended to replace private digital currencies or traditional means of payment. Instead, as discussed below, a CBDC can be used to complement existing systems, create a healthy digital currency ecosystem, and deliver traditional government to citizens financial transactions (taxes, stimulus, unemployment benefits) in a faster, cheaper, and safer manner.
7. How might a CBDC affect monetary policy?
- A CBDC could allow for faster implementation of a more efficient monetary and fiscal policy. Stimulus in times of crisis can be delivered in seconds and the effects of a change to monetary policy will be quicker. Conceptually, an interest bearing and programmable CBDC could have enormous impacts on monetary policy. However, a review of current pilot projects across the globe shows that no central bank is implementing this aspect in their pilot project. Most banks are focusing on the basic capabilities and benefits of a CBDC, as a means of increasing efficiency and speed of regular financial services. For certain banks that face unique circumstances such as negative interest rates like the European Central Bank, this feature may be more applicable in the long term. Yet, these are theoretical concerns at best and are unlikely to be featured in any first phase CBDC project.
10. How might CBDCs affect the economic foreign policies or geopolitical influence of different countries and economic areas? Are there implications for the effectiveness of economic sanctions?
- The pace of CBDC development could become a prime driver of the monetary and financial influence of major economies. Wholesale (bank-to-bank) CBDCs present an opportunity for countries to build cross-border mCBDC (multi-CBDC) mechanisms that dramatically lower transaction costs for currency transactions and international capital movements. Leaders in wholesale CBDCs and in the development of cross-border mechanisms will be well-positioned to strengthen the role of their currency in the global economy and to cement their status as a financial center. Singapore, South Africa, Malaysia and Australia recently announced Project Dunbar to test the use of central bank digital currencies (CBDCs) for international settlements. Led by the Bank for International Settlements’ Singapore Centre, it aims to develop prototype shared platforms for cross-border transactions using multiple CBDCs, allowing financial institutions to transact directly with each other in the digital currencies, eliminating the need for intermediaries and cutting the time and cost of transactions.
- China is building off its rapid progress on RCEP to pioneer the creation of cross-border mCBDC mechanisms. Through a pilot program with Thailand, Hong Kong, and the UAE, China is beginning to build the infrastructure for these wholesale flows. Additionally, it has signaled work to prepare the e-CNY for use in cross-border payments. These programs could increase the share of international flows denominated in yuan and could lead to an outcome in which the renminbi becomes a regional currency across Asia. This would enhance China’s leverage over its neighbors and deliver belt and road funds through a new mechanism (currently most BRI debt is denominated in dollars) Additionally, China’s lead to develop the digital yuan, positions it to set standards for interoperability in areas like privacy, cybersecurity, and illicit finance. If nations like the US and UK do not rapidly catch up, they risk being absent from the standard-setting conversation, handing over enormous power to China to shape this emerging technology. Over a longer time horizon, it is conceivable that cross-border CBDC may vesicate the usefulness of the SWIFT system.
- The US is much further behind on CBDC development, let alone building cross-border mechanisms. While this will likely not undermine the status of the dollar in the short- to medium-term, in the long-term the absence of American innovation and use of alternative mCBDC mechanisms for cross-border flows could begin to erode the dollar’s hegemony and replace the use of SWIFT, thereby reducing US sanctions leverage. Similar effects could occur for currencies like the pound and euro if relevant authorities fail to innovate.
- As it builds a vision of ‘Global Britain’ in the post-Brexit world, CBDCs offer the UK an opportunity to promote British economic leadership. First, the UK should build on the legacy of its 2021 G7 presidency, when it led the issuance of a joint statement on CBDCs and the publishing of 13 public policy principles for CBDCs, to shape the global conversation on standards and best practices. By speeding up its development of a CBDC, the UK can position itself to influence the development of the digital currency ecosystem and set standards for interoperability in areas core to national interests and values, like privacy. Second, by focusing its energy specifically on the development of cross-border CBDC mechanisms, the UK can shape the international financial infrastructure and maintain London’s position as a financial marketplace. Finally, the combination of pioneering CBDC work and the development of cross-border systems will cement London’s status as a global financial center. As financial firms consider leaving London for Frankfurt or Paris amid the fallout of Brexit and pressure from the ECB, innovation in the realm of CBDCs and cross-border mechanisms will eventually be crucial for the UK to maintain its competitiveness since much of future finance will be built on digital platforms like CBDCs. Thus, the rise of CBDCs presents a generational opportunity for the UK to build on its G7 leadership and renew its economic and financial influence by pioneering CBDC standards and cross-border systems.
- To support its financial leadership and ensure the UK’s values and interests are embedded in the future of CBDCs, cooperation with like-minded partners will be key. Most importantly, a commitment to UK-US-EU collaboration on standard setting, interoperability, and cross-border mechanisms will be crucial for ensuring that CBDC development work translates into global financial leadership.
3 November 2021
 For details on the potential design and implications of mCBDCs, see CPMI, BIS Innovation Hub, IMF, and World Bank, “Central bank digital currencies for cross-border payments: Report to the G20,” Bank for International Settlements, July 9, 2021.
 For more on the impact of CBDCs on the dollar and US sanctions leverage, see GeoEconomics Center Deputy Director Julia Friedlander’s July 2021 testimony to a House Financial Services subcommittee: https://financialservices.house.gov/uploadedfiles/hhrg-117-ba10-wstate-friedlanderj-20210727.pdf