Digital dollars: central banks, cyber space and your cash

As central banks around the world contemplate the adoption of digital reserve currencies, what could this development mean for how we use money?

Among the ideas that have emerged, aspirations of what a “new normal” might look like after the pandemic are evolving, with many envisioning a faster shift towards a digital future. Perhaps no developing trend has made bigger headlines than Bitcoin and the emergence of cryptocurrencies.

While many crypto enthusiasts champion these blockchain digital assets as a decentralized method of value for transactions without the inclusion of the state or financial institutions, there are significant concerns of what a non-fiat crypto cyberspace unregulated by central banks could create. Central banks around the world are responding to the enthusiasm for digital assets by commencing the processes to establish their own digital fiat currency. Canada, the United States, the European Union and the United Kingdom have already announced their plans for exploring respective Central Bank Digital Currencies (CBDC), with China and Sweden already having launched pilots. But what would CBDCs look like in practice, and how might they change the current financial ecosystem and the way we use money?

What is CBDC and how central banks are responding

As we have previously explained, a CBDC would be a new form of central bank currency, liability, unit of account, and medium of exchange—in other words, a digital version of what we know as the dollar today. Unlike cryptocurrencies, like Bitcoin, a CBDC would provide a stable price and would be guaranteed and backed by a central bank. According to the Atlantic Council, over 75 countries are exploring a potential CBDC. The European Central Bank issued a report recognizing that a “digital Euro” is a significant step towards the digitalization of the economy in response to a decline in cash payments, by providing consumers with a legitimate digital alternative. In April, the Bank of England created a CBDC Taskforce to coordinate the exploration of a potential UK CBDC. The United States will start discussions this summer for a report on a potential CBDC with particular consideration to how such an adoption would impact the global economy and monetary system as the world’s reserve currency. China has launched a pilot in certain cities using a cyber yuan. And the Bank of Canada has recently announced that it is well into the development process of a CBDC and is exploring what it might look like.

How might CBDCs impact commercial banks and financial payment service providers?

While there is a lot of promise and excitement around how CBDCs might modernize the economy, there are also several risks and concerns. Central banks, including the U.S. Federal Reserve, have raised concerns that such a substantial reform of the economy, if done too quickly and improperly, can have significant economic consequences and privacy concerns. In order to ensure that CBDCs are integrated into the economy in a stable and comprehensive way, commercial banks, credit companies and digital payment processors have an opportunity to work in partnership with central banks and governments to design our digital economic future. Sweden just announced that it is working in partnership with commercial lender Handelsbanken to test out its new e-krona in an effort to evaluate what a CBDC could look like when integrated into the current financial system. In the Bahamas, Mastercard partnered with the central bank and Island Pay to give consumers a flexible way of using the island’s recently issued CBDC—the Sand Dollar. The U.S. Federal Reserve and the European Central Bank, among others, have also recognized that they cannot create the legal infrastructure for the issuance of CBDCs alone and must work with legislators to draft a potential path and framework for implementation. The Bank of Canada has stated the importance of working with the private sector to create a CBDC, but has yet to define a process. This presents a significant opportunity for the industry and stakeholders to work with government in order to create robust implementation.

Privacy concerns have also been raised, with states like China being criticized for the government’s ability to track consumer behaviours and transactions through a CBDC. The Bank of Canada issued a policy note in 2020 discussing the different spectrum of CBDC privacy concerns and some potential solutions, though nothing has officially been decided. A recent European Central Bank survey found that privacy was the most important concern for consumers. Ultimately, stakeholder engagement will be an essential ingredient in establishing the legitimacy of CBDCs to build consumer confidence and engagement.

Conclusion

Central Bank Digital Currencies present an exciting opportunity and challenge to modernize the global economy for a digital future. There is a significant opportunity for financial institutions to help shape the practical and legal framework of CBDCs in order to ensure that Canada and other key economies deliver a secure, stable and robust adaptation.