CBDCs: fulfilling the promise of digital currencies

CBDCs can play a key role in stimulating greater financial inclusion by providing access to financial services for unbanked or underbanked individuals; they can enhance payment efficiency and lower transaction costs, as well as enable the programmability of payments; and they can provide enhanced security for digital transactions.

As a digital form of a sovereign currency, a CBDC is designed to be a universally available means of payment, allowing everyone to participate in the use of digital money – at any time and in any situation.

To make that work in practice, and ensure widespread use, a CBDC needs to support multiple low-cost device formats, such as wristbands and smart cards, and be accessible offline. It needs to be intuitive, with no expectation that users are tech-savvy and financially literate, or even have a bank.

Those properties – inclusivity and universality – simply don’t feature in the crypto-asset ecosystem, where participants are typically university-educated digital natives, relatively affluent, and male.³

Crypto is also a system driven by commercial rather than societal imperatives. Miners of crypto-assets are paid in those assets for validating new blocks in a crypto system’s blockchain. That process highlights another constraining feature of speculative assets such as Bitcoin that limits their universality: transaction throughput. They can scale to a large number of participants (nodes) but cannot scale to a large number of transactions. The current capacity of the Bitcoin blockchain can only process around 7 to 10 transactions per second, a tiny fraction of the throughput of conventional payment systems.⁴

As a government-backed digital currency, a CBDC provides a stable, public way to pay and store money digitally. Like physical cash, a CBDC is backed by central bank deposits and a government pledge, making such digital cash universally accepted, free from social and economic barriers, and independent of any issuer. In almost every respect, that makes it different from a crypto-asset, which is produced by an independent actor, used almost exclusively as a trading and investing instrument, subject to wild swings in value, and unusable for the vast majority of transactions.

Moreover, current monetary systems are fundamentally based on lending – indeed, economies require that. And cryptocurrencies simply do not support money creation through lending.

The security considerations for a CBDC are no different from those for conventional payment systems and online banking, according to the US Federal Reserve. To prevent cyberattacks, central banks issuing digital currencies will commit to implement equally robust information security programs to enable secure digital payments. Again, the comparison is stark: “custodians [of crypto-assets] constitute an attractive attack target and have been demonstrated to be a key point of vulnerability for many cryptocurrencies.”⁵

To ensure the seamless flow of funds between all participants and systems, a public payment infrastructure needs to have interoperability at its core. It needs to be based on a common central bank platform but with linkages that will encourage private sector entities to participate in a dynamic competitive environment, much like the current cash system but with even greater scope for innovation.

The model is markedly different from the “walled garden” approach that characterizes many of today’s vertical crypto offerings and private payment services, where users are enclosed in a private world of transactions. That drives platform fragmentation and prevents any kind of network effect from taking root.

Crypto-assets, such as Bitcoin and Ethereum, are effectively standalone systems, with a lack of interoperability stemming from the different validation mechanisms used across their separate blockchains. An open CBDC design, in contrast, will offer financial service providers the opportunity to develop and launch services on a common platform at a national (and maybe even international) level, thus reducing much of that fragmentation.

An open infrastructure coupled with a collaborative environment between central banks and the finance sector – from fintechs to major retail banks – will inevitably drive waves of innovation around CBDCs. It will inspire new fintech startups, R&D, business models, and private-public partnerships that will ultimately contribute to economic growth and provide major benefits for both consumers and businesses.

The recent disruption in crypto markets may have underlined the scale of risk associated with such assets, but it also strengthens the argument for accelerating the introduction of central-bank-issued digital currency to complement – and have many of the same trusted properties as – traditional cash.

As speculative assets, so-called cryptocurrencies have clearly become attractive vehicles for many investors, but they present a narrow proposition that makes them wholly unsuitable as the basis for monetary system. What their existence has proved is that there is a demand for digital tokens that can be used in day-to-day transactions. And CBDCs are emerging to satisfy that demand.