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  1. Special Reports
August 23, 2021

Retail CBDCs: the next payments frontier

By Mohamed Dabo

Retail central bank digital currencies (Retail CBDCs) promise to provide cash-like safety and convenience for peer-to-peer payments. Mohamed Dabo looks at an IBM research that predicts the advent of a retail CBDC within the next couple of years.

retail CBDC is aimed to take on traditional attributes of physical cash and would be used by consumers and businesses (relative to wholesale CBDC, which would be used by financial institutions).A retail CBDC would represent a cash-like claim on the central bank; and could even come to replace cash altogether. Or rather to become a digital form of cash.

So, this type of currency would be used to pay for things, to send money to friends and family, and possibly to receive government incentives and subsidies.

Transfer payments, such as those provided by governments to people during the Covid-19 crisis, would be made faster and easier if that money could be deposited directly into digital wallets.

In short, retail CBDCs would help advance the digitalisation of payments and the economy as a whole.

Retail, wholesale, and international payments using CBDC would expand choices, enabling more diversified payment systems and greater autonomy for the central bank.

A study by IBM Corporation has concluded that we are likely to witness the introduction of a central bank – that is fiat – retail digital currency within the next couple of years, either as a complement to or as a substitute for notes and coins.

Crypto boom accelerates central bank digital currency plans
Cryptocurrencies have challenged the traditional pillars of the financial system.Central banks are faced with the possibility of individuals being able to store, spend and move value en masse without relying on fiat currency.

Policy-makers and regulators will not simply sit on the fence and watch as incumbent structures face these new threats.

Most central banks view cryptocurrencies not as money but as speculative assets, and regulators and governments are approaching them as such.

Even in situations where cryptocurrencies are used like money, they represent a small fraction of the volume of fiat currencies in circulation and will remain the preoccupation of a minority of outsiders.

More recently, Facebook’s Libra – a prospective privately-issued stablecoin that could challenge the traditional global reserve currency system – has enlivened the CBDC discourse.

Some policy-makers’ implementation trials have shown promise for their specific use cases, and a handful of central banks are setting precedents by attempting to establish fully-functioning retail CBDCs.

Central banks are responding to the reality that digital currencies, either privately or publicly issued, will soon be part of the global monetary system, and that it is in their interest to ensure they are neither left behind nor displaced.

The Covid-19 effect: a changing payments landscape

Fear of Covid-19 contagion through bank notes and coins has accelerated a move away from cash to digital payments – a move that has also reinvigorated digital assets and reinforced discussions about CBDCs.It’s probably no coincidence that the Chinese government has begun to issue blockchain-powered digital currency to its citizens.

France has issued a call for CBDC experiments and the Dutch Central Bank published its own thoughts on CBDC.

Fear of coronavirus-contagion wasn’t the only reason why CBDC received more attention recently.

CBDC and other digital assets have been touted as a tool that could improve the delivery of government funds to those most in need.

Opportunity for CBDCs 

In response to these shifts and to changing consumer behaviours, central banks are reviewing national and international payments architectures.There is significant potential for CBDCs to play a powerful role in upgrading incumbent centralised payments and settlements systems. Central banks should grasp the opportunities presented by emerging technologies.

CBDCs can be defined as a digitalised instrument issued by the central bank for payments and settlements. They can be described simply as an electronic extension of a form of cash.

It is different from money held in central bank accounts, as the public may be able to access the CBDC, which remains a liability on the central bank balance sheet.

To date central banks have been unconcerned with the threat of being rendered obsolete by cryptocurrencies. In their view, privately-issued cryptocurrencies are not currencies, but crypto-assets.

The usability thereof diminishes as they become speculative vehicles with volatile purchasing powers. CBDCs, denominated in an established fiat currency, could resolve these problems.

The marginal costs for issuing such liabilities by central banks are low, since they are considered to be the most credit-worthy institutions in a country’s financial system.

In the retail sector, efficiency gains and policy benefits may accompany the uptake of a digital version of sovereign fiat currency – one that adopts and exceeds the technical benefits of a cryptocurrency, while inheriting all the underlying trust of a sovereign currency.

Trust in sovereign currencies
Technology companies treat Facebook’s old mantra, ‘Move fast and break things’, as a call to arms as they go about disrupting traditional industries, such as banking.Privately-issued money is neither new nor rare. Banks create private money, including commercial paper, bankers’ acceptances, bills of exchange, and sale and repurchase agreements.

There have been more than 60 cases of notes issued by private banks and backed by loans and bonds.

The risk with private money, however, is that people may lose trust and question the value of their money.

The classic image of a ‘run on the bank’ by people to claim safe government money was translated to the digital age when people started questioning the value of repos and rushed into US Treasuries. Such runs are costly.

One can argue that publicly-issued money, specifically cash, is the most trusted form of money. This is most visible during crisis times – when customers and investors shift money into liquidity and risk-free assets, cash is often the general population’s first choice. As such, demand for sovereign paper currency in times of financial instability produces a sustained need for public access to cash.

Because CBDCs would inherit trust from their sovereign issuers, credit risk would be removed, and stability of value provided.

This is crucial if a CBDC is to act as medium of exchange and store of value. Liquidity risk would be removed, as the central bank could issue new CBDC through the traditional means of purchasing securities to increase the money supply.

This contrasts to private digital currencies, where liquidity cannot be injected unless the underlying asset is purchased.

In the case of Libra, this could be an issue if its underlying basket incurs supply shortage or becomes negative or zero yielding. Blockchain has become increasingly prominent as the underlying technology featured in CBDC trials.

One question put forward frequently by central banks is whether this technology is truly a disruptive innovation, or just a solution looking for a problem.

Central banks are at the forefront of testing these new technologies. There have been successful experiments with wholesale systems, and, more recently, central bank trials for high-volume, low-value retail payments have shown positive results.

However, central banks state that technology is less of a determinant for CBDC implementation. It is policy that should drive the decision for CBDC adoption and specify the technology used. Technology should not determine the use cases for CBDCs.

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