Central Bank Digital Currencies

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Central-bank digital currencies: how and why?

The cryptocurrency boom is making the world’s central banks consider launching their own digital currencies. Why? What will they look like? Who will be first? HSBC economist James Pomeroy looks at 10 key questions about CBDCs.

1: Why are central banks looking at digital currencies? Their interest has been spurred by rise of cryptocurrencies and stablecoins and by the decline in cash usage, accelerated by the pandemic. Some are thinking about ensuring financial stability, others about raising financial inclusion, improving payments efficiency or they see digital currencies as a monetary policy tool.

2: Do central-bank digital currencies differ from cryptocurrencies? CBDCs should provide a stable, highly-efficient means of payment, whereas cryptocurrencies have high transaction costs and volatility. Cryptocurrencies use energy-intensive blockchain technology: CBDCs can use less environmentally-damaging alternatives.

3: When will we see CBDCs? We already have one: the Bahamian Sand Dollar was launched in October 2020 using a mobile app. Central banks in mainland China, Uruguay, Ecuador, Jamaica and Ukraine have pilots, but although Sweden is well advanced, developed countries are generally more cautious than emerging nations.

4: What design decisions must be made? Will CBDCs be interest bearing? Probably not, initially. Is blockchain right? Should central banks distribute the currency through the banking system or directly, despite the complexity and financial-stability risks?

5: Is privacy an issue? Anonymous transactions allow illicit activity even more easily than cash does. So should a CBDC be a token - where the unit is verified - or an account, where the user is verified?

6: How advanced is mainland China’s CBDC? The Peoples’ Bank of China’ digital currency, the e-CNY, has been piloted in several cities via lotteries and salary payments with the Shenzhen-Luhuo trial expanded this year to 500,000 residents. It also supports online payments on ecommerce platforms in trials with retailers and restaurants. Expect even wider domestic trials, perhaps with a launch close to February’s Beijing Winter Olympics.

7: And the developed world? The European Central Bank is considering a digital euro. There is a Bank of England taskforce and studies in Norway and Canada, but Sweden’s project began in 2017, though there’s no decision yet on issuing an e-Krona.

8: Are cryptocurrencies and exchange rates moving closer? Cryptocurrency volumes dwarf some emerging-market currencies and have even exceeded daily turnover of the Hong Kong dollar. But these remain very different markets.

9: Will CBDCs be used across borders? They could allow non-US firms trading with mainland China to exchange renminbi directly for foreign currencies without involving the dollar – thus helping internationalise the Chinese currency. And globally, a cross-border CBDC could lower transaction costs and improve payment efficiency. But it would require substantial co-ordination between central banks via their legal, regulatory and technology frameworks.

10: What impact will CBDCs have? A big challenge will be getting households and businesses to use them. But CBDCs offer improved security and business could pass on transaction-cost savings to consumers. And in emerging counties, they can give more people access to banking, lifting financial inclusion and growth. Also, if controversially, programmable money could control how people spend state benefits – or permit parents to supervise how children use pocket money.

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