Central banks in many different countries have been exploring the potential use of central bank digital currencies (CBDCs), which have in turn drawn the interest of cryptocurrency enthusiasts, industry participants and policy analysts. A January 2020 survey conducted by the Bank for International Settlements (BIS) showed that roughly 80% of the 66 central banks polled were doing some kind of work with these digital currencies. Further, approximately 40% of participants had started working on proofs-of-concept.
Also, some of these financial institutions appeared close to issuing a CBDC. According to the BIS poll, "central banks representing a fifth of the world's population say they are likely to issue the first CBDCs in the next few years."
What Is A Central Bank Digital Currency?
CBDCs are traditional fiat money issued in a digital form by a country's (or jurisdiction's) central bank.
It is important to differentiate CBDCs from more traditional cryptocurrencies like Bitcoin. While Bitcoin, the first digital currency to scale, was designed to provide a payment system that could function independently of financial institutions and governments, CBDCs would fall under the control of central banks.
In other words, CBDCs would be centralised, whereas Bitcoin (and many other digital currencies) were designed to be decentralised.
Types Of Central Bank Digital Currency
Retail CBDCs are digital currencies designed for use by the broader public. Central banks in emerging markets in particular have expressed interest in this idea as they aim to transition to a cashless society and therefore decrease the expenses associated with printing and handling cash. These financial institutions also want to lead the way in the Fintech industry.
This particular type of CBDC comes with many benefits, according to the World Economic Forum (WEF). For instance, it could be used to bolster the efficiency of cross-border payments, making them both faster and cheaper. It could provide benefits for savers in certain economies as well, giving them the option to earn interest without incurring the same risk of their bank going under.
Wholesale CBDCs are digital currencies designed for use by financial institutions that hold their reserve deposits with a central bank.
By leveraging these digital currencies, financial institutions could potentially lower liquidity risk, which is the chance they will not be able to cover their financial responsibilities. In addition, financial institutions may use CBDCs to reduce counterparty risk, which is the chance that one party in a transaction or deal with fail to follow through with its obligations.
Many central banks are in favour of using wholesale CBDCs because they could help financial systems become less risky, cheaper and more timely. They are not alone in being optimistic about these digital currencies, as the BIS has stated that such an innovation could improve both payment and settlement systems.
Hybrid CBDCs give financial institutions that usually lack access to central banks the ability to store their reserves at these entities. By implementing one of these digital currencies, different payment systems would be able to work together more easily, according to the WEF.
By rolling out a hybrid CBDC, a central bank could potentially focus on crucial matters, like transaction settlements, instead of needing to address multiple requirements and considerations.
What Are The Benefits Of CBDCs?
Central banks could potentially generate multiple benefits by issuing CBDCs. Research performed by the WEF outlined several of these perks in a "Policy-Maker Toolkit" designed to help government officials make well-informed decisions.
In addition to bolstering the efficiency of cross-border payments, CBDCs could potentially reduce the risks associated with interbank cross-border transfers of securities.
Harnessing CBDCs could potentially prove valuable in helping officials formulate policy, by giving them better access to financial data. In other words, policy makers may be able to do their job more easily if they have real-time data on a financial system's monetary activity.
Further, CBDCs could potentially bolster financial inclusion. However, the WEF stated that that the central bank issuing a digital currency would need to make efforts to ensure that the currency is available to everyone in its financial system.
CBDCs may also help individual states retain their existing control over money and also reap the benefits offered by cryptocurrencies.
Some central bank policy makers have expressed concerns about Libra, Facebook's proposed digital currency. They contend that by reaching billions, the currency could undermine the control that sovereign states have over money. CBDCs could help central banks manage this risk.
While many central banks have invested time and energy into exploring the opportunities presented by CBDCs, some policy makers and industry participants have voiced their concerns about implementing these digital fiat currencies.
The Bank of Japan (BOJ), for example, has stated that policy makers need to further explore how CBDCs could impact commercial banks.
Also, while Federal Reserve (Fed) Chair Jerome Powell wrote a letter in November 2019 stating that people at his financial institution are "monitoring" central banks' continued exploration of CBDCs, he stated that the Fed was not currently "developing" its own digital currency. He noted that creating a CBDC in the U.S. would raise a host of questions that would need to be addressed, including regulatory, policy and legal questions.
In early 2020, Lael Brainard, a member of the Fed's Board of Governors, offered an update during an event at Stanford. She said, "Given the dollar's important role, it is essential that we remain on the frontier of research and policy development regarding CBDC."
She stated that as a result, the Fed was "conducting research and experimentation related to distributed ledger technologies and their potential use case for digital currencies, including the potential for a CBDC." "We are collaborating with other central banks as we advance our understanding of central bank digital currencies," Brainard added.
The Fed governor further stated that in considering a CBDC for the U.S., many different variables would need to be evaluated. She mentioned "important legal considerations," noting that government officials would need to keep in mind "whether CBDC would have legal tender status."
Central Banks Working On CBDCs
Multi-Party Central Bank Working Group
In January 2020, the Bank of England (BOE) announced that it had teamed up with the Swiss National Bank, the Bank of Canada (BOC), the Sveriges Riksbank, the BOJ and the European Central Bank to evaluate potential CBDC use cases and share any findings.
The BOE also revealed that it planned to collaborate with key organisations like the BIS, the Committee on Payments and Market Infrastructures, and the Financial Stability Board.
Hong Kong-Thailand CBDC Pilot
The Hong Kong Monetary Authority (HKMA) and the Bank of Thailand (BOT) released the results of a cross-border payments project in January 2020. Working together, the two groups created a network that allowed participating commercial banks to transfer funds on a peer-to-peer basis.
The network the participating commercial banks used was a cross-border corridor based on R3's Corda blockchain. It also made use of smart contracts to enable atomic payment-versus-payment settlements of foreign exchange transactions.)
The report found multiple potential benefits to using a CBDC. It stated that "payers can directly and immediately settle payments with their payees via CBDC in a DLT network as opposed to going through via RTGS intermediaries, including banks, involving multiple debit and credit account entries.") The report also noted: "The infrastructure for these direct payments further prevents double-spending with temporal transaction orders in place."
After announcing the results of their pilot, the HKMA and BOT announced plans to work together going forward.
People's Bank Of China
Of the individual nations working on rolling out a CBDC at the time of this writing (January 2020), China is the most prominent. China is an economic powerhouse, and it has the second-largest gross domestic product of any nation in the world.
At the time of this writing, China had not only made progress toward issuing a CBDC, but had also taken several regulatory actions in an effort to help lay the groundwork for its new digital yuan.
In October 2019, Chinese lawmakers voted to approve a cryptography law, which was scheduled to become effective 1 January 2020. This legislation divided cryptography into three types: core, commercial and common.
Under this new law, people will need to use common and core cryptography to encrypt their data when sending confidential government information. Information systems that store this data will also need to harness these forms of cryptography.
The legislation "is highly complementary to many of the efforts and tasks required to roll out a CBDC," said Sale Lilly, senior policy analyst at think tank the RAND Corporation. The law applies to several Chinese government organisations as well, including the country's Ministry of Finance and the People's Bank of China (PBOC), said Lilly.
In November 2019, Shenzhen, a city in southeastern China, released a risk warning explaining that the enthusiasm surrounding "virtual currency" had grown stronger, and that certain kinds of illegal activity involving this type of currency had been on the rise as of late. The risk warning specified that the Shenzhen Municipal Government Internet Finance Risk Office
would "investigate" and address illegal activities involving virtual currency.
Later that month, it was reported that 39 exchanges were not complying with the Asian nation's trading ban.
In December 2019, it was reported by Chinese news source Caijing that the PBOC was "expected" to conduct pilot runs of its digital yuan in Shenzhen and Suzhou. According to the report, the first test was scheduled to begin in 2019, and the second was supposed to take place in 2020.
At the time of this writing, the digital yuan had not yet been released. Further, the PBOC had not provided a timeline for when it would issue its CBDC.
Bank of Japan
In January 2020, it was reported that a group of Japanese lawmakers was developing a proposal to create a digital version of the country's currency. Prime Minister Shinzo Abe voiced his support for such initiatives, telling parliament that the government was willing to collaborate with the BOJ to investigate digital currencies and how they can be used to improve the yen's use in settlement.
Businesses would also contribute to these efforts, helping Japan catch up to the latest financial technology developments, said Norihiro Nakayama, a member of parliament and vice minister of foreign affairs.
"The first step would be to look into the idea of issuing a digital yen," Nakayama stated. "China is moving toward issuing digital yuan, so we'd like to propose measures to counter such attempts." He added that the group indicated it may submit a proposal as early as February 2020.
Masayoshi Amamiya, deputy governor of the BOJ, has also stressed the urgency of exploring the possibility of a digital yen. He said, "Depending on how things unfold in the world of settlement systems, public demand for CBDCs could soar in Japan."
"We must be prepared to respond if that happens," Amamiya said, noting that it is "very important" for the BOJ to keep looking into potentially issuing a digital yen.
Reserve Bank Of India
India first explored the idea of creating a sovereign digital currency in 2018 when it formed a group for this particular purpose. In its 2017-2018 annual report, the Reserve Bank of India (RBI) weighed in on the matter.
"Rapid changes in the landscape of the payments industry, along with factors such as emergence of private digital tokens and the rising costs of managing fiat paper/metallic money, have led central banks around the world to explore the option of introducing fiat digital currencies," the report stated.
In India, an inter-departmental group has been constituted by the Reserve Bank to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency," the document added.
In spite of these developments, the RBI has not changed its prior decision to ban private digital currencies. In December 2019, Shaktikanta Das, governor of the RBI, said that the central bank's digital currency was still under development.
European Central Bank
The European Central Bank (ECB), the central bank of the eurozone, has also investigated the possible use of CBDCs, forming a task force for this purpose in December. That same month, Christine Lagarde, the president of the financial institution, stated that the organisation should be "ahead of the curve" on the matter.
In early January, the ECB released a working paper in which it explored a potential risk associated with a euro-based CBDC. The risk, the paper explained, is that individuals could potentially sell fiat for the digital currency in the event of geopolitical turmoil.
The author of the paper, Ulrich Bindseil, director general of Market Infrastructure and Payments, wrote that there may not be adequate justification for a euro-based CBDC. "It is acknowledged that solving the issue of risks of structural and cyclical bank disintermediation does not necessarily lead to the conclusion that there is a sufficient universal business case for CBDC," he said. The merits of adopting CBDC will depend on the preferences of money users and available payment alternatives." 
Bank Of France
In December 2019, François Villeroy de Galhau, governor of the Bank of France, announced that it would begin experimenting with CBDC and launch projects the following year. This pilot was intended to involve financial institutions.
One major reason for exploring CBDC was that "Creating a CBDC would give us a powerful lever with which to assert our sovereignty in the face of private-sector initiatives such as Libra," as Villeroy de Galhau said.
This statement is similar to comments previously made by Bruno Le Maire, France's finance minister. In September, Le Maire stated, according to a CNBC translation, that "all these concerns around libra are serious. So I want to say this with a lot of clarity: In these conditions, we cannot authorize the development of libra on European soil."
Riksbank, the central bank of Sweden, began considering digital currency in 2016. In November of that year, Cecilia Skingsley, deputy governor of Riksbank, said that the financial institution was exploring the costs and benefits of varying technologies.
"We need to do the homework because it's not an option for the public sector to stay on the sidelines and see the private sector cut off access to central bank money for individuals," she stated.
One major development that helped prompt this interest in a digital fiat currency was the strong preference that Swedish people have shown for cashless payments. In 2017 and 2018, the Riksbank released reports regarding its exploration of an e-krona. But the central bank actually described DLT as an "inefficient technology," and seemed reluctant to use it for any future digital currency.
In December 2019, Sweden's central bank offered fresh details, indicating that it had decided to work with Accenture to develop its digital krona. In a statement, the Riksbank indicated that "the primary objective of the e-krona pilot project is to broaden the bank's understanding of the technological possibilities for the e-krona."
Swiss National Bank
Switzerland's government has looked into using CBDC, but members of the cabinet expressed less-than-optimistic responses to this possibility. "Universally accessible central bank digital currency would bring no additional benefits for Switzerland at present," the cabinet said. "Instead, it would give rise to new risks, especially with regard to financial stability."
The group of government officials did provide additional clarity, stating that "the further development of central bank digital currency that is restricted to financial market players would appear to be a more promising strategy."
Bank Of Korea
In December 2018, the Bank Of Korea (BOK) announced that it was looking to create a task force of individuals to explore CBDC. In a report named "Monetary Policy for 2020," the financial institution said that "The Bank will continue to build on the research into new innovations such as distributed ledger technology, crypto assets, and CBDC, and play an active role as overseer to enhance security of the settlement systems."
BOK looked into the possibility of using a CBDC in the past, finding that banks may encounter less demand for services if the Asian nation used a digital fiat currency.
Bank Of Canada
The Bank of Canada (BOC) has looked into the possibility of issuing a digital currency, previously conducting experiments involving transactions. Its officials have made varying statements that made the financial institution seem open to the possibility of using a CBDC.
Carolyn Wilkins, senior deputy governor of Canada's central banks, co-authored a paper in 2019 that stated that "the emergence of cryptocurrencies, paired with a declining use of cash in transactions, has increased interest in the question of whether a central bank should issue its own digital currency."
However, the paper said that several considerations would need to be addressed before determining whether a CBDC would be in the public's interest.
Timothy Lane, deputy governor of the BOC, also weighed in, stating in November 2019 that "we can't really see a compelling reason for doing it under current circumstances, but we can plausibly see the world changing in a way that could actually make it something we'd want to consider very seriously."
In December 2019, the Central Bank of The Bahamas announced that it was going to test a digital version of the nation's dollar, starting out with the district of Exuma. The nation's CBDC, named "Sand Dollar," was designed to be a digital currency and not a cryptocurrency, according to bankers.
The nation has been working to bolster financial inclusion since the early 2000s, and the country's digital currency could potentially help the Bahamas achieve this long-held goal.
After testing the digital dollar in Exuma, the nation plans to pilot the CBDC in Abaco.
Central banks all over the world have announced plans to look into digital fiat currency. Some of these central banks have made more progress than others, with certain financial institutions merely exploring these digital assets and others running pilot programs.
Market observers will need to watch closely in order to catch all the different developments that materialise in this space. CBDCs could potentially revolutionise the financial system, reducing settlement times, lowering costs and providing policy makers with more and better data on the financial system.
At the same time, no major economy has implemented a CBDC, so it is impossible to know exactly how well one of these currencies would operate in real life.