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Prepare for the digital age with Central Bank Digital Currencies

Edward van Dooren

Strategic Advisor

1 July 2021

Prepare for the digital age with Central Bank Digital Currencies

Digital currencies are all over the news. The European Central Bank (ECB) recently published an extensive analysis of the public consultation on a digital euro. Facebook would like to launch a pilot for its own cryptocurrency Diem before the end of the year. Meanwhile Sweden is testing digital currency e-krona and El Salvador is even the first country in the world to embrace bitcoin as legal tender.

Yesterday’s EBAday session, moderated by Robert Bosch, partner of BearingPoint, was all about Central Bank Digital Currencies (CBDC). What exactly is it, what are the problems we are we seeking to address with it and – most importantly – do we really need CBDC?

Four dimensions of classification

Whereas in the financial world we are becoming increasingly familiar with terms like open banking and instant payments, CBDC and digital currencies – as relatively new developments in the market – still require some explanation. Because there are different types of digital money, it is challenging to come up with a specific and precise definition.

According to Marion Laboure, Macro Strategist at Deutsche Bank and lecturer in economics and finance at Harvard University, discussions about digital currencies often lose focus because there are many different concepts. “In order to clarify all the different concepts, there are four dimensions that should be kept in mind in terms of classification: who is the issuer, accessibility, support and transmission.” She fill in the dimensions of the digital euro: “In the case of the digital euro, it’s the liability of the central bank, it will be widely accessible, it’s an electronic form of money and peer-to-peer (P2P)-transmission is possible instead of interbank.”

Added value of digital currencies

Before we ask ourselves whether we need digital currencies at all, the question is in what ways, and in what situations, it can add value. According to the experts, that depends on the design principles. Mallela explained that for commercial banks, digital currency is about creating new infrastructures that provide the ability to have value-added products and services and leveraging programmability. “We move towards an economy with machine-to-machine payments, which requires agility and flexibility. That’s an area where digital currencies can play a role for commercial banks.”

Dirk Schrade, Deputy Head of Department Payments and Settlement Systems at Deutsche Bundesbank, recognizes multiple reasons to consider deploying digital currencies, and in particularly CBDC. “We see developments caused by digitization but still we only provide cash to the general public today. Especially in crisis times, trust in overall monetary system could be improved by providing a public form of digital money. As CBDC is a claim to the central bank, it adds additional value (e.g. to use in e-commerce, peer-to-peer instead of using interbank clearing) and is a sign of supporting innovation. CBDC could therefore help to promote an open and innovative ecosystem.”

Another discussed opportunity of CBDC lies in the area of cross-border payments. Mallela explained that multi-CBDC (mCBDC) could play a key role in connecting all kinds of domestic payment networks. “To promote cross-border payments, it’s important to enable the same real-time experience. This can only be done with all parties cooperating. All involved players have a role to play. Even with mCBDC, commercial banks play a role in distribution and building value in products and services (e.g. FX services).”

Financial instability risk of CBDC

However, there is also another side of the story, as Sophia Bantanidis, Head of Regulatory Strategy and Policy at Citi pointed out. “On the flip side of the coin, CBDC can cause financial instability. Payment systems work best as a public and private partnership and payments with CBDC shouldn’t be an exception to this. If anything’s done that potentially crowds out the private sector, that could cause instability.”

The need for Central Bank Digital Currencies

The real question of the session was whether we do or do not need Central Bank Digital Currencies. Even though some doubts were expressed in yesterday’s session, it’s fair to say there is one clear answer. The question no longer seems to be do we need CBDC, but when is it coming? It raises both questions and opportunities. We see so many innovations and opportunities; they just need get more structure. I’m excited to see where we will be standing with CBDC in 5 years’ time.