CBDCs: What's Not To Love? - Flow – Deutsche Bank

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  CBDCs: what’s not to love?

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• CBDCs: what’s not to love?

13 April 2022

As Jamaica prepares to launch its own central bank digital currency and China’s digital yuan is fast gaining traction, Deutsche Bank Research’s recent white paper on the future of cash offers a progress report on CBDC launches and initiatives. flow shares its core findings

China is fast rolling out the digital yuan (e-CNY), its central bank digital currency (CBDC) that debuted at the Beijing Winter Olympics. The People’s Bank of China (PBoC) has announced1 that 11 more cities will be added during 2022 to 10 centres where the e-CNY is already being piloted. Sweden is closest to becoming a cashless society, with notes and coins now representing only 1% of the country’s GDP and the electronic krona (e-krona) in development since 2017. Cash increasingly resembles a dinosaur in the age of digital transactions, even if it is not doomed to extinction just yet.

In the latest of Deutsche Bank Research’s series on the progress of digitisation The Future of Cash: Central Bank Digital Currencies (March 2022), Macro Strategist Marion Laboure recaps the history of cash and CBDCs and examines future trends. As she reports, despite the changes wrought by a global pandemic of more than two years in many countries people are not yet ready to bid farewell to cash – particularly for their smaller, regular in-store purchases.

Figure 1: There are some wide disparities across countries in terms of cash in circulation

(Currency-GDP ratio)

Source: Central banks, International Monetary Fund, World Economic Outlook Database, Deutsche Bank

Nonetheless, global trends evidence a shift towards digital and cashless societies – as illustrated in Figure 2, the pace of change has been accelerated by the Covid-19 pandemic – and Laboure notes that for business-to business (B2B) transactions “cash and cheques are two species close to extinction”.2

China’s progress has not been matched by other major economies though. In the US, the Federal Reserve plans a 2023 or 2024 launch for FedNow, a real time payment (RTP) system to support faster payments in the US. The Fed is considering the use of digital ledger technology (DLT) for wholesale payments, which could help eliminate inefficiencies in the current US economic infrastructure.

The European Union is stepping up its digital push via digital wallets; in June 2021 unveiling its plan for enabling Europeans to digitally identify themselves and to utilise both public and private services via their mobile phones at no extra cost and with fewer obstacles. And worldwide, many countries have steadily raised the limit for contactless payment transactions; for example, the UK’s figure was initially set at £10 in 2007 and has since increased five times – most recently from £30 to £45 in April 2020 and to £100 in October 2021.

Figure 2: The Covid-19 pandemic accelerated the shift to digital payments

(Most preferred method of payment)

Source: Deutsche Bank dbDIG.

Warming to the CBDC concept

Another major sea change has been in the perception of central bank digital currencies (CBDCs), which less than a decade ago still attracted responses ranging from dismissal to hostility. Since late 2018 however, Deutsche Bank Research reports have tracked a steadily more positive attitude towards CBDCs from central banks. A growing number are undertaking CBDC projects and Covid, again, has been a catalyst in accelerating the change. In October 2020, the Central Bank of the Bahamas issued the Sand Dollar, a digital version of the Bahamian Dollar, since when operational retail CBDCs have also been issued by the Eastern Caribbean and Nigeria, with Jamaica expected to follow before the end of June 2022.

"With more than 1.4 billion inhabitants, China’s CBDC has the potential to advance digital currencies into the mainstream"Marion Labour, Senior Strategist, Deutsche Bank Research

But these contenders are relative minnows against China’s e-CNY initiative, which has been piloted for the past two years by the PBoC and is set to challenge the country’s established payment methods and instruments – principally AliPay, WeChat Pay and the UnionPay bank card. Even before the Beijing Winter Olympics and its official release in app stores last January, the e-CNY app nearly doubled its number of unique users between October and December 2021 and ended the year with 261 million according to PBoC data.

“With more than 1.4 billion inhabitants, China’s CBDC has the potential to advance digital currencies into the mainstream,” notes Laboure. The declared main purposes of the e-CNY are to replace paper money and improve financial inclusion, although e-CNY are not issued directly to Chinese citizens. There are also other likely contributory factors to explain the digital yuan’s progress, such as China’s trade war with the US.

Ten million corporate accounts have been created and the report also examines the characteristics of the corporate e-CNY wallet, which reports suggest is now being used for construction project payments. The main benefits are the cost savings from it being free of charge, efficiencies from real-time payments being possible and the convenience of cross-bank transfers.

• Different from individuals, corporate clients have to register e-CNY wallets on a real-name basis (i.e. provide business license, etc.).
• Corporate clients could top-up/withdraw e-CNY from/to their bank account in the same bank on a real- time basis.
• As per regulation, caps are set on transactions and balances of corporate e- CNY wallets.
• Transfer between two e- CNY wallets is on a real-time basis and free of charge.
• No interest on e-CNY. Corporate clients could consider converting out e-CNY to bank accounts within the day.

Figure 3: Corporate e-CNY wallet

Source: Deutsche Bank

Further down the track

By contrast, Laboure summarises the EU’s CBDC progress as “not there yet” but with the possibility of a 2025-26 launch. The European Central Bank (ECB) announced in July 2021 plans for a 24-month investigation phase towards a digital euro project, which subsequently began last October. Its scope involves design and distribution options, impact on markets, and required changes to EU regulations. Once this project concludes – and assuming that the e-euro is given the go-ahead – work on the prototype is likely to begin at the end of 2023. The EU’s attitude could be summarised by what ECB Executive Board member Fabio Panetta told MEPs last November3: “If we don’t satisfy this demand, then others will do it.”

Meanwhile in the UK the Bank of England and the Treasury set up a joint CBDC taskforce in April 2021 to work with other UK authorities in reviewing the potential for a digital pound. But enthusiasm seems lukewarm at best; a UK Parliamentary report published in January 2022 was titled ‘Central bank digital currencies: a solution in search of a problem’, concluded there was no convincing case to suggest that the UK needed its own CBDC and that the potential advantages could be offset by significant challenges for financial stability and privacy protection.

A similar ambivalence is evident in the US, where Federal Reserve Chairman Jerome Powell has consistently maintained that the central bank is not concerned with not being first in the CBDC race and that the US dollar’s status as the world reserve currency already gives it a “first-mover advantage.” However, in August 2020, the Fed announced that it was expanding experimentation on technologies related to digital currencies and in January this year it released a white paper assessing a potential digital dollar. The paper highlights five potential benefits and five key risks that a CBDC would create and solicits public comment on 22 questions, with the consultation period ending on 20 May.

What problems could a Digital Dollar aim to solve?

Risks

Inclusion of those who are unbanked or under-included in the formal financial system Lower the cost of digital payments Improve speed Enhance security Enable other financial innovation through easier tracking of useful transaction data Improve cross-border payments Support the existing international role of the USD as the preeminent currency of choice for trading, settlement, savings and investment

Disintermediation of banks Structural change of the financial system, potential disruption of funding markets (e.g. deposits) System stability Efficacy of monetary policy transmission (is interest paid on CBDC holdings?) Privacy and anonymity Financial crime prevention Operational cybersecurity risks

Figure 4: The digital dollar: pros and cons

Source: Deutsche Bank Research

One issue that Laboure’s report does not explore is whether Russia, traditionally hostile to unregulated cryptocurrencies such as Bitcoin, might also launch a CBDC. On 15 February, only days before the invasion of Ukraine, the Bank of Russia announced that it had started the pilot stage of the digital rouble and three banks had already supported pilot transactions for clients. Whether sanctions imposed by the West accelerates or derails this process remains to be seen – Russia might learn to Bitcoin after all if it serves as a means to circumvent the financial punishment now being heaped on the country.

Deutsche Bank Research report referenced:

Chartbook: The Future of Cash – Central Bank Digital Currencies? by Marion Laboure (March 2022)

Sources

1 See https://reut.rs/3vaw3Ss at reuters.com 2 For more information on the relevance of CBDCs for B2B payments see flow article on “Why CBDCs could be a gamechanger for B2B payments” 3 See https://politi.co/3O7eBH6 at politico.eu 4 See https://bit.ly/3rmBOLT at coindesk.com

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