Central Bank Digital Currencies (CBDCs): Implications for the Global Financial System

Central Bank Digital Currencies (CBDCs): Implications for the Global Financial System

The development of a Central Bank Digital Currency (CBDC) has been announced by numerous prominent Central Banks worldwide. The development of CBDCs may be perceived as a declaration of monetary sovereignty—possibly the final opportunity to do so in the context of technological advancement—but it also presents numerous socio-economic obstacles. This article critically examines these issues, including the configuration of a CBDC system, in relation to the level of involvement permitted for the commercial banking sector, through the lens of policy papers published by global regulatory bodies (e.g., the Bank for International Settlements (BIS) and International Monetary Fund (IMF). It also discusses the utility of various technologies that central banks have proposed and their influence on the protection of consumer privacy. This article explains that CBDCs are a final frontier in the field of digital money and digital payments, rather than merely heralding the return of the state in the domain of money and payments.

Additionally, it is possible to argue that any monetary policy and financial stability challenges that CBDCs may present could be effectively addressed by employing interest rates and internally imposed limits on deposits and withdrawals. The uniformity of the means of exchange that may be employed for international payments is facilitated by the digitization of international payments. The primary concern regarding the cross-border use of CBDCs is technological connectivity, which remains an unresolved and challenging issue. A new era of faster and seamless cross-border payments could be initiated if connectivity is guaranteed, resulting in the widespread use of CBDCs across borders. This could lead to intense competition among nations to promote their own CBDCs. This could potentially result in reduced transaction costs for cross-border payments, which would in turn significantly reduce the cost of migrant labor remittances to their home country. Consequently, the cross-border use of CBDCs would contribute significant social value. The adoption of a foreign CBDC would be equivalent to currency substitution, as CBDCs will have an exchange rate of one equals one in relation to the underlying currencies. In fact, numerous countries worldwide have experimented with dollarization, which involves replacing their local currency with the USD.

A critical assessment of the justifications for the development of CBDCs

This raises a question that appeared to have been resolved by the fact that central banks typically implement monetary policy through the balances of commercial banks, thereby enabling the proliferation of private money in the economy. The concept of CBDCs is a response to the recent trend of the increasing digitization of money and privatization of payments. Better financial inclusion is one of the benefits of CBDCs that has been discussed, particularly in countries where access to a commercial bank branch network is costly. The private sector has largely dominated the digitization of money and payments, which has presented a variety of challenges for public policymakers. These challenges include the identification of methods to ensure universal and affordable access to private payment networks and the protection of consumers from cryptocurrency scams.

Several countries have not responded to these challenges in the manner that was anticipated, namely by implementing a more extensive form of regulation for cryptocurrency markets and private payment system providers. Rather, they have introduced a competing digital currency and payment system. The Bank of International Settlements has enumerated the primary justifications for the implementation of CBDCs. These payments are finality, which counteracts the market power of private purveyors of payment systems. This ensures that innovation is equitable for all citizens and that consumers have uninterrupted access to payment systems.

Cross-border utilization of CBDCs?

International payments, such as migrant remittances and international inter-bank transfers, are characterized by their high cost and slow efficiency, which presents a potential opportunity for the cross-border use of CBDCs. The potential for a new era of international payments that are seamless is present with the cross-border use of CBDCs.The most critical prerequisite for the establishment of functional cross-border CBDCs is the protection of technology connectivity between payments systems in various countries. Another challenge that has been overlooked until recently is the need to address energy consumption and carbon emissions, which are also influenced by system architecture and design.

Additionally, the extent to which CBDCs will facilitate and reduce the cost of cross-border payments will be contingent upon the cooperation of the respective central banks, which will guarantee the connectivity of their systems and the feasibility of cross-border payments. In this context, an open legal question is whether the property laws and tracing remedies of both the issuing and adopting countries would apply to unlawful cross-border transfers of CBDCs. The conflict of laws rules in private international law (e.g., the rules governing cross-border holdings of digital assets and the rules pertaining to cross-border holdings of digital assets/dematerialized assets) could be examined to address this inquiry. The principles’ application in this context may be contingent upon the location of the CBDC ledger or the central bank that manages the accounts.

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A concise examination of certain legal and economic aspects of CBDCs

Is it feasible for CBDCs to function as a currency?

In principle, CBDCs will be considered a form of money if they fulfill the three functions of money, which are as follows:

a. The token functions as a means of exchange.
b. The token functions as a value storage device.
c. The token that functions as a unit of account.

Most central banks and international financial regulatory bodies attribute the aforementioned properties to money. The issuing state has the authority to designate CBDCs as legal tender, as they are likely to be classified as fiat money, albeit in a digital form. In addition, the sociological theory/approach to money will undoubtedly be satisfied by CBDCs that are extensively used by the public for the emergence/creation of money. CBDCs can indeed be classified as money, a distinction that cryptocurrencies do not possess. If CBDCs are also designated as legal tender by specific countries, they will also meet the criteria established by the Chartalist approach to the emergence/creation of state money. It is important to emphasize that cryptocurrencies are not compatible with either theory. In contrast to cryptocurrencies, CBDCs will satisfy both the sociological and Chartalist definitions of money.

The concept of a Central CBDC appears to be the response of governments and central banks to the recent revolution in finance, payments, and money. CBDCs are essentially a digital representation of fiat money. There has been a significant amount of discussion regarding CBDCs worldwide, and numerous discussion papers have been published by prominent central banks, including the US Federal Reserve, the European Central Bank, the Bank of England, and those in China, Japan, and Singapore. However, there is no agreement on the architecture of CBDCs.

Financial stability and CBDCs

The primary concern in this context is that CBDCs may induce or initiate a run on commercial banks by means of mass withdrawals of bank deposits, which would enable savers to convert their funds into CBDC holdings that are remunerated. It is possible that central banks could establish a limit on the quantity of CBDC that an individual user can possess, and banks in general could restrict the amount that an individual can withdraw at a single time. The likelihood of a mass exodus of bank deposits would be reduced by these measures. Additionally, the extent to which CBDCs compensate holders with interest rates will be dependent on whether they are sufficiently high to compete with banks’ savings accounts. In the event that interest is payable, the rate associated with remunerated CBDCs may be sufficiently low to prevent them from competing with savings accounts offered by commercial institutions.

Monetary policy and CBDCs

Although CBDCs may result in the centralization of monetary policy, this does not inherently imply that they would result in an increase in interest rates. The control of the money supply by countries has been challenged by the emergence of a variety of digital quasi-currencies. Consequently, the question of whether CBDCs would increase the amount of money in circulation, thereby leading to inflation, is raised. However, this concern is primarily specific to retail CBDCs, which have the potential to facilitate the consumption of households. As CBDCs are merely a complement or replacement for fiat money that is already in circulation, it is improbable that they will result in an increase in demand that leads to inflation or have a significant impact on the current quantities of money in circulation in the economy.

In general, it is difficult to determine the immediate benefits of CBDCs, particularly in the context of retail payments, in a market with advanced payment systems. The only possible exception is that they may serve as a means for governments and central banks to regain control over the money supply and payments in an economy, as well as in the implementation of monetary policy. The privacy of payments is influenced by infrastructure and technology solutions.

Possible CBDC models

In general, CBDC systems may be configured as either wholesale or retail systems. The complete involvement of the commercial financial sector in CBDC payments and the safeguarding of CBDC wallets would be necessary for a wholesale system. Conversely, a retail CBDC would entail the utilization of CBDCs for payments made by modest businesses and individuals (e.g., coffee shops, book shops). The private banking sector’s participation would address numerous regulatory compliance issues, particularly the issue of which entity is responsible for conducting Know Your Customer (KYC) controls and the onboarding process of such individuals onto the CBDC system. Currently, banks perform these steps on their customers as part of their routine operations. Otherwise, it is uncertain which participant will be responsible for conducting these tests if CBDCs are stored in individual wallets that are owned and managed by the retail holders. For example, it is unlikely that merchants will be obligated to implement these controls when they serve as the point of entry to the CBDC system.

The issue of compliance with applicable regulatory regimes and the impact they will have on the architecture of the CBDCs will also be addressed by the selection of the CBDC model. If commercial banks are included in the system, they will be responsible for the user onboarding and KYC controls, as well as regulatory conformance with respect to the various requirements that pertain to money transfers and payments. In contrast, if the entry point is through a network of private merchants, it will be exceedingly challenging to compel merchants to implement regulatory controls in the event that a consumer makes a payment through their systems. Additionally, there have been proposals that the public could maintain the account directly with the central bank if the CBDC is account-based.

Conclusion

CBDCs are the final frontier in the gradual disappearance of cash in the physical form and in day-to-day transactions, potentially reinforcing the use of fiat money by the broader public, and in the increasing digitization of money and payments. Additionally, they appear to be the final opportunity for state governments to assert their monetary sovereignty as the exclusive providers of money and payments in national economies. However, it would be imprudent for CBDCs to completely replace currency in a physical form in the long term. The initial rationale is that money in a physical form has a unique advantage in terms of simplicity of use, for example, inclusiveness, as it does not exclude the digitally handicapped. The second reason is that currency in the tangible form (cash) can serve as a useful and potentially critical backup in the event of an emergency, such as a disruption of technology, or an act of God, such as a physical disaster or manmade disasters, such as war.

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