With the vertiginous rise and tumultuous volatility of cryptocurrencies such as Bitcoin, the success of a new form of digital currencies known as stablecoins and the decline of cash, central banks and governments are striking back.
They get ready to start issuing digital money, referred to as Central Bank Digital Currency or CBDC, an electronic version of notes and coins.
This new form of central bank-issued money will complement cash and be accessible to the general public for transactions using various devices.
Although there is no single CBDC issuance framework -different approaches are being investigated- the good news is that these digital currencies could make payments more efficient, improve fiscal and monetary policies and boost financial inclusion.
However, the introduction of digital currencies raises considerable challenges, including cybersecurity and privacy protection.
In this article, we discuss the key benefits and potential of CBDCs, provide an overview of the current landscape of projects in 2023 and present some of the challenges that CBDC deployments will face.
One such challenge is the support of offline CBDC payments, and the article is complemented by a position paper from Thales describing how offline CBDC payments could be designed.
Digital cash: from cryptocurrencies to government-backed digital currencies
What is digital money?
Digital money refers to encrypted tokens or "coins". Those can be stored on a decentralised and distributed online ledger using blockchain technology. This represents a familiar manifestation of digital cash, distinct from regulated forms and private cryptocurrencies like Bitcoin. Other forms of Digital Money remain controlled by central authorities such as the Digital Yuan.
What are stablecoins and CBDCs?
Stablecoins were developed to offer the tradability of cryptocurrencies without price volatility. They peg their value to an existing currency, one for one. For example, one of the largest private stablecoins by market cap, Tether, is tied to the US dollar. One Tether equals one US dollar.
Central banks have accelerated their efforts to explore, test and launch their own stable digital currencies. These Central Bank Digital Currencies (CBDCs), issued by government-mandated financial institutions, hold equal legal status as their fiat currency counterparts. For example, DCash is the CBDC issued by the Eastern Caribbean Central Bank for seven countries.
CBDCs could be used for various purposes by individuals and businesses (retail CBDCs) and financial institutions for interbank transactions (wholesale CBDCs.)
Download the whitepaper
"Considerations on offline Central Bank Digital Currency payments".
e-Money: facts and figures
Over thousands of decentralized cryptocurrencies exist, with an aggregate market value exceeding $1 trillion in August 2023.
The FTX bankruptcy in late 2022 caused a ripple effect in the volatile crypto market, leading to a loss of billions and a valuation drop below $1 trillion.
Bitcoin's market cap makes up almost half of the overall market capitalization.
JAM-DEX (Jamaica) 2022
Digital Yuan or e-CNY (2022)
130 countries are exploring a CBDC as of August 2023. Sixty-four are in the advanced phase. 9 G20 countries are in the pilot phase.
Countries with digital currency: 11 have launched a digital fiat currency. In 2020, the Bahamas became the first nation to mint digital Bahamian dollars. DCash is designed for use with the East Caribbean dollar, a digital currency launched in March 2021 by the Eastern Caribbean Central Bank. Montserrat and Anguilla joined this CBDC in December 2021. The Bank of Jamaica launched JAM-DEX in July 2022.
The Philippines, Kenya, Denmark, Singapore, Haiti, Ecuador and Finland have cancelled their projects.
Why central banks want to launch digital currencies (CNBC Report- February 2021)
What are the potential benefits of central bank-backed digital money?
With CBDCs, central banks are looking to leverage the flexibility of cryptocurrencies for economic development while limiting their potential risks to ensure financial stability.
More precisely, central banks put forward three significant benefits to issuing digital cash:
The need for cash substitutes
CBDC addresses the steady decline in cash in payments, a trend going on for years now.
With the regular rise in online shopping, the array of electronic payment options, including contactless at physical shops and restaurants, are gradually replacing payments with coins and banknotes.
With a 42% decline from 2019, cash will be the least-used payment method in 2025.
CBDCs for financial inclusion
One of the essential drivers for CBDCs' popularity is its ability to nurture broader financial inclusion. CBDCs would allow everyone to generate electronic payments in central bank money.
In particular, users wouldn't need a conventional bank account to leverage digital cash.
CBDCs would offer a new way to transfer money digitally, including peer-to-peer for the unbanked.
Efficiencies in the payment system
With government-backed currencies, this type of transaction would not require going through different banks (from one bank deposit to the other) and take several days. It could all happen in seconds on one digital ledger and slash associated costs.
CBDCs could streamline payment systems by removing unnecessary intermediaries in payment processes by their very nature.
Without the need for transactions going through different banks (from one bank deposit to the other), CBDC payments will be measured in seconds at a reduced cost.
According to the World Bank (July 2022), about 1.4 billion people are financially excluded.
The costs of being unbanked or underbanked (Forbes 28 July 2020)
Inclusion by design: crafting a CBDC to reach all Americans (Kansas City Fed 2 December 2020)
How Fintechs impact cross-border payments and remittances (Payments Journal 17 December 2021)
CBDCs can address the risks of new forms of private money creation
Central Banks have the mission to maintain monetary and financial efficiency and stability in the public interest.
CBDCs represent a response to the disruptive forces created by cryptocurrencies and alternative finance (aka DeFi for Decentralized Finance) on national payment ecosystems. The Bank of England discussion paper stated they could "avoid the risk of new forms of private money creation".
Fan Yifei, a deputy governor of the People's Bank of China (PoBC), put it more bluntly (July 2021 on MSN Money) when talking about the private digital currencies that have turned into speculation tools: "There are potential threats to financial security and social stability".
The PBoC is opposing the "disorderly expansion of capital".
Government-backed digital cash is about to become a reality if you are in China.
What is the digital currency landscape in August 2023?
The potential of transformation and innovation of CBDCs has prompted over 130 central banks to start exploring the topic with projects at various stages, from research to proof of concept, pilot or deployment. Hereafter are some significant examples:
China is running ahead in the global CBDC race with its digital yuan.
The People's Bank of China (PBoC) has been doing large-scale live tests since April 2020.
Introduced by the People's Bank of China (PBOC), the e-CNY enhances payment system efficiency, backs up retail payments, and promotes financial inclusion.
China's digital yuan, the e-CNY, has experienced substantial transaction growth, reaching 1.8 trillion yuan ($249.33 billion) by the end of June 2023, up from over 100 billion yuan in August of the previous year.
This growth is significant despite the e-CNY constituting only 0.16% of China's M0 money supply.
Emerging as an alternative to Alibaba and Tencent in payments, the e-CNY aimed to replace physical cash and offer a secure option for commercial platforms.
While e-CNY adoption remains limited domestically, China aims to leverage it for cross-border payments, potentially challenging the dominance of the U.S. dollar in global transactions.
Project mBridge, a wholesale CBDC pilot led by China, focuses on large-value cross-border bank transfers, aligning with global efforts to reduce dollar reliance in trade and reshaping financial geopolitics.
U.S. digital currency: In a state of debate
As of August 2023, no decision has been taken on issuing a CBDC in the U.S. payments system.
Despite the potential benefits, the transition to a digital dollar is anticipated to be a gradual process, with years likely passing before any concrete developments occur.
The topic of a general-purpose Fed digital dollar is still very much debated.
President Joe Biden's executive order in March 2022 directed the exploration of a digital dollar, indicating a degree of interest from the government in understanding the implications and feasibility of a CBDC.
The Treasury is leading an interagency working group to study the potential of a U.S. CBDC.
Fed officials have, however, expressed varying opinions, with some doubting the necessity of a CBDC, according to Forbes (7 July 2023).
Some officials and lawmakers, like Rep. Warren Davidson of Ohio, strongly criticize the idea of a CBDC, expressing concerns about potential centralized control, surveillance, and loss of financial privacy.
They argue that money should remain a stable store of value and a means of exchange rather than a tool for authoritarian control.
Overall, the U.S. remains in a phase of evaluation and discussion, with various stakeholders weighing the pros and cons of introducing a digital version of the national currency.
The debate revolves around balancing innovation, financial inclusion, privacy, and potential risks associated with centralized control.
U.K. digital currency: Britcoins for 2025 at the earliest
The U.K. is exploring the development of a digital version of its currency - the digital pound. One key goal is to promote innovation in domestic payments.
However, the Bank of England (BoE) has not decided whether to proceed with a digital currency and is still in an exploratory phase.
The Bank of England and the Treasury are targeting a decision on whether to launch Britcoin (aka digital pound or digital sterling) in the middle of the decade.
Interestingly, Tom Mutton, director of fintech at the Bank of England, said in a recent interview that CBDC would most likely be used with a phone app. Still, special attention should be given to including those who don't have a smartphone. That's why prepaid cards are being explored as well.
Apps and cards are to be provided by private-sector companies.
Digital cash in European wallets no sooner than 2027
The European Union is moving at a similar pace in the matter.
The digital euro benefits from the digital euro experimental work launched by Eurosystem in 2020.
In July 2021, the European Central Bank (ECB) opened an investigation phase for a digital euro. This first step started in October 2021 and will last two years.
Its goals are to address critical issues regarding the design and distribution of the digital euro, the potential impact on the market, data privacy, and the necessary changes to European legislation.
The decision to develop a digital euro will happen based on this investigation phase.
A three-year implementation phase shall follow.
Valdis Dombrovskis, the Commission's Executive Vice-President, highlighted that the digital euro will be a legal tender backed by the European Central Bank and will offer the same level of privacy as cash.
A ceiling on how much one can hold in digital euros will be imposed to ensure financial stability. The European Central Bank (ECB) might introduce a cap of €3,000.
For this proposal to become law, it needs the support of the 27 E.U. member states and the European Parliament. If approved, the ECB might introduce the digital euro by 2027.
India's e₹-R Revolution
India has launched its own Central Bank Digital Currency (CBDC), known as e-rupee (e₹-R), as a digital token representing legal tender.
The e-rupee's pilot is based on blockchain technology and aims to enhance convenience, faster payments, and financial inclusion.
The country focuses on scalability, regulatory framework, operational standardization, and technology for wider adoption.
Banks are informing clients about connecting bank accounts to CBDC wallets, and the government aims to maximize the Digital Rupee's use through regulatory coordination and macroeconomic considerations.
What are the main challenges and vulnerabilities of digital money?
Competition from existing electronic payment methods, which are today very effective in most countries
For example, card-based payments provide a robust infrastructure and business model which, despite the criticism (fees, de facto duopoly…), have proven remarkably resilient in the past 50 years. The model works for issuers, acquirers, customers and merchants.
Other more recent methods, based on instant credit transfers, have emerged to enable fast peer-to-peer payments and are multiplying.
CBDCs will have to prove that their promised benefits justify the investment in acceptance and processing infrastructures.
Attractiveness for users
CBDCs will be successful if they are used on a vast scale. Therefore, they must create sufficient attractiveness that users will massively use them.
A CBDC will have to prove it is different, better in some aspects and as effective as existing payment methods.
Different/better could mean privacy-preserving, accessible to the under-aged, without revenue conditions, without need for a bank account or a financial history, etc.
Effective could mean very simple enrolment (if any enrolment at all in some cases), universal acceptance, broad payment channels and use cases, faster cross-border payments, etc.
The dilemma of privacy protection vs. the need for anti-money laundering regulation
Cash has the benefit for users that it is anonymous, with the flipside that it can be used for fraudulent activity. Digital currency should approach this anonymity while, at the same time, complying with Anti Money Laundering obligations.
These obligations tend to limit the ability to perform anonymous payments severely. The challenge for CBDC deployments will be to find the right balance so that the population widely accepts this new form of money.
Offline CBDC transaction support
The capability for a CBDC solution to support offline payments is often mentioned as a desirable feature, for example, in reports from the Bank for International Settlements.
Offline payments are described as improving the overall CBDC system for resilience, greater reach and enhanced financial inclusion.
Indeed, offline transactions could be supported by other, cheaper devices than smartphones that do not necessarily have online/over-the-air connectivity.
Yet, today, many trials and experiments are based on distributed ledgers with a necessity to connect online for every transaction. Offline payments are indeed challenging to implement:
A consequence of (consecutive) offline payments is that digital money is stored in devices, and no entity exercises control during payment other than the participating devices. Therefore, offline payments have specific requirements from a security perspective and a subsequent monitoring perspective.
Where do we fit in?
Thales helps more than 3,000 financial institutions, retailers, and other players meet the challenges of payments.
The company also provides a growing range of software and services for digital banking and payment services.
This includes strong identity verification, payment data encryption, and multiple authentication schemes, including biometrics, to access digital banking services.
Thales has also partnered with industry-leading blockchain and cryptocurrency partners to provide enterprise-grade solutions for securing transactions.
Together with Ethereum, Hyperledger, IBM, Ledger, BitGo, R3, Symbiont and ConsenSys Quorum, we protect how industries conduct business, bringing efficiency and establishing trust.
Thales also supports multiple blockchain applications, including Bitcoin, Hyperledger, Ethereum, Altcoins, Monero, and more.
Now it's your turn.
If you have a question about digital currencies or CBDC cybersecurity in general, we'll be happy to help.
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