Implementation of CBDCs

Ever since money was invented almost 5000 years ago, it has predominantly existed in the physical form as either coins or dollar bills. However, with the advent of both decentralised currencies in the form of cryptocurrencies like Bitcoin and centralised central bank digital currencies (CBDCs) like China's digital Yuan, countries worldwide are at a crossroads in adopting digital currencies.

As CBDCs are digital versions of traditional national currencies, they are still faced with the traditional limitations of physical currencies, such as the risk of hyperinflation and the need for public confidence in the currency for it to hold value. However, their natively digital nature allows for many political and economic consequences to arise, causing their establishment and adoption to be met with calls for caution.

How should governments then proceed with its implementation?

Firstly, governments worldwide, especially those of countries with a strong rule of law, should centre their CBDCs around consumer privacy. While citizens of authoritarian states like China are already used to data transfers from Tencent's WeChat and Alibaba's Alipay to the government, citizens and institutions of liberal democracies would almost certainly reject intrusive CBDCs. Therefore, a potential strategy for central banks to adopt is to anonymise the consumer's identity through a cryptographic technique known as blinding signatures performed on each user's device.[1] As the spending records of an individual consumer would not be revealed to the central bank in this case, the central bank would not be able to profile its citizens. At the same time, central banks could instead have access to firms' transaction history, allowing them to monitor the level of consumer expenditure and investments by private firms in real-time. Such a strategy would allow for a privacy-preserving digital currency that still allows the central banks to reap the benefits of real-time expenditure data.

Secondly, governments should involve commercial banks in developing CBDCs to form a two-tiered system. Commercial banks are fundamental to the world's financial system, and the partnership between central banks and commercial banks worldwide must evolve to include CBDCs. As commercial banks have experience managing the consumer-facing side of banking, they should still oversee the distribution of the digital currency, even though it is the central bank issuing the CBDC token. By devolving some authority to commercial banks to regulate CBDCs, commercial banks can then evolve their business model to include new product categories and offerings surrounding CBDCs. For instance, commercial banks could include rebates to attract new consumers, form partnerships with private firms for exclusive discounts and implement differentiating features like spending caps and parental controls for youth.

Lastly, central banks must decide whether to expand their CBDCs overseas. Connecting a CBDC with another allows for more convenient cross border bank transfers, with central banks mutually recognising CBDCs. Central banks like the Federal Reserve and the European Central Bank should consider mutually recognising each other's CBDCs, especially if both countries have similar privacy, safety and security standards built into the digital currency. On the other hand, small, developing countries should also remain open to adopting CBDC standards or protocols from countries with greater technical abilities.

Christian Grothooff and Thomas Moser, “How to Issue a Privacy-Preserving Central Bank Digital Currency, SUERF Policy Brief .:. SUERF - the European Money and Finance Forum,” The European Money and Finance Forum, June 2021, https://www.suerf.org/suer-policy-brief/27227/how-to-issue-a-privacy-preserving-central-bank-digital-currency. (Accessed January 26, 2022).

Wolfram Seidemann, “The Role of Commercial Banks in CBDCs,” The Global Treasurer, November 15, 2021, https://www.theglobaltreasurer.com/2021/11/15/the-role-of-commercial-banks-in-cbdcs/. (Accessed January 26, 2022).

Jesse McWaters, “Countries Are Diving into Digital Currencies. Here Are Five Choices They Need to Make.,” Mastercard, July 20, 2021, https://www.mastercard.com/news/perspectives/2021/central-banks-and-cbdcs-digital-currency/.(Accessed January 26, 2022).