10 December 2023
Central bank money remains at the heart of national payment systems. Today, central banks offer two formats of money, banknotes to the general public and reserves or scriptural money to banks. The former serves the cash infrastructure and the latter the large value payment system. Central bank money is often the preferred payment instrument. As alternative financial market infrastructures are emerging, central banks will need to consider offering alternatives formats to ensure equitable access to central bank money for eligible entities and that the financial system can benefit from the best possible payment instruments. This is why consideration is given to central bank digital currencies (CBDC).
The adoption of CBDC is advancing. The Swiss National Bank announced introduction of a wholesale CBDC—to serve interbank payments—in December as part of an extended life pilot. The European Central Bank in October affirmed that it moves forward with the preparatory phase for a digital euro. The Bank for International Settlement wholesale CBDC project mBridge with the participation of the Bank of Thailand, Central Bank of the UAE, Hong Kong Monetary Authority and the People’s Bank of China and 23 observing member central banks plus the International Monetary Fund and World Bank is scheduled to adopt an extended life pilot. Most countries maintain investigative work on CBDC.
The tokenisation of money is being accompanied by the emerging tokenisation financial instruments like deposits, money market fund shares and other securities, and also real assets. In November, the UK Investment Association launched a major campaign into the tokenisation of mutual fund shares. In November, the Monetary Authority of Singapore announced that it will “expand asset tokenisation initiatives and develop foundational capabilities to scale tokenised markets.” UK Finance is moving forward to experiment with tokenised commercial bank money. The settlement of tokenised financial assets with tokenised money promises important efficiency gains.
CBDC is usually understood to represent a new format of central bank money, a digital token, circulating on a new financial market infrastructure, the blockchain or other distributed ledger technology (DLT) platforms. A CBDC is the same euro, dollar, real or won only in a different format to complement banknotes and reserves and serve digital token-based financial market infrastructures.
The motivations for adopting CBDC are at least threefold: Diversification, new functionalities, innovation.
CBDC contributes to providing a more diversified payment system supporting choice, resilience and competition. It may help attract new actors and new instruments, redefine access and thereby extend the utility of payment arrangements.
CBDC brings new features and properties to payments including through programmability and traceability. Token-based mediums are not necessarily meant to serve existing processes but to support new ones. CBDC seems particularly well adapted to address bi-directional trades like payments versus payment, delivery versus payment and delivery versus delivery. It is therefore expected to play an important role in foreign exchange trading and securities settlement.
CBDC is about financial innovation. Central banks recognise token-based payments can give rise and support new use cases and business models. It is to equip the financial system with new possibilities to develop new uses, offers new possibility for automation and address future payment needs.
The most important contribution of CBDC will likely be in international wholesale payments. CBDC promises implementation of an entirely new architecture for international payments based on the outright exchange peer-to-peer of CBDCs denominated in the national currencies of the participant central banks. It aims to advance use of local currencies in international payments to lead towards greater diversification and choice in international payments.
Some argue payments work and there is no need to fix them. Others may argue that existing payments instruments are sufficiently adaptable to address future use cases. Even if it were true and needed adaptation are not unduly onerous, it does not seem optimal to limit money just to two formats.
The bus from Berlin to London shows a journey time of 25 hours. The plane for the same trip advertises a flying time of 2 hours. The bus works perfectly well. While the plane may not be the best mode of transport for all journeys, it is superior for long distance travel. CBDC may not serve all payment uses cases, but there are certain use cases where it is expected to excel by far. Central banks will want to make sure central bank money stays relevant and future proof to meet actual and future use cases.