Austrian National Bank, Open Forum on the digital euro and payment system, Vienna, 25 June 2024, prepared remarks
Dear Conference participants,
I'm most grateful to the OENB for the invitation. My remarks shall focus on recent developments around central bank digital currencies (CBDC). I'd like to reflect on some fundamental aspects about CBDC, offer a brief history of CBDC projects, then cover on-going CBDC project mBridge, take a quick look at Switzerland on CBDC project Helvetia 3 and comment on new BIS projects Agora and Meridian FX. I hope this will provide you with some insights about the rationale for adopting CBDCs and possible expected impact on payments. I shall also offer some brief comments on the digital euro and why the Eurosystem should be pursuing it. The remarks are my own and do not necessarily reflect the views of Accenture.
Before I start, I would like to quickly draw your attention to the fact that this year, as many of you of course are aware, the international community is celebrating, though that may be too strong a word, the 80-year anniversary of the Bretton Woods Conference. On 1 July 1944, 44 allied nations met at Bretton Woods, New Hampshire, to thrashed out a new international monetary order and found the International Monetary Fund. One of the key purposes of the IMF was to assist in the establishment of a multilateral payments system. This remains largely unachieved and brought considerable asymmetries in the use of national currencies in international payments. CBDC is very much about advancing needed reforms of the international monetary system as it may be able to respond better to international payments needs.
As we are in Vienna, I also cannot help but remind the audience that Austria offered an early lead in rethinking international payments. The Austrian silver coin Maria Theresa Taler, as the same Holy Roman Empress, was one of the first truly international currencies to serve as one of the principal settlement mediums in commercial transactions throughout Eastern and Southern Africa and the Middle East. It became legal tender in several countries including in Ethiopia, Saudi Arabia, Oman and Yemen through well into the 20th century. The Maria Theresa Taler had many of the features that CBDC is aiming to achieve.
To clarify, CBDC shall denote here, central bank money issued in a digital token format on blockchain or other distributed ledger technology platforms. It is the same euro, dollar, peso but in a different format to serve alternative financial market infrastructures. It is to complement the existing central bank monies, that is, banknotes accessible by the general public and book-entry money or reserves accessible by banks and other financial institutions. Retail CBDC shall thus denote use of CBDC by the general public and wholesale CBDC shall refer only to interbank transactions.
CBDC is about monetary innovation. It had brought a new debate about what money is, who should issue it and what it should be able to do. It made us think harder about how to address persistent deficiencies in payments. A key driver to spur interest has also been the threat of new monies including the announcement about Facebook’s Libra in 2019.
At a high level, CBDC aims to replicate in the digital space the simplicity, transparency and velocity of payments using banknotes. Banknotes are transacted peer-to-peer where payment is instant and execution is settlement. There is no need for other steps like clearing or netting or the need to reconcile payments across different ledgers and systems.
CBDC is very much about speed. Transactions shall be instant and processed 24/7. Bi-directional trade to process delivery versus payment and payment versus payment transactions shall be simpler to execute and monitor enhancing transparency. Instant and atomic settlement, meaning both legs of the transaction have to succeed, or none does, collapses the instrument life cycle into a single step.
The principal motivations for using CBDC are the added functionality including programmability, new payments infrastructure and expected efficiency gains. It is about diversification, greater resilience and more competition in payments and to ensure central bank money is being made available beyond incumbent users and systems. Instant and atomic settlement significantly de-risks transactions and should bring important liquidity and capital savings for the financial system. CBDC is about ensuring central bank money remains attractive and can sustain its role as nominal anchor in the financial system.
The biggest impact of CBDC will likely be on international payments. This is where most of the international economic policy debate around CBDC is concentrated. International payments today rely on long payment chains processed by correspondent banks. It makes them costly, slow and opaque. As correspondent banks’ balance sheets shrink and as so-called active payment channels decline, the capacity of the international financial system to process cross-border payments is diminishing. CBDC has led to new considerations about access and the residency of potential users that may lead to more direct payments relations and a new geography of central bank money.
My remarks refer to CBDCs only. However, other tokenised payment instruments may of course offer similar functionalities and serve in similar transactions. But central bank money plays a special role amid its unique credit attributes and therefore is likely the preferred settlement medium for large value payments.
Brief history of CBDC projects
The BIS shows that the vast majority of central banks conduct work on CBDC. At the BIS Innovation Summit in April, five governors of leading central banks underscored that CBDC is among their strategic and policy objectives affirming it has become a top-level priority for many central banks. Yet, CBDC projects advance at quite different pace and vary vastly in terms of maturity. The short history of CBDC projects is naturally a multi-dimensional space of functionality, use cases, main areas of concern, regulation and deployment. Projects are not developing linearly and similar use cases are being deployed across several projects. The latest BIS survey suggests that wholesale CBDC is more likely to be introduced than retail CBDC over the medium term.
CBDC projects started with studies on usability of blockchain platforms for financial transactions as in projects Jasper 1 by the Bank of Canada. Projects started to combine CBDC with other payment instruments like in projects Khokha 2 by the central bank of South Africa. Project E-Krona by the central bank of Sweden pioneered the adoption of the two-tier distribution for retail CBDCs. Jasper-Ubin by the central banks of Canada and Singapore was one of the first cross-border CBDC projects. Project Jura of the central banks of France and Switzerland explored a new approach for cross-border payment based on an outright transfer and exchange of CBDC between resident and non-resident institutions redefining central bank access policy and the boundaries of central bank money.
CBDC projects evolved from proof-of-concept, to pilots, to production. Most CBDC projects remain at a design and conceptional stage like the digital euro by the Eurosystem. Several CBDC projects are at POC stage, that is, all transactions are simulated, including recent ones like projects Dunbar and Meridian FX, both by the BIS Innovation Hub. There have been very few CBDC projects that conducted a pilot, using real transactions, like projects Jura and mBridge by the BIS Innovation Hub. Helvetia 3 by the central bank of Switzerland deployed a wholesale CBDC at near production level and is the most advanced wholesale CBDC. The e-CNY by the central bank of China is a retail CBDC in circulation in an advanced pilot. The sand dollar by the central bank of the Bahamas and e-naira by the central bank of Nigeria are two retail CBDCs in production.
The conduct of real transactions in CBDC projects marks an important difference with POCs. POCs offer only limited insights into conditions for adoption as the simulation of transactions does not inform about the measures that would have to be taken in particular by banks from internal controls to system integration, to regulation. Today, the ambition should be for all CBDC projects to be conducted as pilots.
The main use cases are payments and securities settlement. Payments comprise retail applications including at the point of sale and for off-line payments and wholesale applications for inter-bank clearing and foreign exchange and securities settlement. For retail CBDC project, some central banks want to offer an alternative to a decline in the use of cash as in Sweden and in the UK while other countries aim to reduce use of cash as in Israel and Saudi Arabia. Some central banks also aim to use retail CBDC to expand financial inclusion although it is not clear if central banks are equipped to do so.
The projects have covered many functional requirements and tested some performance attributes. Wholesale CBDC projects explored certain transaction types in particular payment versus payment and delivery versus payment. For retail CBDC, integration with the existent acceptance infrastructure has been tested to some extent and also off-line functionality has been explored relatively widely. Actual integration of CBDC with existing systems has been limited.
The adoption of CBDC remains very limited. The sand dollar after at least 3 years represents just 0.4 percent of currency in circulation with the same for the e-naira. The e-CNY since 2022 still on trial pilot in select areas of Hong Kong and China represents 0.1 percent of currency in circulation. The low adoption is indicative of the fundamental problem for retail CBDC in not providing a clear differentiation over other digital payment means.
The first generation of CBDC projects has mostly looked at the mechanics of how CBDCs work. The second generation will be more concerned with studying the impact of CBDCs and in particular instant and atomic settlement on financial markets, price formation and volatility. Advanced functionalities like instant repurchasing operations and nested or multi-condition transactions are of considerable interest. More consideration may also be given to issue CBDC on public blockchains. Those projects are yet to get started.
Central banks, I believe, should embark on second generation projects to advance knowledge about CBDC and gain a better understanding of the conditions for adoption.
CBDC projects will need to convey that they are path to production to incentivise potential participants. Some important breakthroughs will likely be needed to sustain interest in CBDC. There is already considerable POC-fatigue.
Residual concerns remain as to the maturity of blockchain-enabled platforms though it is not clear those are warranted at least for wholesale applications. Most CBDC projects have used permissioned blockchains which may constitute an undue limitation.
Public communication has been a central element to engage with the general public and financial markets. For retail CBDC, central banks seem to struggle to make a convincing case about future acceptance. For wholesale CBDC, there seems to be greater acceptance in principle among market participants of the case for adoption. The long duration of public campaigns through implementation in particular for retail CBDC also risks exhausting the attention span of the public.
I will now cover different CBDC projects including mBridge, Helvetia 3, Agora, Meridian FX. Naturally, there are many more interesting CBDC projects on-going.
mBridge
The BIS Innovation Hub project mBridge is with the participation of the central banks of China, Hong-Kong SAR, Thailand, UAE and since May Saudi Arabia and with 26 observer central banks and international financial institutions. The aim Is for commercial banks from each jurisdiction to use a common platform to conduct cross-border payments in CBDCs issued by the participating central banks. It is to promote use of local currencies in cross-border payments and as such offer an alternative to the conventional payment channels and use of third-country currencies. It is by far the most advanced multi-country CBDC project and is progressing towards pre-production or minimum viable product state.
The project had conducted a pilot during 2023 with real transactions and the participation of 20 commercial banks. The four CBDCs were used in cross-border transfers and foreign exchange settlement. Local banks obtained CBDC from their central banks against reserves and were then able to use them in payments with banks. It thereby allowed to use CBDCs outright in transactions between resident and non-resident institutions from the point of view of the issuing central bank. Only local banks could retire their CBDCs by returning them to the issuing central banks. Transactions were conducted instant and to settle foreign exchange on an atomic or payment versus payment basis.
mBridge rests on a combination of a change in access policy and establishing direct payment relations. The project used the same high-level architecture as CBDC project Jura.
The mBridge platform is projected to use a permissioned blockchain and be operated on a decentralised basis. Central banks will be running their own node on the platform and possibly commercial banks too. The governance structure in place operates through a steering committee with representatives of each participant central bank. The platform is governed by a rule book.
The success of mBridge and capacity to on-board more participants will naturally rest on the attraction to conduct payments in local currency. This, I shall argue, will depend to a large extent on the level of liquidity of the CBDCs. Commercial banks will need to be comfortable that conducting payment in local currencies is more efficient than using third-country currencies. They also want to have confidence that they can trade easily in and out of a given CBDC. This will likely require a pro-active role of central banks to ensure liquidity conditions are adequate and may include significant accumulation of foreign-currency CBDCs by the participant central banks.
The foreign exchange transactions on mBridge have used market-based exchange rates. Exchange rates between renminbi, Hong Kong dollar, dirham and baht are normally quoted as cross-rates only. Looking forward direct quotations among the currencies would be a sign that transaction levels of pairs involving the currencies has increased significantly. However, this may be off for some time.
The fact that Saudi Arabia joined mBridge seems to confirm that that leading economies are looking for new approaches to international payments. It should be seen as part of a broader effort to establish a more diversified international payment system.
Helvetia 3
The central bank of Switzerland deployed a wholesale CBDC on the SDX digital exchange to serve as settlement medium. The SDX platform, the first fully licensed blockchain-enabled digital exchange that went live in 2021, has seen few issues and transactions. It highlights the difficulty of adoption of blockchain-based financial instruments. It also serves as a reminder that issuing a wholesale CBDC is not sufficient to attract issuance and transactions in tokenised financial instruments.
The low level of issuance of blockchain-enabled financial instruments on the SDX exchange can be attributed, it shall be assumed here, to insufficient incentives for issuers. There have been 9 tokenised bonds issued on SDX since October 2021 with a total nominal value of CHF1.3 billion or about 0.2 percent of listed CHF bonds outstanding. Issuers may not find the needed depth and liquidity in the market to make it attractive to issue.
The SNB announced last week that it had issued tokenised SNB bills, short-dated debt instruments, on the SDX platform. This represents a most important step. Successful adoption of tokenised instruments will most likely depend on supply to establish attractive secondary market conditions for issuance. Large sustained tokenised SNB bill issuance could help overcome existing adverse market conditions for tokenised financial instruments. The central bank where applicable and the government are in a unique position to act as anchor issuer to spur interest in the market.
Agora
The mew BIS CBDC project Agora with the participation of the central banks of France, Korea, Japan, Mexico, Switzerland, U.K. and U.S. together with a number of commercial banks is set to mark a new level of CBDC engagement. The project will aim to test the interaction of CBDC with tokenised deposits in cross-border payments and make it a first multi-instrument and multi-jurisdictional CBDC project. But as largely a POC, it may struggle to provide new insights into the adoption of alternative financial market infrastructures.
The project has not announced what architecture it will adopt for cross-border payments. The use of tokenised deposits may offer a new angle to explore cross-border interbank deposits. Where commercial banks do not maintain correspondent relations, CBDC could be used as a clearing layer to enable cross-border acceptance of tokenised deposits possible also as an alternative to existing vostro/nostro account bank relationships. This would represent a very interesting line of investigation.
Agora is part of a unified ledger approach. This is quite similar conceptually to the regulated liability network initiated by commercial banks. The unified ledger idea promises set standards to facilitate adoption and integration. At the same time, the idea of building large universally accepted infrastructures may be difficult to implement and unduly hold back innovation and limit flexibility.
Meridian FX
The new BIS project Meridian FX with the participation of the central bank of the UK and the Eurosystem aims to explore integration among large value and with new blockchain-enabled payments systems. It will test through a synchronisation operator connecting to three solutions explored by the Eurosystem, the trigger solution by the central bank of Germany, TIPS hash-link solution by the central bank of Italy, both to connect a large value payment system to a blockchain-based platform, and a wholesale CBDC developed by the central bank of France. The project aims to demonstrate how foreign exchange payments can be synchronised across systems using the three Eurosystem solutions.
The focus on the foreign exchange market is most relevant. It is the biggest financial market and affects most other financial transactions and is in need for better settlement conditions as it suffers from an increasing proportion of trades lacking critical risk mitigation thereby exacerbating general market risk.
The project may yet be too narrowly focused on payment synchronisation. Payment synchronisation between the euro and sterling already exist for foreign exchange settlement through CLS-Bank. The trigger solution and TIPS hash-link solutions are not CBDC applications. It is not clear what additional insights above the trigger and TIPS hash link solutions the project will be able to offer.
Digital euro
The digital euro is one of the largest and most comprehensive CBDC undertakings. It is to serve as a digital representation of a banknote to be used by the general public as a complement to cash. While a decision to adopt a digital euro has yet to be taken, it seems rather safe to assume that it will be adopted. This may not be before 2030 though.
The digital euro has had a mixed reception. Citizens may not quite appreciate the case for a digital euro as most payments are already digital and many seem concerned about privacy. Banks do not appear to like it because they fear it may reduce interest in holding ordinary bank accounts even though there is little if any evidence of a structural migration out of bank deposits. However, the biggest beneficiary may indeed not be the end-user or the banks but the financial system and the economy at large.
The digital euro, I shall argue, is an innovation project that can position the Eurosystem at the frontier of monetary developments. It is to adopt a new medium to drive diversification and competition and strengthen the resilience of the payment system. While privacy is a legitimate concern, it should be directed towards legislators and not the Eurosystem.
The digital euro should ideally be issued on a public blockchain. It would be consistent with the circulation of banknotes that are processed by an infrastructure independent of the Eurosystem. It would allow the digital euro to form an integral part with a vast existing ecosystem and emerging token economy and such be truly complementary to existing applications.
The predecessor central banks of the ECB were established largely to bring order to the issuance of banknotes or paper money. Central banks shaped the modern banknote and as such enabled new ways to conduct payments. This often occurred against considerable scepticism as to the legitimacy of paper money. The German word Zettelwirtschaft to denote a state of disorder is derived from the word Zettel which refers to banknotes. Today, the ECB will need to overcome similar scepticism but has a historical opportunity to advance development of a new format of money and as such drive innovation of money itself.
To conclude, CBDC has brought a new thinking about the utility and functionality of money. It should be seen as an extension of existing payment systems but may be most effective for specific use cases only. CBDC is to equip financial systems with new functionality to address actual and future payment demands. It is to ensure central bank money can remain competitive. While there may be residual uncertainties in some areas, CBDC is largely ready for introduction.
When being asked whether CBDC is a solution in search of a problem, I normally answer, that the question is referring only to problems we know. If we are looking to address the problems we know today, we are unlikely to be ready for the future.
Thank you for your attention.