Around the world, central banks are pondering a technology that will provide one of the biggest changes to the world of banking in decades: central bank digital currencies (CBDCs).

Inspired by Bitcoin, although wholly distinct from the world’s biggest digital currency, these would see fiat currency becoming digital, either on the wholesale or retail side, or both.

For central banks, CBDCs offer enormous opportunities, potentially offering unprecedented levels of transparency where it would be possible to see exactly who held every unit of a CBDC at any given time – from individuals right up to major corporations – as well as the entire history of all transactions. This could therefore make money laundering and financial fraud impossible, as well as provide additional benefits for auditing, transfers and cross-border payment, to name a few.

But while the potential benefits are significant, implementing CBDCs is no mean feat. It requires an incredible amount of work to decide on a host of potential options for implementations, make them a reality in a secure manner and ensure full interoperability between the world’s central banks.

However, this cannot wait. Private corporations are setting up their own digital challengers to the world’s fiat currencies, most notably Facebook with Libra, and failing to act risks allowing the keys of everyday finance to fall into the hands of organisations that lack the rigour and governmental oversight of central banks.

But these banks have by no means been complacent. Over the past months, representatives from a host of central banks have been meeting, alongside key private organisations across finance and digital currencies, to discuss the issue under the Official Monetary and Financial Institutions Forum (OMFIF), a think tank for central banking and economic policy.

So far, these meetings have been held behind closed doors, but in August a meeting held in public for the first time, enabling hundreds of financial, business and digital currency professionals to attend virtually, and get a sense of the emerging reality that CBDCs provide.

Central bank digital currencies: A “clear before and after”

While the details of exactly how CBDCs will develop remains unclear, there are areas that all central banks agree on.

“The one area that all central banks agree on is that this is clearly a different form of technological innovation,” says Chris Ostrowski, commercial director of OMFIF.

“CBDCs are not just another small technical change; there is a clear before and after for central bank digital currencies and what that means both on the wholesale side and on the retail side.”

Nevertheless, there are profound differences in central banks’ perceptions of when and how the technology will emerge.

“We have heard one central bank official say that in their region, they don’t think we’ll see a retail CBDC for 100 years,” he adds. “And we have had others talk about a CBDC becoming fully operational and coming on stream in the next year or two.”

Wholesale CBDCs vs retail CBDCs

One of the biggest areas of variation is the question of whether central bank digital currencies should just be used for wholesale applications, such as lending to banks, or if they should be used for retail applications, so effectively replacing or augmenting currency as we know it today.

Different banks are taking very different positions on this. For example, the Bank of England is, according to Simon Scorer, senior fintech specialist, exploring CBDCs as “a compliment to cash that could be held by the public”.

Meanwhile, the Swiss National Bank, driven by the decision of the Swiss Stock Exchange to build an exchange based on digital ledger technology (DLT), is exploring both a wholesale CBDC built on the same platform, but doesn’t yet see the benefits to implementing a retail version.

For Sky Guo, CEO of enterprise blockchain developer Cypherium, argues that “both wholesale and retail CBDCs are necessary”.

“If a central bank only uses wholesale CBDC, not retail CBDC, it needs to manage both digital currency and cash in its financial system, limiting the efficiency of CBDC,” he says.

“On the other hand, without a wholesale CBDC, the central bank will lack the tools to deliver CBDC to commercial banks.”

However, he says that if he was forced to select the one that would win out over the other, he would choose retail.

“Retail CBDCs are designed to replace cash. Cash has many disadvantages such as physical insecurity, forgery, lack of hygiene and other practical inefficiencies. Retail CBDCs address these drawbacks,” he explains.

“Retail CBDCs can also accelerate the propagation of monetary policy. For example, if a central bank wants to adopt negative interest rates, it would be difficult to do this with cash, but with a retail CBDC they can do it easily.”

Notably, however, Thomas Moser, alternative member of the governing board of the Swiss National Bank, does not believe that implementation of a wholesale CBDC, which many banks are considering first, will automatically lead to the creation of a retail version.

“I don’t think one naturally leads to the other because right now also we have the situation that central banks have digital money just for the banks, the wholesale payment system, but not for the retail customers,” he says.

“And I think it’s clearly possible that you would have a wholesale CBDC in the same way only for certain financial institutions, but not for households at large.”

However, he argues that if exchanges adopt DLT, then the situation could become less clear.

“If you have a blockchain let’s say for a digital exchange, then the rules on who can participate on that blockchain is done by the exchange, there is some regulation attached to it, but there the question more is, will you have different players? Can you maybe have in the future in exchange where you will also let households directly trade on the exchange, not just financial institutions?” he says.

“Then the question becomes more difficult: is it then a wholesale or retail? Even though you stay with that special CBDC only on that blockchain and only for a specific purpose, the question kind of becomes blurred.”

CBDCs on the blockchain? Not necessarily

It would be easy to assume that blockchain is essential to any form of CBDC, retail or wholesale, however in reality the technology is not essential to making them a reality.

“Some [central banks] have said that there is no role or no need for blockchain technology when it comes to CBDCs, others have said that there’s no point in launching or issuing a CBDC without the advantages that blockchain can bring,” says Ostrowski.

The view from those attending the panel is mixed on this front.

“If it comes to pure retail CBDC, then I’m in the camp of those who believe that you do not need a blockchain or a DLT; that it’s more efficient to use a different technology,” says Moser.

He adds that he is currently exploring alternatives in a project with American computer scientist David Chaum, often described as the “godfather of cryptocurrency”, and Christian Cachin, from the University of Bern.

“We have a proposal on how you could issue a retail CBDC not based on blockchain, but still based on public key cryptography. I hope we can issue that soon and show how we would do that.”

Guo, meanwhile, believes that central banks are “very likely to issue blockchain”, adding that smart contracts will automatically enable financial transactions “never before seen in history”, citing speed as a key driver.

For Scorer, however, blockchain is likely to serve more as a mindset-changing technology than one that ultimately ends up in banking infrastructure.

“I think what we may come to see is blockchain as this catalyst, the spark of innovation, and maybe aspects of the technology that find their way into adoption in different parts, but that may not necessarily come to be defined as a blockchain itself,” he says.

“One of the main things that the whole Bitcoin and blockchain ecosystem has done is prompt the financial system to rethink the way things have traditionally been done.”

But for Aniko Szombati, chief digital officer of the Hungarian National Bank, blockchain will play a role – albeit not a particularly special one.

“I do believe that central banks will use blockchain technology in their fields where they find it to be the most effective,” she says.

“So there will be no special status of blockchain. It will be one of the options.”

The central banks of the future

However, while the role of blockchain in central bank digital currencies remains in doubt, what is clear is that there is massive technological change ahead – and that CBDCs will emerge in one form or another, be it next year, or in over a decade.

“In the changing world, the central bank’s role will also change,” says Szombati.

“They will not only issue prudential or consumer protection standards, but they will also have to issue technical standards for the industry and also for its partners.

“So this will be a really exciting time ahead of us.”


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