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How CBDC should be designed to meet future payment needs?

Updated: Sep 3, 2020

Dialogue with Movers and Shapers by eCurrency

In this episode of Dialogue with Movers and Shapers, Barry Cooper, Technical Director of Centre for Financial Regulation and Inclusion (Cenfri) and Jonathan Dharmapalan, Chief Executive Officer of eCurrency explore the immense opportunity of central bank digital currency (CBDC) beyond the immediate challenges with the host, Lars Arvidsson, Chief Commercial Officer of eCurrency

What is CBDC?

Jonathan Dharmapalan: When we think of central bank digital currency it is essentially a form shift from what we think today of as central bank physical currency. Central bank physical currency is the cash that we carry around as notes and coins and is traditionally thought of as base money. Base money, also known as M0, is a liability on the books of the central bank. It is denominated in the currency of the country... This tradition of producing a currency, considered base money, and held as a liability on the central bank has been in place for many years. A tradition that was started almost 150 years ago and is now a common practice in any sovereign nation or jurisdiction and in some cases in economic unions like the European Union. This base money is in a transforming state right now.

Most central banks, if not all central banks, are considering the possibility of changing the form of this base money which comes today in notes and coins into a digital form. In other words, they are going to be producing a digital version of their base money which again will be denominated in the currency unit of the country and issued as a part of the central bank liability that the public can have access to. So, when we talk about CBDC, it is actually something we have known about for a long time that is currency except issued in digital form by the very same central banks that issue currency today in physical form.

Barry Cooper: I think it’s been a long time coming. Back when we were going to change physical mail for email, there was a lot of consternation about it. The question that was being asked was ‘where are you going to put the stamp?’. It’s a whole new paradigm shift. Between then and now I think the time has been right for central bank digital currency to be issued. ... It’s the natural progression from a physical representation to a digital representation. Commercial currency has led the way for many years and you’ll see that even in developing markets that there is a pressing need to be digital. E-money and other modalities have been developing to fill the void. It’s only natural that central banks follow, it’s long overdue that central banks themselves started issuing digital currency. For me it is a natural progression. It’s somethingthat is long overdue.

Why is the time right now for CBDC?

Barry Cooper: The issue we’re seeing now is that more and more people are being included in the economy and there are in fact more and more people. The logistics around cash, and around and old world commercial instruments have run to the limit. Currently if you ran out of oil or diesel, your financial system would stop because diesel transport is a major component of financial systems given that in many developed economies and most developing economies, digital payment streams ultimately articulate into retail physical cash reticulation systems which need to be constantly on the move in trucks to close the loop. It’s time to liberate it. In the background what we have is a lot of crypto assets and DLT types of interventions coming in. Those are posing a potential threat to the sovereign currencies of the world. That’s just a bit of a push factor. But a pull factor is definitely that the way that we work and the way that we live is becoming increasingly digitized. Not digitizing currency would mean central banks would be taking a step back outside the emerging economy.

Jonathan Dharmapalan: I know physical currency has been a very powerful instrument. And is the great equalizer, meaning, anyone with physical currency has the ability to execute an equal transaction to another person with an equivalent amount of physical currency. It’s a very, very powerful instrument. It frees people from having to obligate themselves in whatever way when a service or a product is offered, or purchased, or exchanged. Physical currency allows you to settle that obligation, near instantaneously. But there is one major obstacle or impediment which is that it doesn’t transcend space and time. Two individuals would have to be in the same place at the same time, making physical contact or close to physical contact to execute a physical currency transaction. COVID-19 has put a spotlight on the ability or necessity for people to transact across space and time, without having to be in the same place at the same time. Needless to say, that has brought out the possibility that transactions can be and should be executed across space and time. And the way to transcend space and time would be to do it digitally. That challenge aside, to your point that we are transacting digitally anyway and have been and in many ways it is the directions in which transactions and the economy are moving. To complement that capability, it only makes sense to have a digital currency.

What is the main change factor for CBDC to be important now?

Barry Cooper: In the developing market space, it’s more important to have something that people trust. And that trust element is a driver in the retail space, mostly. Not just in the wholesale space. So, for me CBDC has become important as a driver of trust within a digital retail space. The amount of people that are left out of the economy and left out of the financial system is immense. And it becomes difficult to bring them into a banked economy and provide them with a trusted, useful digital instrument so that’s why retail CBDC in the developing market is very important. Because it can give people without bank accounts, and with limited technology, a foot up into the formal economy.

Lars Arvidsson: You mean it can support financial inclusion on the national level, is what you are saying?

Barry Cooper: Financial inclusion and economic inclusion.

Jonathan Dharmapalan: Central bankers are also looking at the inefficiency of physical cash. It’s surprisingly expensive to produce, expensive to transport, expensive to transact with. Several people have looked at the cost of cash and it’s a pretty significant component of the gross domestic product of any given country. Cash, as we know it today, even though it has been quite effective is an expensive instrument. And to Barry’s point, even a slightly blunt instrument that we have gotten used to. If a central bank wants to bring a more efficient instrument that a public can trust in and use on day-to-day basis, it has to come with a lot less friction... Fiat money in the form of CBDC is such an incredibly powerful tool for central banks to reach the broadest base of their populace. Allow any simple transaction to take place and provide the same capabilities as cash with lot less friction and lot less efficiency... When a central bank digital currency is available, making it available in the hands of the broadest base of the public through these digital access means is actually imminently possible today. May not have been possible 20 years ago. These things converging are some of the major drivers and a central bank digital currency that is created by a central bank and issued today will power today’s economy, but more importantly will power an economy that our children will inherit. Those reasons have made it now a good time for central banks to look at this.

What could be the right design elements for CBDC?

Jonathan Dharmapalan: A decision on design on whether or not CBDC is held in a register or a ledger of central bank where every member of the public has direct access to the central bank’s books and that all transactions made by the public somehow touch the central bank. Versus what we may consider a value- based CBDC, sometimes referred to as a token CBDC. The latter, the value based CBDC is one that is not necessarily provided for by the central bank controlling every transaction, but rather is allowed to free flow very much like physical case into the hands of the broader public. A value based CBDC is a de-centralize, de-tethered instrument, that the central bank has secured so that you and I can trust it, and you and I can exchange it without having to go back to the central bank for permission to exchange it. This looks more and more like physical cash. This design element then drives a lot of how the technology itself is implemented. I would suggest that most central banks and most people thinking about this problem are now leaning more towards a value based CBDC rather than a ledger based CBDC.

Barry Cooper: Trust is the most important design objective of CBDC. What you need from CBDC is a mechanism or instrument that has embedded trust. That trust can then translate into consumer trust and institutional trust which determines the relative complexity or simplicity in how we deal with a digital instrument. Aligned with that is the regulatory approach and practicalities, what you don’t want to do is to start a financial revolution where you upend everything and recreate entire financial and regulatory systems on new rails from scratch with unknown processes or consequences. With a value based CBDC, leveraging the trust and security built in the instrument, it is possible to use existing rails or use existing familiar configurations within the financial system. With the least disruption as possible, making the transition to digital intuitive. I think most policy makers and many regulators, (in fact regulators are much more sensitive to risk) would agree with that.

How can CBDC improve payments for consumers and the work between public and private sector?

Barry Cooper: There are a number of factors. One of the most important ones we have seen is that the security of a CBDC system or instrument can enable a whole new industry of players. Currently the mobile money or e-money space is heavily regulated and convoluted because it runs on commercial money instruments and poses a risk to monetary policy because it coexists with other forms of commercial currency accounting for the same underlying value. There rightly needs to be considerable checks and balances in place. With a trusted instrument like value based CBDC, the whole restrictive environment changes. It becomes a lot more fluid and a lot more interoperable. One of the main things coming out of this type of CBDC is the ubiquity of channels. That opens up the space for fintechs, for regtechs, and for many other players to fill up this ecosystem that is currently missing. Mobile money and many other modalities don’t work that well because they lack the ecosystem. CBDC has an important role to play in filling that out. Trust and ubiquity are the main factors that CBDC can offer.

Jonathan Dharmapalan: The things that will come once a central bank digital currency is available to the public, will go beyond the P2P (person-to-person) world. There are now several innovations in motion that enable machines to transact. Taking micro-transactions that are able to operate at high volumes, at high speed, to enable pay-per-use type of services that are also powered by machines rather than powered by individuals all becomes imminently possible and the buildup that it creates, and the innovation that will come because a central bank has chosen to put a central bank digital currency to work is in some ways beyond imagination. It will release a whole new wave of innovation which is the really exciting part of a CBDC underpinning the economy that is still to come that we haven’t yet seen. These are very exciting times. Some of us may live to see how a central bank digital currency changes the economy and improves the economy and raises the quality of life for a broader base of the world’s population and brings a level of efficiency to the world that we haven’t seen as yet.

The world that we live in today, the physical cash world, not only is it inefficient, but it also consumes a tremendous amount of natural resources and energy. Looking forward into the future a central bank digital currency should be a very green technology. Green, as in the cost associated with the transport and the enabling of transactions should be minimized in a world of central bank digital currency. That’s not just a design element, but it should also be a policy intent on the part of governments and central banks as they move towards CBDC.


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