CBDCs – From the outside

State of play in the adoption or not of retail CBDC

This short report (7 pages) by the Kansas City Fed offers a nice summary on the state of play regarding the adoption of a retail CBDC

www.kansascityfed.org/Payments Systems Research Briefings/documents/8835/PaymentsSystemResearchBriefing22HayashiToh0526.pdf

Here is the conclusion

Several EMDEs have implemented CBDCs primarily to promote financial inclusion and improve their payments systems. Several advanced economies have made significant progress in assessing the case for a retail CBDC; though a few have identified motivations for implementing a CBDC, most have not found a compelling case to do so.Many other central banks are still at an early stage in exploring motivations for a retail CBDC, including the Federal Reserve, which recently published a report aiming to foster a public discussion with CBDC stakeholders on the potential benefits and risks of CBDCs (Board of Governors of the Federal Reserve System 2022). Through research and public dialogue, these central banks may increasingly identify motivations for a retail CBDC or scenarios in which a retail CBDC may be warranted. The motivations and scenarios will likely vary across countries, as each country has a unique set of opportunities and challenges in its economy and payment system.

Tony – From the Outside

Lessons from Brazil’s “Pix” fast payment system

In a recent post devoted to a BIS report summarising the results of interviews on what a small group of central banks had been doing with regard to Central Bank Digital Currencies, I posed the question whether central bankers might be better placed using their resources and powers to foster the development of fast payment systems rather than Central Bank Digital Currencies (CBDCs) and offered the following perspective:

the business case for a retail CBDC seems to have the most weight in the emerging market and developing economies with relatively poorly developed financial infrastructure
the business case for a retail CBDC in an advanced economy is less obvious
other initiatives such as central bank sponsorship of fast payment systems might be a better use of central bank resources
not explicitly referenced in the paper, but the recent experience with the roll out of fast payment systems in Brazil and India offer interesting case studies
the central bank focus on CBDCs seems to continue to be heavily weighted toward account based systems
token based CBDCs are mentioned in passing but do not seem to be high on the list of priorities

From the Outside – 15 March 2022 – “Central Bank Digital Currencies: A new tool in the financial inclusion toolkit”

For anyone interested in CBDC’s and fast payment systems, the BIS has published another report exploring the lessons to be learned from Brazil’s adoption of the “Pix” fast payment system. The authors identify three takeaways from Brazil’s experience which I think broadly support the thesis that fast payment systems often have the potential to achieve many if not all of the public policy objectives associated with CBDCs:

Public payment infrastructures build on the central bank’s foundational role in the monetary system by promoting competition and interoperability between payment platforms. They can reduce costs for users and promote financial inclusion.
Brazil’s recent experience with the Pix retail instant payment system illustrates the potential gains. In little over a year since its launch in November 2020, Pix has signed up 67% of adults in Brazil, with free payments between individuals and low charges for merchants.
The two key ingredients in the success of Pix are, first, the mandatory participation of large banks to kick-start network effects for users, and second, the central bank’s dual role as infrastructure provider and rule setter.

It is important to note however that these benefits do not flow automatically from just building the payment system infrastructure, the report highlights the importance of the central bank using its power to:

mandate the participation of large banks and other large players in payment services in order to kickstart the network effects and
to set rules that promote competition

I may be missing something here but it still feels to me like CBDCs are over-rated and (well constructed) fast payment systems under-rated. There are no doubt some economies where a CBDC has a role to play but I for one am paying more attention to the roll out of their less glamorous sibling.

Tony – From the Outside

The E-Cash alternative

CBDCs and stablecoins have been getting most of the attention lately. In contrast the release in late March 2022 of a draft bill titled the ECASH Act seems to have flown under the radar. The bill as I understand it is only a proposal at this stage and not something actively in the process of becoming law. It is however worth noting for a couple of reasons

Is is a useful reminder that an account based CBDC is not the only form of government issued digital money that might be pursued (though the account based model does seem to be the model preferred by the BIS mostly due to concerns about illegal use of anonymous forms of money)
Primary responsibility for E-Cash is assigned to the US Treasury, not the Central Bank (so technically it is not a CBDC per se)
Although I personally am not overly concerned by the current state of Know Your Customer and related anti money laundering, anti terrorist financing requirements applied to bank accounts, I respect the views of those for whom privacy is a priority or don’t have the benefit of living in the kind of economy/society that allows me to be relaxed about these questions
So long as the digital form of cash is subject to an equivalent set of controls on illicit activity as is applied to physical cash, then I can’t see why the digital option should be prohibited
Adding a digital money option that is capable of operating in an off-line environment also looks to me like a useful (albeit limited) level of redundancy and resilience in a world that increasingly relies on a 24/7 supply of power and internet connectivity for money to function

Who needs e-cash?

You can find more detail about the proposal here but for those short of time the argument put up by the Act’s proponents for why someone might want to use E-Cash is summarised as those who:

1. Lack access to traditional banking/payments services;
2. Value privacy and wish to avoid surveillance and/or data-mining;
3. Are concerned about third-party censorship and/or discrimination;
3. Lack reliable internet or digital network connectivity; and
5. Are low-income and/or cannot afford high transaction, withdrawal, and exchange fees.
www://https.ecashact.us/#whyuse

The Act’s proponents emphasise however that “… E-Cash, like physical cash, does not pay interest, and offers less third-party protections than traditional bank accounts or payments app (chargebacks, loss and fraud-prevention, etc).” The basic idea is that this is a complement to the existing forms of money (physical and digital) and it is not envisaged that most people will seek to hold large amounts in the form of E-Cash.

What exactly does the ECASH Act proposes?

1. Directs the Secretary of the Treasury to develop and introduce a form of retail digital dollar called “e-cash,” which replicates the offline-capable, peer-to-peer, privacy-respecting, zero transaction-fee, and payable-to-bearer features of physical cash, and to coordinate their efforts with other agencies, including the Federal Reserve through an intergovernmental Digital Dollar Council led by the Treasury Secretary;
2. Establishes an Electronic Currency Innovation Program within the U.S. Treasury to test and evaluate different forms of secure hardware-based e-cash devices that do not require internet access, third-party validation, or settlement on or via a common ledger, with a focus on widely available, interoperable architectures such as stored-value cards and cell phones;
3. Establishes an independent Monetary Privacy Board to oversee and monitor the federal government’s efforts to preserve monetary privacy and protect civil liberties in the development of digital dollar technologies and services, and directs the Treasury Secretary to, wherever possible, promote and prioritise open-source licensed software and hardware, and to make all technical information available for public review and comment; and
4. Establishes a special-purpose, ring-fenced Treasury overdraft account at the Federal Reserve Bank of New York to cover any and all government expenses related to the development and piloting of E-Cash, and directs the Board of Governors of the Federal Reserve System to take appropriate liquidity-support measures to ensure that the introduction of e-cash does not reduce the ability of banks, credit unions, or community development financial institutions to extend credit and other financial services to underserved populations, as prescribed under the Community Reinvestment Act of 1977 and related laws.

www:https://ecashact.us/#ecashact

Summing up

I have been a professed sceptic on the need for a retail CBDC in advanced economies with well functioning fast payment systems (see here and here) but this proposal is intriguing and one that I will watch with interest.

Tony – From the Outside

Central bank digital currencies: a new tool in the financial inclusion toolkit?

The BIS recently published a paper summarising what had been learned from a series of interviews with nine central banks exploring how these institutions were thinking about the potential of a CBDC to support the pursuit of “financial inclusion” objectives explicit or implicit in their mandates.

A lot of what the paper documents and discusses will be pretty familiar to anyone who has been following the BIS and individual central banks on this topic but I think the following observations offered by the paper about the best way to pursue financial inclusion is worth noting

It needs to be noted that many of these features [i.e. the benefits of a CBDC] can, in isolation, be offered by other payment innovations, and many gaps could be addressed through regulation and sound oversight arrangements. Combining different payment innovations – such as open application programming interfaces (APIs), fast payment services, contactless chips and QR codes – could achieve many of the same goals. This is particularly true when accompanied by robust regulatory and oversight arrangements that public authorities can use to catalyse private sector players, enforce sound governance arrangements and foster required coordination and collaboration. Adoption of relevant technologies for supervisory and regulatory compliance could also improve the efficiency and effectiveness of regulators and supervisors. What is truly different about CBDC is that it is a direct claim on the central bank. It is an open question for central banks whether CBDCs or other policy interventions are the best fit for their jurisdiction. Yet if a CBDC is to be issued (for financial inclusion or other motives), interviews with central banks clearly point to the importance of inclusive design elements to successfully promote inclusive outcomes. We discuss these elements in the next subsection.
Page 13, paragraph 16

There is a narrative that sees CBDC adoption as inevitable based in part on the fact that so many central banks are looking at the question. In contrast, the BIS paper clearly states that a CBDC is not a “panacea” and that many of the outcomes a CBDC might deliver could equally be delivered by other payment innovations such as “open application programming interfaces (APIs) , fast payment services, contactless chips and QR codes”

It is also worth noting that, of the nine central banks interviewed, eight were emerging market and developing economies and only one (Bank of Canada) an advanced economy. The results should therefore be interpreted with that bias in mind.

Summing up, my take is that

the business case for a retail CBDC seems to have the most weight in the emerging market and developing economies with relatively poorly developed financial infrastructure
the business case for a retail CBDC in an advanced economy is less obvious
other initiatives such as central bank sponsorship of fast payment systems might be a better use of central bank resources
not explicitly referenced in the paper, but the recent experience with the roll out of fast payment systems in Brazil and India offer interesting case studies
the central bank focus on CBDCs seems to continue to be heavily weighted toward account based systems
token based CBDCs are mentioned in passing but do not seem to be high on the list of priorities

Let me know what I am missing

Tony – From the Outside

The need for a Central Bank Digital Currency (CBDC)

JP Koning offers a Canadian perspective on the need for a CBDC that identifies two issues with the idea and concludes it is not a priority.

His argument rests on two planks. Firstly he argues that the existing payment infrastructure in Canada is pretty good so the obvious question is whether the CBDC is really worth the required investment of public resources. Secondly he highlights the operational and governance problems associated with payments that lie outside a central bank’s core area of competence.

His post also links to an article by David Andolfatto that arrives at similar conclusions. David however adds the qualification that a wholesale CBDC might be worth pursuing.

Neither post introduces anything radically new into the discussion of CBDC so far as I can tell but they are worth reading to get a Canadian perspective. The key points the articles reinforced for me where:

That the need for financial innovations like a CBDC (or indeed payment stablecoins) depends a lot on how good the existing payment rails are. Some countries have pretty good systems but others (which surprisingly seems to include America) are not keeping up with best practice.
Cross currency payments is an area that appears ripe for disruption and a wholesale CBDC might have a role to play in this process.

Tony – From the Outside

Why is the United States lagging behind in payments?

… is the title of a useful paper by Christian Catalini and Andrew Lilley that digs into the puzzle of why it is that one of the (if not the) key players in the global financial system seems to lagging global best practice in terms of the cost, convenience and speed of its payment system.

It has to be noted that the authors are not neutral observers in this space. Christian Catalini is the Chief Economist of the Diem Association and Diem Networks US, and Co-Creator of Diem (formerly Libra). He is also the Founder of the MIT Cryptoeconomics Lab and a Research Scientist at MIT. Andrew Lilley is an employee of Novi Financial, Inc. who contributed to the paper as part of his work with Diem Networks US. With that caveat in mind, the paper still offers a short (12 pages) and useful summary of the ways in which the US lags best practice.

They frame the US problem as follows:

The US enjoys one of the least concentrated banking systems among the G30, but this feature has also created a fragmented and expensive payments system. Transfers between major US banks incur fees ranging from $10 to $35 for same-day wires, and up to $3 for 2-day transactions. Compare this to the UK, where individuals and businesses have access to a free, 24/7 interbank payments system which settles within seconds and supports over 8M transactions per day. While the US does have a Real Time Gross Settlement (RTGS) system, the Fedwire Funds Service carries less than 1 million transactions per day, has limited 21/5 availability, and is almost exclusively used by financial institutions and large corporations. Its fees, moreover, are larger than alternative payment methods such as ACH, creating a trade-off between cost and immediacy. Private sector alternatives are limited, and while some banks have deployed real-time solutions, these come with transaction limits and little adoption, which severely reduces their usefulness.
Catalini and Lilley (2021), Why is the United States Lagging Behind in Payments?

The paper then outlines how these limitations affect individuals, business and government and concludes with suggestions of what might be done to address the problems discussed:

There are at least three ways to remove frictions in payments and rapidly expand the number of individuals and businesses that can access the financial system and cheaply transact in real time. The first is to bring deposits on a single ledger through a Central Bank Digital Currency (CBDC), so that transfers between banks are not limited by external liquidity constraints or third-party rails. The second approach is to follow countries such as India and Mexico and increase the throughput of always-on RTGS systems. This is the model the Federal Reserve is pursuing with the introduction of FedNow, targeted for 2023. FedNow, however, is expected to have an initial transfer maximum of $25,000, which would limit its usefulness to businesses. The third approach is to facilitate the growth of interoperable, stablecoin payment rails by creating the right regulatory framework for these new types of networks to safely increase competition in payments.
While each one of these approaches presents different challenges, opportunities and trade-offs in terms of complexity, development costs and ability to expand access to segments that are currently excluded, it is important to stress that they are likely to be complements, not substitutes.
Advancing the US payments infrastructure will require both regulatory and technical developments targeted at improving market structure, lowering barriers to entry, and facilitating collaboration between public and private sector efforts in digital payments.
Catalini and Lilley (2021)

I am trying to keep an open mind on the future of payment systems but find myself drawn towards the conclusion that fast payment systems that the FedNow initiative is based on seem to have worked pretty well in other countries in terms of improving cost, speed and convenience so it is not obvious to me why either a CBDC or stablecoin solution is necessary in the United States.

If you want to explore these issues further, JP Koning recently offered a nice summary of what has been achieved by fast payment systems in other countries while a speech (“CBDC: A solution in Search of a Problem?”) by Governor Waller of the US Federal Reserve neatly summarises the issues associated with whether a CBDC is necessary or desirable (at least so far as the USA is concerned). It is important to recognise however that the conclusions that Waller draws do not necessarily apply to other countries (China being the prime example) which are responding to very different types of payment systems.

Let me know what I am missing

Tony – From the Outside

Central bank digital currencies – Game On

FT Alphaville today wrote up some of the highlights they picked up from a report included in the Annual Economic Report published by Bank for International Settlements (BIS).

The highlights I picked up from the Alphaville column included:

Central Bank Digital Currencies (CBDCs) now seem a matter of when, not if, primarily because the BIS has concluded that they need to get ahead of Big Tech (i.e. Big Tech are pushing ahead with their own versions of digital currency in a number of jurisdictions so central banks need to respond to these initiatives)
The fact that China is committed to a digital currency with the potential to gain a “first-mover advantage” also seems to be a factor
The BIS does not however see a CBDC as adding much value if your financial system already has a well functioning, retail fast payments system with all of the safeguards required by know-your-customer regulations
In terms of design, the BIS seems to be opting for an account based (as opposed to token based) form of digital money
Two of the larger design issues associated with implementing a CBDC are privacy versus security concerns and the potential for crowding out (i.e. how the new form of digital money impacts financial systems where banks are established as the primary suppliers of digital money).

There is a lot to unpack in the BIS paper but it is worth noting one thing I found immediately curious. In responding to the concerns about privacy versus security, Alphaville noted that “The report … says CBDCs could even have a built-in layer of anonymity for very small inconsequential transactions“.

That might work from an Anti Money Laundering (AML) perspective but it is far from clear to me how you would define “very small inconsequential transactions” in a world where a relatively small number of low value payments can finance child pornography. Westpac Banking Corporation paid a high price for failing to comply with reporting requirements in this regard so it is hard to see how a CBDC could define a threshold that was inconsequential.

Alphaville is of course just one perspective. I am yet to read the BIS paper in full but these are the key takeaways that the BIS author has chosen to highlight:

. Central bank digital currencies (CBDCs) offer in digital form the unique advantages of central bank money: settlement finality, liquidity and integrity. They are an advanced representation of money for the digital economy.
• Digital money should be designed with the public interest in mind. Like the latest generation of instant retail payment systems, retail CBDCs could ensure open payment platforms and a competitive level playing field that is conducive to innovation.
• The ultimate benefits of adopting a new payment technology will depend on the competitive structure of the underlying payment system and data governance arrangements. The same technology that can encourage a virtuous circle of greater access, lower costs and better services might equally induce a vicious circle of data silos, market power and anti-competitive practices. CBDCs and open platforms are the most conducive to a virtuous circle.
• CBDCs built on digital identification could improve cross-border payments, and limit the risks of currency substitution. Multi-CBDC arrangements could surmount the hurdles of sharing digital IDs across borders, but will require international cooperation.
“CBDCs: an opportunity for the monetary system”, BIS Annual Economic Report 2021

Tony – From the Outside