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CBDC: explore what they are and why they will replace cryptocurrencies

CBDC: explore what they are and why they will replace cryptocurrencies

The world witnessed the emergence of a new type of payment technology, i.e., cryptocurrencies. Relying on decentralization and anonymity, cryptocurrencies started to gain popularity in different countries as a means of secret payment transactions, including illegal activities. As a response, central banks of many countries started to develop their own versions of this technology, namely, central bank digital currencies. Soon, they will replace the altcoins and stablecoins we are already familiar with.

Since 2009, when the world's second digital currency, Bitcoin, appeared, there has been a rapid increase in the importance of digital technology in the financial sector. According to the Global Cryptocurrency Benchmarking Study research released in 2017, 8.2 million cryptocurrency wallets dedicated to Bitcoin were created in the first four years. By 2016 the number had grown to 35 million, and by 2018, there were 12 million more. By 2018, more than 200 types of digital money were issued, ranging in features from physical asset backing to pegging to existing fiat money. This boosted their popularity and resulted in a surge of imitators. The distinctive feature of all issued "digital coins" was the complete absence of regulation by central banks and financial regulators, resulting in new payment technology, namely, cryptocurrency. The emergence of a competitor forced many national regulators to investigate further - according to a 2019 Bank for International Settlements (BIS) survey, nearly 70% of the world's central banks were considering issuing their own digital money, which should provide some sort of counterweight to the growing popularity of cryptocurrencies.  

Despite many studies on the role of digital currencies in the world's financial systems, today, there is no comprehensive understanding of the benefits and risks of digital currency issue by central banks. At the same time, the standalone experience of using fiat and cryptocurrency payment technologies is mostly used, without considering the synergy effect. The urgency of the problem of a comprehensive understanding of the benefits and risks of central banks is confirmed by the data of the World Economic Forum, which shows that at least 40 central banks are conducting research work and pilot launches in this area. However, there is no successful example of a central bank issuing digital money today. Some countries, like Ecuador or Venezuela, announced it, issuing money backed by physical assets that cannot be considered full-fledged digital money by central banks (as the issue of fiat money after the abolition of the Gold Standard in 1971 does not involve their security with physical assets. Such CBDC should be regarded only as a type of financial tool for attracting new funds).

Main features of CBCD

Today, we can identify several distinctive criteria applicable to all CBCD projects. These include sales options (retail or wholesale), issue type (on balance or as a token), availability of interest income, and anonymity level. 

The main implementation options are:

  • Retail or general CBCD option offers the issue of digital money available to all individuals and legal entities. This makes them an alternative to bank deposits, although without interest income. 
  • Wholesale CBCD option involves the issue of digital money available only to a specific group of users like financial institutions, financial market participants, etc. Acting as a counterpart to the existing correspondent accounts and deposits at the central bank, they offer interest income, allowing the national regulator to implement monetary policy more effectively to ensure financial stability. 

In terms of the issue type, there are two concepts, the main feature of which is the process of payment verification: 

  • Account-based, balanced concept involves the creation of digital money by opening individual accounts for all economic agents at a central bank. The website or mobile application provides access to the account. The major risks here are the rising costs of creating, controlling, and keeping track of all accounts, as well as developing the disintermediation process, i.e., reducing the role of financial intermediaries. A distinct threat is the protection of the entire digital infrastructure to avoid collapse due to the actions of intruders. 
  • Value/token-based concept offers a completely digital cash issue (token), replacing cash in whole or in part. Such an approach is similar to the traditional architecture of the banking system, which means that it assumes already familiar risks and elaborated measures to reduce them, including dealing with anonymity.  

Let us point out that in the first case, we are talking about credit money, while tokens are not related to the issuance of loans. Accordingly, each of the concepts will have different economic consequences upon increasing supply. 

The features listed above can be combined to create new variants of the CBCD models with their own individual properties. As an example, let’s look at Sweden, a country that treats the wholesale option apprehensively, preferring to research the combined method of retail approach with two concepts. In contrast, the central banks of such countries as Canada, Singapore and Thailand consider wholesale sales as a promising option.    

In our opinion, depending on the state of the economy and financial infrastructure, each country should find its own approach model for issuing CBCDs. The main criteria here should be the expected results pursued by financial regulators. Generally, countries expect the following effects from the CBCD implementation:

  • Reducing the cost and increasing the speed of transactions (China, Ecuador);
  • Improving access to financial services for the population (China, Tunisia);
  • Reducing the share of existing cash in circulation (China, Canada, Sweden).  

At the same time, the major risks are cybersecurity, the availability of technological capabilities for the digital financial infrastructure, financial stability, the possibility of flexible implementation of monetary policy, and the avoidance of reputational losses.  

Depending on the chosen model of development, CBCD can compete with existing payment technologies such as deposits of commercial banks, payment systems, credit cards and cash. The full-fledged development of CBCD will transform the financial system not only within the country, but also beyond its borders, influencing neighboring countries and trading partners. 

Probable scenarios for the CBCD implementation

Based on the above, there are three most likely scenarios for the introduction of new digital money:

  • Fiat and digital money can become complementary. 
  • Fiat money is being replaced by digital money, but commercial banks are finding their niche, adapting to it, and remaining in it. 
  • Mass abandonment of fiat money converts banks into private investment funds, completely changing their role and tasks in the financial sector.   

So far, however, no country has announced any final decision on the use of digital currency. Thus, the People's Bank of China in 2019 announced the testing of its digital currency DCEP (数字货币和电子支付工具 or Digital CurrencyElectronic Payment), but the deadline for the final implementation has not yet been set. As we know, the China's CBCD feature is token-based wholesale distribution. At the same time, DCEP can be converted into common yuan at a ratio of 1:1. 

In 2019, the National Bank of Ukraine announced the completion of the pilot project e-hryvnia. A certain number of digital hryvnia were issued to perform various operations, including recharging e-wallet accounts, cell phones, and some types of payments. 

Riksbank of Sweden has no plans for mass introduction of CSDs yet, but it keeps on studying the issue closely, having launched the e-krona project. In April 2021, the country's Central Bank announced the completion of the first test phase, reporting that the biggest concern was cybersecurity. 

That same month, Japanese authorities announced their own launch of a similar test project, to be completed in 2022. Other countries are also conducting research, but they are still hesitating to integrate them into the current financial system (see table). 

Summarizing the above, we would like to note that according to a Central Banking survey, most central bank governors of developing and advanced countries believe that cash will not disappear anywhere in the short term (up to 10 years). 

Alternative development scenarios 

A synthetic central bank digital currency (sCBDC) could also be a potential substitute for fiat money. Its main difference is the issuance of monetary units by private issuers, while the central bank only protects the assets of its clients and supervises the organizations that issue the digital currency. At the same time, we believe that such a replacement will allow the synthetic currency to become more flexible and adapted to customers' needs. However, there is also a risk of fraud and bankruptcies, where the users of such money will suffer the main damage. The most similar to synthetic currencies are stablecoins, whose rates are pegged to fiat money or other physical assets. Mark Zuckerberg plans to implement such an idea with his cryptocurrency Diem (former Libra). 

In our opinion, the option with synthetic CBDCs is only possible if the private issuer has a good reputation. In this case, the provision of guarantees by the central bank is of minor importance. For instance, Ecuador issued its own digital currency in 2015, which was not widely accepted due to a lack of public trust in it. 

Another option could be the creation of one or more dominant CBDCs, acting as the world's modern dollar or euro. China appears to be the most advanced country in the creation of CBDCs. According to the People's Bank of China, the DCEP project was launched in 2014. In 2017, an additional digital currency research institute was established. Still, only in 2019, Chinese President Xi Jinping announced his support for blockchain technology and, consequently the creation of their own digital currency. With a head start of several years, the country managed to fully develop the concept of using and implementing "cryptoyuan" in its society. Today, test work is ongoing, involving a part of Chinese people being paid in DCEP. The new currency is transferred through private payment systems like AliPay and WeChat, installed by almost all residents of the country. However, if the experiment is deemed successful, it is likely that the Chinese regulator will launch its own version of the e-wallet. It was expected that a mass launch for foreigners would take place at the 2022 Olympics in China. The U.S. had already stated its concern about the development of CSDs - in April 2021, Bloomberg, a financial publication, stated that the Biden administration was paying close attention to the development of that technology.


Central banks' digital currencies could lead to distortions in the international monetary system: competition with other payment technologies, an increased role for relevant ministries regarding the country's cybersecurity, and the closure or transformation of banks. In order to avoid collapsing it all at once, the authorities do not aim to introduce the new technology in the short term. However, the possibility of increasing the availability of financial services, reducing the cost of the transaction, and increasing its speed will contribute to making the economy of any country more flexible and adaptable to crises. Reducing the share of cash in circulation will help lower the cost of its maintenance and facilitate the process of controlling money laundering and financing of illicit activities. As a result, central banks from different countries continue to research in this area, looking for the best approach to the issuance and implementation of CBDCs.   

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