The Retail Avatar
In its retail form, CBDCs are meant to be used by individuals and businesses for daily transactions, just like physical cash or electronic payment methods such as credit cards and digital wallets. They are expected to provide benefits such as faster, cheaper, and more secure payments, as well as greater financial inclusion for those who lack access to traditional banking services.
Scalability in a retail environment is where cryptocurrencies come up short. The full decentralization of cryptocurrencies comes at the cost of limited scalability and an excessive environmental footprint for consensus mechanisms such as “proof‐of‐work”. This makes them particularly unattractive for retail payment systems which require a very large “through‐put”. This issue can be addressed by moving away from a fully decentralized model towards a permissioned DLT where only specific network nodes can update the ledger. This is exactly what Meta’s Diem was targeted to do, but that has been done and dusted with.
One of the renderings is the settlement of domestic transactions in real time and on ‘gross’ basis, as opposed to delayed, end of day, settlements where money movement is ‘netted’ or aggregated. But most economies today already have some sort of an RTGS system where this feature is already available for transfers. In addition, most countries also have a Faster Payment System, which ensures the removal of counterparty risk in any such transactions. This essentially means that CBDC is unlikely to introduce any additional advantages in this regard.
So then, how will the Retail CBDC work out? To understand that, we need to start with the design considerations.
The retail CBDC can be token based or account based or may have features from both designs. The token based CBDCs are like banknotes but in a digital format. In this form, the currency focuses on the token object rather than the holder’s identity (particularly related to transaction validation). Hence it can arguably afford greater anonymity and fewer user‑identity requirements. It can enable payments to be made offline which could be useful in areas where internet access is not optimal and can help when it comes to financial inclusion efforts. The flip side would be that in the absence of identity requirements, the visibility and control would be a lot lesser. On one hand, this will affect the programmability of the money, and on the other hand, it will increase the risk that CBDCs could be used for illicit activity. As such, it is very likely that a token based CBDC would be restricted to small-value transactions.
The Account based CBDC will have the money available only in the form of an account that is maintained in a central register by the Central Bank or its intermediaries. This essentially takes away anonymity in payments that was possible in the token-based model. Since the account-based model requires synchronization of the central register, it is highly unlikely that true offline payments would be possible in this design.
There are different approaches that a Central Bank can take in rolling out a Retail CBDC. Two approaches are worth noting:
- A two-tiered CBDC where the provision of the CBDC to retail is only through commercial banks or other financial intermediaries that have an account at the central bank. In this model, the central bank only records net transactions at an aggregated level, and hence requires a much simpler platform. The privacy of individual transactions is somewhat maintained, and the financial intermediaries are happy because it somehow retains the existing status quo. This type of retail CBDC has seen quite a bit of experimentation so far, with one of the first central banks to conduct such two-tiered issuance experimentation was Sweden with the e-kronor pilot announced in early 2020.
- In the platform/hybrid model, the central bank also records retail balances on its main ledger (versus recording only wholesale balances in the two-tier model.) In such a model, the private sector onboards all clients; is responsible for enforcing AML regulations and ongoing due diligence; and conducts all retail payments in real time. However, the central bank also records retail balances, allowing the central bank to act as a backstop to the payment system. If any of the intermediaries fail, the central bank has the necessary information, including the balance of every retail client, allowing it to substitute for the failed intermediary and guarantee a working payment system. The e-CNY in China and the proposal put forward by Bank of England are on these lines.
The Central Bank would propose a fast, highly secure, and resilient technology platform (which it called the “core ledger”), which would provide the minimum necessary functionality for CBDC payments. This would serve as the platform on which private sector firms, called Payment Interface Providers (beyond Commercial Banks), could connect in order to provide customer‑facing overlay payment services
In conclusion, CBDCs represent a potential evolution in the way we transact and interact with money in the digital age. While they offer several potential benefits, such as increased financial inclusion, reduced costs, and increased efficiency, they also raise important questions about privacy, security, and monetary policy.
It is kind of like trying to impress your crush with a new haircut, but also worrying about whether it looks good from every angle. In all seriousness, further experimentation and societal debate are likely required before we can see numerous countries issue their own CBDC. But it is going to be an interesting ride, so buckle up and enjoy the show!