Abstract: The development of Central Bank Digital Currencies (CBDCs) will bring about many new changes, of which three issues are worth attention: first, the impact of digital currencies on the disintermediation of commercial banks and other financial institutions may be underestimated; second, if a digital cross-border payment system is established, it might become a parallel system competing with the existing payment systems including SWIFT; third, we need to sort out what the issuance of a CBDC means for the collection, analysis, and protection of data.
I. THE PURPOSE OF ISSUING A CENTRAL BANK DIGITAL CURRENCY
Before issuing a digital currency, central banks will weigh its pros and cons. From the perspective of economics, central banks will take into account three potential impacts to decide whether to launch a digital currency or not.
First, the impacts on financial intermediaries, or how the issuance will disrupt and affect the existing financial system in terms of credit creation, bank runs, financial stability, etc.
Second, the impacts on investment. This relates to the macroeconomy as investment is an important means through which financial intermediaries support economic activities. Therefore, we need to watch closely how the launch of a CBDC will affect private-sector investment and total social investment.
Third, the impacts on overall social welfare. Academic research can build theoretical models to analyze whether the launch of a central bank digital currency (CBDC) will increase or decrease net welfare.
In fact, academic research has not provided a definitive answer to this question. The final conclusion depends on the market environment and the specific design of a CBDC.
For example, launching a CBDC might provoke shocks to banks, which will reduce social welfare. However, if a country’s banking system is not competitive enough, issuing a CBDC offers a new instrument, which might in turn increase welfare.
The takeaway is that the design of CBDCs should adapt to the specific market environment so as to achieve the desired goals. Each country is under different circumstances, and thus has different considerations and priorities.
According to a survey of central banks worldwide by the BIS, developing countries and developed countries prioritize different aspects of CBDCs. Specifically, developing countries focus more on the efficiency and security of domestic payment and the need for financial inclusion; developed countries, on the other hand, focus more on the efficiency and security of cross-border payment. The difference in focus occurs because developing and developed countries have different pain points and problems.
Currently, the share of cash use in many countries has been declining, while that of digital payments has been increasing sharply. At this point, the question is not about whether to adopt digitalization but about whether central banks should participate in the process. For example, now that China already has mobile payment, why the central bank is still developing a digital currency payment system? One view is that although the payment system established by the private sector is efficient, problems such as negative externality remain hard to solve and can be fixed by public institutions. Therefore, though the payment system built by the private sector can solve most of the problems, it is not necessarily the optimal solution. Some issues might be more efficiently addressed by the public sector and central bank system.
In 2014, the People’s Bank of China started to research CBDC. June 2019 was a watershed when other countries’ central banks shifted their attitudes towards CBDCs. Since then, the interest in CBDCs has been increasing, and the progress of research has also been speeding up.
The reason is that on June 18, 2019, Facebook released the Libra White Paper. Previously, almost everyone thought Bitcoin was just a type of digital asset that cannot replace existing currencies; but unlike Bitcoin, Libra is a stablecoin backed by sovereign currency with intrinsic value.
If Libra was successfully launched, it could immediately create a cross-border payment system, because Facebook, with 3 billion users, can roll it out in many countries; meanwhile, if everyone started to use Libra, it could become an international currency. This would be a direct concern for central banks, for example, the international role of RMB might be undermined. We can't even rule out the possibility that some countries will be one step ahead by first introducing CBDCs as they are now stepping up efforts on research, while other countries will be left behind or not even start to conduct research, thus losing the opportunities.
This would not only become the competition among private, sovereign, and digital currencies, but also the competition between countries. Hence, the release of the Libra White Paper might directly trigger the “competition pressure” in the digital currency market. However, Libra was renamed as “diem” and the project was scrapped in the end.
From a broader picture, digital currency is also related to the digitalization of a country’s own financial sector and payment system. Before issuing a digital currency, the most important thing is to weigh the pros and cons of developing it.
II. THREE NOTEWORTHY ISSUES
First, the impact of digital currencies on the disintermediation of commercial banks and other financial institutions may be underestimated. Currently, China’s central bank envisages its digital currency to be used for retail payments and pay no interest, which means to replace M0. In addition, the PBC thinks that the issuance of a CBDC will not deal a huge blow to banks or cause disintermediation of commercial banks.
As no interest is paid on money in the e-wallets of Alipay and Wechat pay, most people are not supposed to put their money there. But in fact, there is a huge amount of money in these wallets. In the future, convenience will be an important aspect of people’s demand for digital currencies and thus makes them willing to keep a considerable amount of money in their e-wallets. Given this, digital currencies might cause greater-than-expected shocks to financial intermediaries.
Second, if a digital cross-border payment system is established, it might become a parallel system competing with the existing payment systems including SWIFT. While developed countries emphasize the efficiency and security of cross-border payment, China’s CBDC mainly serves domestic payment. But recently the PBC has started to work with the Hong Kong Monetary Authority (HKMA) and central banks in the Middle East to test cross-border payment using e-CNY. Will digital currencies be adopted for peer-to-peer cross-border payment? Will digital currencies generate a new framework for cross-border payment or become a new infrastructure? Since digital currency payment is peer-to-peer, perhaps based on this form, digital currencies will create a new international system, thereby reducing the importance of the existing international payment systems, including SWIFT.
Third, we need to sort out what the issuance of a CBDC means for the collection, analysis, and protection of data. A literature research points out that how well a country protects data has a big impact on people's willingness to use CBDC. In other words, if data is well protected, people will be more willing to use digital currencies; otherwise, the willingness will be much lower.
Some research only considers the transition from cash to CBDCs, whereas China’s national conditions are different. We already have private payment systems like Alipay and Wechat Pay and the payment data has been stored in these closed-loop systems. Though Alipay does not have access to the payment data of the entire country, it can see all the data within its own system, which make it possible for the payment platforms to provide other financial services based on the payment data such as big tech credit.
How will the adoption of a two-tier operational system for China’s CBDC (in which the central bank acts as the first tier and commercial banks as the second）affect the collection, analysis, and protection of data? Data is a big issue for the launch of a CBDC, and the situation varies from country to county. Some countries that used to rely on cash payment now will have payment data, while most countries including China that already have digital payments will only need to transfer the data from the original payment institutions to another type of institution. Therefore, there is an urgent need to sort out the implications of central bank digital currencies for data collection, analysis, and protection.
This article is edited based on the author’s speech at the CF40 seminar on “Central Bank Digital Currencies: International Trends and China’s Practice”. The translation made by CF40 has not been reviewed by the author. The views expressed herewith are the author’s own and do not representthose of CF40 or other organizations.
