Earlier this month, the International Monetary Fund (“IMF”) issued a paper titled Behind the Scenes of Central Bank Digital Currency (the “Report”) which offers a take from six jurisdictions that have begun issuing central bank digital currency (“CBDC”)[1], engaging in pilots related to CBDC, analyzing the merits of CBDC, or that have decided against adopting CBDC for the time being. Jurisdictions covered in the Report include the Bahamas, China, the (Eastern) Caribbean[2], Uruguay, Sweden and Canada.

The Report explores areas such as policy goals, design features, operational models, legal foundations, central banks and private sector roles, supporting technologies and implementation considerations.

Key Insights

Several insights can be gleaned from countries where CBDC pilots were pursued, and where they were not.

• The Bahamas stressed the importance of market research and collaboration with participating private intermediaries to understand the needs of potential users.
• China noted the importance of technological neutrality given the absence of a solution. It has chosen to remain open to different technologies that serve different purposes as its CBDC technology solution. Conversely, Bahamas advocated using the simplest and most appropriate off-the-shelf technology available.
• The Bahamas pointed to the importance of cross-border payments and adhering to the principles of no disruption, compliance and interoperability.
• The trade-off between anonymity and privacy was viewed by China as a key area of tension to manage, with the acknowledgement that full anonymity could not be considered.
• Sweden highlighted the need for central banks to be transparent by allowing public access to information about CBDC efforts, as payment systems concern all citizens and that sufficient time should be provided to allow for a full understanding of CBDC, as a payment innovation.
• The Bahamas raised the importance of the non-technical aspects of CBDC, such as cultural norms.

Policy Goals

As one would expect, policy goals varied by jurisdiction as circumstances differ widely between countries. However, overarching themes such as modernization and preparing payment systems for digitalization were consistent themes in all of the countries reviewed. In total, 7 policy goals were gleaned from the study namely:

• financial inclusion
• access
• efficiency
• illicit use of money
• resilience
• sovereignty and
• competition

Financial inclusion, which refers to the availability and equality of opportunities to access financial services, was a key policy goal for all countries, except Canada and Sweden. This is not surprising given that the World Bank Global Findex Data 2017 reports Canadians and Swedes as being 99.7% banked.[3] The report states that CBDC could potentially serve “as a gateway to wider access to financial services” [4] in countries whose populations remain financially underserved.

Four countries[5] noted access to payments as a policy priority. While the issue of accessing payments may be more prevalent in countries with large populations of unbanked citizens, the report remarks that access can still be an issue in banked countries, particularly where the use of cash is declining. In the authors’ view, CBDC could play a role in achieving universal access to payments.

All countries except Canada were looking to increase the efficiency of payments. The report explains that this is likely because the use and cost of cash and cheques remain high and that CBDC may offer digital forms of payments that are less expensive to operate.

Ensuring the resilience of payments was flagged as an important policy objective for all countries, save for Uruguay. The report notes that payment resiliency is a concern in countries with high levels of digitization and resulting vulnerabilities related to elevated disruption and concentration risks.

In terms of monetary sovereignty, Canada was aligned with China preferring it over foreign digital currency or a global stablecoin. The Bahamas was the only jurisdiction with the policy goal of reducing the illicit use money, which, in the authors’ view, may be due to it being listed on the Financial Action Task Force grey list (2018) for strategic deficiencies in its AML/CFT program. Increasing competition was a policy imperative for countries such as Canada, China and Sweden which may be experiencing large concentrations of a few large participants. CBDC could not only compete with existing participants but could also be designed as a platform open to private payment service providers, which could lower the barriers to entry for new firms.

Operating Model

Three CBDC models are examined in the report: a “unilateral” CBDC, an “intermediated” CBDC and a “synthetic” CBDC”.

The “unilateral” model makes central banks responsible for all payment functions, from issuance and distribution to end-user interaction, while the “intermediated” model operates with responsibilities split between central banks and the private sector. In the latter scenario, central banks would look after issuance and distribution, while the private sector would take care of end-user interactions and could include intermediaries such as financial firms, payment service providers, mobile phone operators, as well state-owned intermediaries and cooperatives. On the other hand, the “synthetic” model envisages the issuance of a digital currency – backed by central bank liabilities (also known as a stablecoin or sCBDC) – by private firms. The paper notes, however, that all of the countries surveyed preferred the intermediated model, with none preferring either of the other two models.

One of the considerations related to the intermediated model, as explained in the report, is private sector profit. If private sector payers’ involvement is expected to form part of the CBDC ecosystem, profit generation will have to be considered. Similarly, central banks may look to recovering their costs of building their CBDC system and subsidizing its use to increase adoption. In its response, the Bank of Canada indicated that the central bank could provide a basic CBDC payment function to the public, and possibly but not necessarily charging a fee for using it.[6]

Design Features

To mitigate the risks of bank runs and other risks that might be precipitated by CBDC, central banks have committed to adopting CBDC design features that will maintain financial stability and avoid sudden shifts in financial system structure. As a result, the features considered by the countries surveyed include restrictions to ensure financial system stability, user anonymity, offline capacity and cross-border payments.

The report refers to two types of restrictions to ensure financial stability: restrictions on CBDC remuneration and quantitative restrictions. CBDC remuneration (e.g. payment of interest) restrictions aim to limit competition with bank deposits. The three jurisdictions[7] surveyed that currently have circulating CBDCs have opted not to pay interest on CBDC holdings. That said, their CBDC projects were all designed with quantitative restrictions, such as restricting CBDC balances or taxing the use or balances of CBDC above a certain threshold. 

The paper states that the feature of anonymity also engenders policy trade-offs, for example, financial inclusion versus undermining AML/CFT measures. To address these trade-offs, the approach taken by the Bahamas, China and the ECCU has been to provide a tiered selection of wallets with different threshold levels. Lower wallet thresholds carry with them greater anonymity, thereby making CBDC more accessible in rural areas where virtual identification may be difficult. 

Offline capacity, the definition of which differs between jurisdictions, has been shown to be of great importance to disaster-prone areas and in areas where the telecom access is unreliable. While China reported that it has implemented a solution that provides safe and efficient offline payments, the pilot conducted by the Bahamas revealed that its offline solution did not achieve its policy objective. The issue therefore continues to be technologically complicated to solve.[8]

Cross-border Payments

All six jurisdictions surveyed are exploring cross-border payments from a domestic perspective. However, looking beyond its borders, China has partnered with the BIS Innovation Hub in the Multiple CBDC (mCBDC) Bridge project which leverages distributed ledger technology to facilitate cross-border payments. The Bahamas does not currently allow its CBDC outside its borders but is planning to explore this possibility within the next few years. The ECCU has started discussions with other regional central banks to enable cross-border payments given the importance of remittances and trade.

The main hurdles to cross-border payments identified by the six countries surveyed relate to technical interoperability – coordinating technology and messaging standards could be costly and complex – and legal/regulatory harmonization related to data, privacy, tax and payments laws and capital flow management measures.[9] 

Technology

Suppliers – Unless a central bank opts to build the technology that will support its CBDC in-house, the decision related to the right technology supplier will be key to ensuring central banks procure technology that suits their needs. The report indicates that there are currently two approaches to procuring technology: the “CBDC packaged solution” (adopted by the Bahamas, the ECCB, Sweden and Uruguay), where the technology is supplied and the supplier collaborates with the central bank to develop the CBDC, and the approach where the central bank develops the solution mostly in-house with the help of contractors, as needed (adopted by Canada and China).

Distributed ledger technology (“DLT”) vs. centralized technology – The paper reports that the case for DLT as the primary engine of CBDC has not been universally made. That said, the Bahamas and the ECCB chose DLT-based systems for their respective projects. Conversely, after testing DLT during its pilot work, China has determined that the technology does not meet its data and storage and transaction processing requirements. It remains open however to a hybrid solution where DLT can be used in areas where it presents advantages over other solutions. The Bank of Canada has not decided on technology but is said to be considering various solutions, including DLT. Similarly to China, it is exploring combining different technologies to address different requirements.

Legal Foundation

To issue CBDC, central banks will have to ensure that they have the supporting legal framework to do so. Of the six countries surveyed, one has enacted the appropriate reforms to allow for the issuance of CBDC[10], three have legal reforms underway[11] and two are not envisaging any changes to their frameworks at this time[12]. Some of the considerations being examined by the countries where framework reforms are being considered involve understanding the legal nature of CBDC, determining its legal tender status, determining the legal reforms necessary to allow for a pilot/preparatory phase and the final phase, and determining whether to effect specific or general law reform.

Implementation

1. Organizational models - To implement the necessary reforms to accommodate CBDC, China and the Bahamas have created new units devoted to their CBDC programs within their central banks. On the other hand, Canada carried out the bulk of its CBDC work first by leveraging the resources of departments reporting to a senior officer devoted exclusively to CBDC and then by creating a dedicated research team tasked with exploring suitable technologies and monitoring conditions that could “trigger the need to proceed”[13]. A similar approach was taken initially by Sweden, but in 2019, it created a separate division within the central bank to develop a proof of concept for its CBDC. The ECCB and the Bahamas have not made any changes to their organizational structures and continue to draw on their existing resources.
2. Internal resources – Many considerations factor into the number of internal resources involved in the CBDC effort of the six central banks surveyed. These include the extent of outsourced activities, the scope of the pilots undertaken, and the size of the respective jurisdictions. China reported its CBDC project team grew from approximately 40 full-time employees to approximately 300 full-time employees. The Bahamas, the ECCB, Uruguay and Sweden have operated with a significantly lower number of employees[14]. The Bank of Canada indicated having a team of 50 employees dedicated to its CBDC work, while Sweden indicated it had 20 employees working on its initiative.
3. Pilot – With the exception of Canada and Sweden, what follows relates to the organization and execution of the various pilot projects undertaken by the central banks surveyed for this report.

Design – there were three main considerations related to pilot design. These included pilot scope, timeframe and goals. 

Uruguay’s e-pesos pilot, which was launched in November 2017 for a twelve month period, was the most limited in terms of timeframe and scope. Total issuance was limited to 20 million e-pesos and no more than 10,000 end-user could participate. Pilot responsibilities, funding and development were divided among organizations interested in testing their technologies and did not involve commercial banks or an open platform.

The Bahamas Sand Dollar pilot ran in 2019 and included 2,000 wallets. A survey was administered to its citizen as a baseline to measure the progress of digital payments adoption. The central bank launched its CBDC in October 2020.

In China, in excess of 123 million e-CNY wallets were in circulation with individuals, while approximately 9.2 million additional ones were held by firms. Trials have thus far been conducted in 10 localities. Given its scope, the project has allowed China to test both its core technologies and its ancillary features such as identification, offline payments and programmability.

The ECCB, for its part, introduced its DCash pilot to four of its countries in March 2021, and is set to conclude in March 2022. The roll-out proceeded on an on-demand basis, targeting 4,000 end- users and 35 merchants in each of the four countries. However, plans required revisiting because of the unexpected surge in demand caused by COVID-19 and a need to increase pilot availability to St. Vincent and the Grenadines due to a volcano eruption.

User recruitment – The report refers to financial incentives as a means to recruit pilot participants in the countries where pilots were launched. In Uruguay, the first 1000 users received 1000 e-pesos free of charge, with the top 20 users receiving an extra 1000 e-pesos each month. China offered free e-CNYs that could be used with participating pilot merchants. Conversely, both the Bahamas and the ECCB relied on public marketing campaigns to recruit pilot users, with the ECCB recently adding a financial incentive for payments made at registered merchants.

Results – Demand in the ECCB has been so significant that it is contemplating formally launching its CBDC and extending it to all of the ECCB countries based on the belief that ending the pilot might potentially cause harm to the payments system. China reported its satisfaction, as well as the satisfaction of its users, with the pilot and the testing it was able to perform related to offline usage, facial recognition and tap-and-go features. Uruguay is considering a second pilot but this time based on different principles and the inclusion of multiple vendors and commercial banks. Finally, the Bahamas’ pilot provided a better understanding of the motivations behind users’ adoption of CBDC and firms’ participation in the ecosystem as intermediaries. It also revealed the importance of increasing interoperability with its banking system to facilitate the conversion of user bank deposits to its CBDC.

Communications and stakeholder engagement

Recognizing the importance of reaching out to potential user communities, the Bahamas partnered with communication and marketing experts for its pilot and official launch, both of which were supported by surveys and market research. It also engaged in private sector consultations and promoted the potential benefits of CBDC related to lower cash-handling costs and customer base expansions. And while the central bank noted the Bahamian government’s support of its CBDC efforts, recognizing its potential benefit of lowering the cost of public transfer payments to individuals, the bank also noted that it should have increased its engagement with government agencies to ensure the synchronization of their respective digitalization efforts.

In China, in addition to the information disseminated by the central bank, private intermediaries were also engaged in end-user communication given their daily face-to-face interactions with them. The ECCB collaborated with market research agencies to better understand the needs of end-users and solicit their real-time feedback. In Sweden, rather than launching formal educational and marketing campaigns, the central bank opted for project transparency and openness, by regularly publishing its CBDC work on its website .

Challenges

Not surprisingly, the various CBDC initiatives studied by the IMF encountered a healthy number of challenges, the more common of which involved the lack of an established model or precedent, the shortage of resources (financial and human), the lack of buy-in from the general population related to CBDC and digital payments, the lack of legislative frameworks, the risk of cyberattacks and technological uncertainty regarding the best solution.

Conclusion

The paper stresses in its conclusion that the exploration of CBDC is only beginning. Just as there is no universal case for CBDC, there is no universal design or implementation roadmap on which countries can rely to develop their CBDC programs. Each CBDC effort must be based on individual country context and desired policy outcomes. That said, areas of convergence, such as an intermediated operational model and CBDC characteristics which aim to limits competition with bank deposits, have emerged and will continue to emerge. As they do, continued international collaboration and information sharing will be critical to address the questions that remain unanswered.

For more information about our firm’s Fintech expertise, please contact the authors and see our Fintech group page.

 

 

[1] CBDC is digital money issued by a central bank and is conceivable in both retail and wholesale form. Retail CBDC, or sometimes general purpose CBDC, refers to CBDC that can be held and used by individuals, whereas wholesale CBDCs are available only to a selected set of financial institutions (Behind the Scenes of Central Bank Digital Currency, footnote 1).

[2] The Eastern Caribbean Currency Union (ECCU) is a monetary union consisting of Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, Saint Lucia, and St. Vincent and the Grenadines.

[3] “banked” per the Findex is an individual who holds an account at a formal financial institution.

[4] See p. 4 of the report.

[5] The Bahamas, China, ECCU and Uruguay.

[6] See p. 11 of the report.

[7] The Bahamas, China and the ECCU.

[8] See p. 13 of the report.

[9] For a summary of the design features under consideration by the countries surveyed, see p. 15 of the report.

[10] The Bahamas.

[11] Sweden, China and the ECCU.

[12] Canada and Uruguay.

[13] See p. 20 of the report.

[14] The Bahamas started with 35 FTEs and is currently operating with 15 FTEs; The ECCB is currently operating with 12 FTEs; Uruguay is operating with 5 full-time and 5 part-time FTEs and Sweden is operating with 20 FTEs.