In an age where cash is increasingly being replaced by digital payment, central bank digital currencies (CBDCs) are emerging as a new frontier in the evolution of money. CBDCs are digital versions of a country’s national currency issued by its central bank. They utilise the convenience of digital technologies but also face challenges such as the impact on monetary policy and market competition. With the rise of cryptocurrencies such as Bitcoin and Ethereum challenging the traditional role of central banks, many countries are looking to CBDCs as a way to provide the benefits of a digital currency in a regulated and controlled way. 

“CBDCs have the potential to fundamentally change the landscape of the international and domestic financial systems and reshape the roles of the private sector and the central banks,” shares Heng Wang, Professor of Law. In his research paper, Prof Wang discusses how the CBDC could reshape the international financial system and the many challenges they present. He sheds light on the complexities and regulatory considerations that might arise from a groundbreaking shift of this nature. 

At present, 130 countries, representing 98 per cent of global GDP, are currently exploring the use of a CBDC, with some countries launching pilot programmes while others remain in the research and development phase. For now, it remains to be seen whether CBDCs will become commonplace or an integral part of the international financial system. Nevertheless, as digitalisation becomes the norm and technological advancement reduces the need for traditional financial institutions, how might these centralised digital currencies change the world we live in?

Here are five things you need to know about CBDCs -

1. CBDCs could supplement current financial systems but also face challenges

CBDCs could have a wide range of uses in the financial world. Retail CBDCs are designed for public use and can be used for everyday payments such as grocery shopping, facilitating trade between businesses and supporting taxation. Meanwhile, wholesale CBDCs can be used by financial institutions for purposes such as transfers among banks. Other categories include account-based and token-based CBDCs. Just like digital payment modes of today, CBDCs can ensure faster and more efficient transfers, but they also introduce a whole new ecosystem with many potential applications and benefits. 

Since CBDCs are managed on digital ledgers such as blockchain where transactions are recorded in a secure and transparent manner, users can benefit from its programmability and trackability functions. In the case of insurance, for example, customers can automate their insurance premium payments while companies can use the trackability functions to assess the legitimacy of claims.

CBDCs would also bring new levels of automation and efficiency to cross-border services such as trade finance, supply chain financing, e-commerce, foreign exchange (FX) derivatives and bond issuance. This could reduce transaction costs and eliminate intermediaries that currently slow down international payments.

Nevertheless, CBDCs face many challenges. These challenges include the design of a CBDC governance system (such as that concerning privacy protection) given its complexities, different national approaches and considerations, cybersecurity, the costs of technology development, the impact on sustainable development, and the interoperability with other financial systems.

2. CBDCs could promote financial inclusion for the unbanked, if challenges like offline access are first addressed

CBDCs have the potential to boost financial inclusion, bringing unbanked populations into the formal financial system. To attain this goal, however, many primary challenges need to be addressed. Offline functionality, for example, is crucial to reach remote areas with limited internet connectivity and power disruptions, but the problem of device security and managing offline access duration during disruption first needs to be solved. 

Furthermore, to ensure that offline access to CBDC is easier than cash, devices like mobile phones need to be widely available to the populations in question. These technological needs increase the costs of CBDC adoption

3. China is a first-mover of CBDC and other countries in Asia and elsewhere are  speeding up the efforts to explore its possibilities

China is the first major economy to issue CBDCs with legal tender status. It began its CBDC research in 2014 and has since accelerated with a large-scale pilot involving millions of users and billions of yuan in transactions. Moreover, China is exploring CBDC use beyond its borders through projects like mBridge, collaborating with the Bank for International Settlements and several central banks. Japan, Korea and Singapore are also actively studying CBDCs. Singapore, for example, has conducted multiple trials to assess the use of a digital Singapore dollar for specific payment schemes.

4. Foresight and adaptability are central to effective CBDC regulation

Implementing a safe, resilient and sustainable CBDC ecosystem will come with many challenges, some of which may be difficult to predict. Cybersecurity is a major concern since the exploitation of CBDC vulnerabilities could compromise the entire nation’s financial system, and affect the significant volumes of data generated by this digital infrastructure. There are other concerns ranging from the impact on financial stability to currency competition. Overcoming this challenge will require foresight, institutional capacity, strong cooperation among all stakeholders in the CBDC ecosystem, and robust adaptability.

Given the uncertainties faced by CBDCs, transparency, accountability, and public engagement will be essential for ensuring public trust, alongside stringent data governance measures. Environmental implications such as e-waste and energy consumption are additional factors that must be considered due to their financial costs and health and environmental risks. While some research suggests that digital currencies like CBDCs might use less energy than existing payment systems, countries have to ensure environmentally conscious designs in order for this difference to be significant. Meanwhile, others may argue that CBDC, as an extra layer of the financial system beyond the existing ones, would increase carbon emissions.

5. A CBDC network among countries could bring both cooperation and inconsistency

Prof Wang’s co-authored research paper envisions what a CBDC network among countries might look like and how this would affect the international financial system. He shares that as different countries gradually introduce CBDCs, it could result in the development of one or multiple CBDC clusters in the global financial network. This network might work in a decentralised manner, where all states rarely act as a unified group. This may bring challenges in addressing common problems ranging from cybersecurity to sustainable development.

The CBDC network could have significant implications for regulations and policies. While it might lead to some countries learning from and adapting to each other’s approaches, it is not guaranteed to result in the adoption of the same rules by everyone. Countries in the CBDC network might act in their best interests in response to the disruptive impact of the CBDCs, potentially leading to limited cooperation and potential inconsistency among different CBDC standards and practices. This conflict could cause fragmentation in the international monetary system and higher transaction costs, affecting individual states in their international economic relationship, including their participation in different cross-border CBDC arrangements and more broadly, international financial landscape and standard-setting.

Nevertheless, Prof Wang hopes to see efforts by international organisations, central banks, the industry, and other actors to find common grounds and to enhance transparency, legitimacy, and accountability in the governance of CBDCs, if the issuing of CBDCs becomes commonplace. This would be crucial for public trust, which is of paramount importance for any currency.