Why We Don’t Need Retail CBDCs!

Introduction to CBDCs

Central Bank Digital Currencies (CBDCs) represent the digital form of a country’s fiat currency, issued and regulated by its central bank. Unlike cryptocurrencies such as Bitcoin, which are decentralized and often speculative in nature, CBDCs are designed to maintain parity with the nation’s official currency, ensuring stability and regulatory oversight. The design and implementation of CBDCs vary, leading to two primary types: retail CBDCs and wholesale CBDCs.

Types of CBDCs

• Retail CBDCs Retail CBDCs are digital currencies available directly to the general public for everyday transactions. They function as a digital form of cash, enabling people to make payments, transfer funds, and even store value. Aimed at public use, retail CBDCs are intended to provide safe, accessible, and efficient payments for individuals and businesses. They may offer particular benefits in countries where banking infrastructure is underdeveloped, providing an additional avenue for financial inclusion.
• Wholesale CBDCs Wholesale CBDCs, by contrast, are intended for use by financial institutions rather than the general public. They are designed to facilitate large-value, interbank transactions, allowing central banks and financial institutions to settle payments with greater efficiency, speed, and security. Wholesale CBDCs often leverage blockchain or Distributed Ledger Technology (DLT) to streamline the settlement processes in complex financial transactions.

Captured the imagination of Central Banks across the World

CBDCs have captured global interest as central banks explore ways to modernize payments, improve financial inclusivity, and address specific economic challenges. As of September 2024, 134 countries, representing 98% of global GDP, are exploring Central Bank Digital Currencies (CBDCs). Among these, 66 countries are in advanced stages—development, pilot, or launch—of their CBDC projects. Notably, all G20 nations are investigating CBDCs, with 19 in advanced stages and 13 already in the pilot phase.

A significant portion of these nations are exploring retail applications. For instance, countries like China, Nigeria, and the Bahamas have launched or piloted retail CBDCs aimed at public use. In every country with an advanced retail CBDC project, the distribution is intermediated through banks, financial institutions, and payment service providers. While the precise number of countries developing retail CBDCs isn't specified, it's clear that a substantial number of the 66 countries in advanced stages are focusing on retail solutions.

Salient Features of CBDCs

CBDCs, while still evolving, generally share several key characteristics:

• Centralized Control: Unlike decentralized cryptocurrencies, CBDCs are controlled by the issuing central bank, which determines issuance, distribution, and redemption policies.
• Digital Ledger: Most CBDCs operate on either a centralized or distributed ledger to record and verify transactions, ensuring transparency, traceability, and security.
• Token- or Account-Based: Retail CBDCs can be either token-based (similar to physical cash) or account-based (requiring identity verification for access), depending on the central bank's objectives and the regulatory environment.
• Programmability: CBDCs have programmable capabilities, allowing central banks to design rules and conditions around their usage. For example, they could enable targeted stimulus payments or facilitate automated taxation.
• Offline Functionality: Some retail CBDCs are designed to support offline transactions, ensuring that users can still make payments without an internet connection, which is especially beneficial in regions with poor connectivity.

Use Cases for CBDCs

CBDCs are being developed to address a range of economic and technological needs, with use cases varying by country. Below are some of the prominent use cases:

1. Financial Inclusion CBDCs can help extend basic financial services to unbanked and underbanked populations by enabling digital payments without the need for a traditional bank account. This is especially valuable in emerging economies where digital penetration is high, but access to banking infrastructure continues to be limited.
2. Payment System Modernization In developed economies, CBDCs can provide an upgrade to existing payment systems, offering faster, cheaper, and more secure payment options compared to traditional credit or debit cards. They can also reduce dependence on private payment systems, ensuring that payment infrastructure remains under public control.
3. Cross-Border Payments CBDCs hold potential for streamlining cross-border transactions by eliminating intermediaries, reducing costs, and speeding up settlement times. Several countries are exploring international CBDC interoperability, enabling more efficient cross-border payments for remittances, trade, and financial transfers.
4. Transition from Cash CBDCs could help central banks reduce the costs associated with printing, storing, and securing physical cash. Additionally, they offer a more hygienic and traceable alternative to cash, supporting a broader shift to a digital economy.
5. Enhanced Monetary Policy Tools Central banks can leverage CBDCs to implement more direct and precise monetary policies. For instance, they could provide targeted stimulus payments directly to citizens’ digital wallets or enforce expiration dates on certain transfers to encourage spending.
6. Counteracting Cryptocurrencies and Stablecoins As the use of cryptocurrencies and stablecoins rises, CBDCs offer a way for central banks to maintain control over the monetary system. By providing a regulated digital currency, central banks can offer an alternative to these unregulated and quasi-regulated assets, preserving monetary sovereignty and mitigating potential risks associated with other forms of digital currencies.

Why the Majority of Countries Don’t Need a Retail CBDC Solution

While a retail CBDC can theoretically offer new avenues for financial inclusion, streamlined transactions, and digital efficiency, many of the underlying issues they aim to resolve are either overstated or already addressed by existing solutions. The majority of countries may not require a retail CBDC solution, and in many cases, the pursuit of one could prove counterproductive.

1. Existing Digital Payment Infrastructure Is Already Robust

Most countries today have a maturing and resonably efficient/ effective digital payment systems that meet the needs of consumers and businesses.

Established platforms like credit cards, digital wallets (e.g., Apple Pay, Google Pay), and local systems such as India’s Unified Payments Interface (UPI) or Europe’s SEPA Instant Credit Transfer provide fast, reliable, and cost-effective solutions for everyday transactions. Introducing a Retail CBDC in environments where digital payments are already flourishing can be redundant, offering little added value to consumers or businesses - according to a study by the Bank for International Settlements (BIS), over 80% of global transactions occur in countries where digital payments infrastructure is highly advanced, making CBDC a redundant solution for daily transactions.

2. Limited Improvement in Financial Inclusion

One of the key arguments for retail CBDCs is the potential to enhance financial inclusion. However, in many cases, a CBDC would only provide marginal gains in reaching unbanked populations, especially where barriers to inclusion are socioeconomic rather than technological.

• The World Bank estimates that 1.7 billion people remain unbanked, primarily due to poverty, lack of digital literacy, and limited internet access. Addressing these barriers requires social and infrastructural development rather than a digital currency.
• In regions like sub-Saharan Africa, mobile money solutions such as M-Pesa have successfully enhanced financial inclusion without the need for a centralized digital currency issued by a central bank.

3. Privacy Concerns and Public Resistance

Retail CBDCs could grant central banks unprecedented access to individual financial data, potentially infringing on citizens' privacy. Countries with strong traditions of privacy protection may face significant public resistance to a government-backed digital currency capable of tracking every transaction. In surveys conducted in Europe, over 70% of respondents expressed concerns over privacy when considering a digital euro. Countries like Germany and Switzerland have witnessed substantial opposition to proposals for retail CBDCs, citing potential surveillance concerns.

4. High Cost of Implementation with Uncertain Benefits

The development and maintenance of a CBDC infrastructure require significant investment in technology, cybersecurity, and regulatory oversight. For many central banks, these costs could far outweigh the potential benefits, particularly when the existing financial system is already capable of handling digital transactions effectively. A recent IMF report estimated that the cost of developing and implementing a national CBDC could range from $200 million to $1 billion, depending on a country’s technological sophistication. For smaller or developing economies, this cost is a major deterrent.

5. Cybersecurity and Operational Risks

CBDCs introduce new operational risks, particularly related to cybersecurity. A centralized digital currency system could become an attractive target for cyber-attacks, and any breach or service interruption could disrupt the entire national payment system. The risks associated with a CBDC in an era of growing cyber threats make many central banks wary of its potential vulnerabilities. The Federal Reserve has pointed out that a retail CBDC could become a single point of failure, exposing the entire national economy to cyber threats. In 2021, over 5,000 cyber-attacks targeted financial institutions, with an estimated 20% directed at critical payment systems.

6. Potential for Financial Disintermediation

Retail CBDCs could disrupt traditional banking by encouraging people to shift deposits away from commercial banks to digital accounts held directly with central banks. This shift could result in a reduction in commercial banks’ funding, leading to tighter credit availability and higher interest rates, ultimately impacting economic growth. In Sweden, where the e-krona project is among the most advanced, some experts have expressed concerns about financial disintermediation. The project’s pilot phase revealed that, under certain conditions, citizens might move their deposits to e-krona wallets, reducing bank liquidity and challenging banks’ lending capacity.

7. Limited Added Value in Countries with Stable Currencies

For countries with stable currencies and monetary systems, a retail CBDC offers limited advantages. In contrast, CBDCs might appeal more in countries facing severe inflation or monetary instability, where they could serve as an alternative to cash or circumvent currency controls. However, in nations where the currency is already trusted and inflation is well-managed, the demand for a CBDC is minimal. In the United States, the Federal Reserve has maintained that a digital dollar would offer little value beyond existing payment systems. Similarly, Japan and Switzerland have been reluctant to pursue retail CBDCs, citing limited consumer demand.

Closing Thoughts

While retail CBDCs are technically feasible and may be appropriate in a few specific contexts, the vast majority of countries have little to gain from them (happy to be educated otherwise). With established digital payment infrastructures, strong consumer privacy concerns, high costs, and operational risks, a retail CBDC could potentially do more harm than good. Central banks should instead focus on optimizing existing payment systems, advancing financial inclusion through other means, and safeguarding consumer privacy and security.

I suspect, Retail CBDCs might remain a technological novelty rather than a necessity for most economies around the world but I guess time will tell (.... and I usually get these things wrong!)

PS - In my next article, I will try to compare and contrast between CBDCs, Stablecoins and Cryptocurrencies (such as Bitcoin)