Central Bank Digital Currencies

What is a central bank digital currency (“CBDC”)?

A CBDC is a digital form of fiat money issued by a central bank or monetary authority. (Fiat money is government issued currency not backed by a physical commodity like gold). A CBDC is “digital” because it is not physical money and instead is a value on a computer or similar device.

How is a CBDC different to an electronic representation of currency (e.g. a credit in your bank account)?

CBDC transactions do not pass through banks and instead occur instantaneously on a digital ledger. You don’t need a bank account to transfer CBDCs. Money in a bank account is a claim on the bank, but a person holding CBDC has a claim on the central bank – like physical cash.

How is a CBDC different to a cryptocurrency?

Cryptocurrencies are digital currencies like a CBDC, but a CBDC is different as it is issued and regulated by a central bank and stored using a centralised method, rather than a decentralised blockchain ledger.

The value of a typical cryptocurrency can fluctuate significantly, while the value of a CBDC is based on the currency of the country whose central bank issues the currency. (A “stablecoin” is a special type of cryptocurrency whose value is tied to another currency, commodity or financial instrument).

What is the difference between a retail CBDC and a wholesale CBDC?

There are two types of CBDCs, retail and wholesale.

Retail CBDCs are available to consumers and businesses, similar to physical forms of currency. Wholesale CBDCs are primarily used by financial institutions.

Retail CBDCs make central bank digital money available to the general public, just as cash is available to the general public, as a direct claim on the central bank. Retail CBDCs take on two forms, differing in how individual users access and use the CBDC. Token-based retail CBDCs are accessible within private/public keys. This method of validation allows users to execute transactions anonymously. Account-based retail CBDCs require digital identification to access an account. 

Wholesale CBDCs enable the settlement of interbank transfers and related wholesale transactions; for example, to settle payments between financial institutions. They could encompass digital assets or cross-border payments.

Wholesale CBDCs and central bank reserves operate in a similar way: settlement is made by debiting the account of the bank that has net obligations to the rest of the system and crediting the account that has a net claim on the system.

Have any countries issued a CBDC?

Currently, 10 countries have live CBDCs, 15 have ongoing pilots and 67 are involved in research and development.

The countries that have issued CBDCs include Nigeria, Cambodia, and several Caribbean nations.

China launched a digital yuan (also known as the e-CNY) on a pilot basis in 2022.

In the United States, President Biden signed an executive order on 9 March 2022 stating that his Administration would place “the highest urgency on research and development efforts into the potential design and deployment options of a United States CBDC.”

In March 2022 the Bank of International Settlements released the report of Project Dunbar, which developed two prototypes for a shared platform that could enable international settlements using digital currencies issued by multiple central banks.

What is the status of CBDC in Australia?

In 2018-2019 the Reserve Bank of Australia (“RBA”) examined the use of a wholesale CBDC for domestic interbank transactions and concluded that there were few benefits in comparison to its existing real time gross settlements system (RITS).

In September 2020, the RBA published a report highlighting design considerations for a retail CBDC, and concluded that there was not a strong public policy case to implement one. 

The report of the Senate Select Committee on Australia as a Technology and Financial Centre chaired by Senator Andrew Bragg (the “Bragg Report”) in October 2021 outlined 7 digital currency recommendations, including reviewing the case for a retail CBDC. 

On the back of the Bragg Report, the Treasury indicated that it would further investigate the viability for a retail CBDC in Australia. 

CBDC implementation in Australia will likely be shaped by both domestic demand and international pressures, with a wholesale CBDC a more probable outcome.

What are the benefits of a CBDC?

Some of the claimed benefits of a retail CBDC include reducing cash hoarding and the operational inefficiencies of cash, reducing crime, frauds and scams, and the use of a CBDC to make social and emergency payments, as well as a means for instant payments and settlement.

Other benefits for consumers might include no merchant fees, no surcharge fees, and easy tracking of transactions. It is also said that CBDCs will provide more control on recovering assets lost to scams because there are fewer intermediaries involved in transactions. 

Retail CBDCs are also said not to entail any credit risk for payment system participants, as they are a direct claim on the central bank.

Wholesale CBDCs would allow for new forms of the conditionality of payments, requiring that a payment only settles on condition of delivery of another payment or delivery of an asset.

CBDCs built on digital identification could improve cross border payments by reducing costs and limiting the risks of currency substitution. Multi-CBDC arrangements could surmount the hurdles of sharing digital IDs across borders but would require international cooperation.

What are the risks of a CBDC?

While there are many touted benefits of CBDCs, there are also risks.

The most prevalent concern is the effect of disintermediation – the reduction in the use of intermediaries between producers and consumers, for example by individuals or financial institutions putting their money into a CBDC system instead of into commercial banks. This could mean fewer loans and less private sector economic activity. Some advocates believe regulation may address this problem, by placing issuance limits on CBDC units, limiting CBDC access for wholesalers and major players only, or imposing penalty interest rates or fees on CBDC holdings.

Another important consideration is security, which includes the prevention of counterfeiting, fraud and double spending.  The security considerations for a CBDC are not dissimilar to those for conventional payment systems, online banking and other financial activities.

A broader political and social concern is the potential concentration of power and control that a CBDC would enable. A central CBDC ledger could operate as a record of how everyone spends their money, with obvious implications for privacy, while a CBDC could be programmed so that your money could only be spent on certain things.

Proper oversight and control will be important design factors to ensure that a CBDC does not undermine personal privacy, economic liberty and freedom of choice.

Patrick Dwyer and Kathleen Harris
Legal Directors

Thanks to Danielle Hodgson for her assistance in preparing this article.