According to McKinsey, four-fifths of the world’s central banks have issued or experimented with Central Bank Digitial Currencies (CBDC). The European Central Bank announced in July this year it is progressing with a digital euro, which simply is a euro in digital form rather than a note. The ECB has already experimented on the digital euro ledger; privacy and anti-money laundering; limits on digital euro in circulation; end-user access while not connected to the internet and facilitating inclusiveness with appropriate devices. It found no major technical observations.
In Singapore, the Monetary Authority of Singapore and local and foreign banks have experimented with the digital SGD in Project Ubin, initially for interbank payments and subsequently in cross border transfers. The MAS has now progressed to Project Dunbar with other central banks to experiment with mCBDCs or multiple CBDCs for cross border payments.
Like the so-called cryptocurrencies, these CBDCs are produced by decentralised or distributed ledgers. Blockchain is a form of distributed ledger. Bitcoin and other cryptocurrencies are minted by these distributed ledgers. Ledgers are simply an account of transactions. Digital distributed ledgers are an account of transaction in a digital format, where each transaction - or node - is immutable, that is, it cannot be changed, An immutable ledger provides data security and proof that the data has not been altered.
Although the aggregate market value of such cryptocurrencies now exceeds US$2 trillion (dwarfed of course by fiat), extreme price volatility, strong price correlation to bitcoin, and often slow transaction confirmation times have impeded their utility as a practical means of value exchange, McKinsey observes.
Stablecoins have advantages compared to cryptos. Stablecoins peg their value to a currency such as the US dollar, euro, yen or sterling, or commodities such as gold or platinum. They are issued on faster blockchains than crypto, and aim to address cryptocurrencies' shortcomings. McKinsey estimates that nearly US$3 trillion in stablecoins such as Tether and USDC were transacted in the first half of 2021.
China’s experiment with E-CNY
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The most advanced market application of CBDC at present is by the People’s Bank of China’s (PBoC) in a multi-city pilot of E-CNY (digital RMB).
From late 2019 the PBoC began to pilot test E-CNY in Shenzhen, Suzhou, Xiongan, and Chengdu, initially through app and wallet-based payments. The pilot gradually expanded to Shanghai, Hainan, Changan, Xian, Qingdao, and Dalian. As of June 2021, the pilot test included over 20 million personal wallets, more than 3.5 million merchant wallets, and a throughput of RMB34 billion.
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Initial focus has been on cash replacement for payment scenarios covering transportation, shopping, and government services. Bankers who are following the experiment say that the effort is largely domestic. “PBOC can control liquidity and monetary flow. For example, during golden week, if everyone is going to Shanghai, PBOC would need more liquidity there and hence it can channel more more liquidity to the city. Or, PBOC can quickly foster spending when spending is slowing down to boost the economy through, say, retail sales for instance,” the banker says.
To implement E-CNY, the Chinese government had to implement a law so the E-CNY is legal tender. The PBoC will distribute the digital currency to six authorised state-owned banks, which will circulate it to consumers. A use-case is the Beijing Winter Olympics from Feb 4-20, 2022, where mainly E-CNY will be in circulation.
A different type of blockchain
Although distributed ledger and blockchain theoreticlly have no central node, in E-CNY, the PBOC is in the centre. “The PBOC issues the E-CNY and the Chinese banks, the big 4+2, distribute the CBDC in first tier cities and participating banks distribute it further in tier 2 cities,” the banker says.
Consumers are able to download and deploy a digital wallet from these banks without holding an account with them. Benefits include mitigated KYC risk and reduced compliance cost related to transaction monitoring and reporting, given E-CNY’s “controlled anonymity” (only central banks will have full access to trading data), McKinsey indicates. Enhanced technical underwriting capabilities are also anticipated, creating competitive differentiation for participating banks. As a social benefit, the digital currency is expected to to be used for the distribution of targeted subsidies.
“There is middle ground to make this effective if you want to use blockchain for good. The central bank may not want direct contact with the end user, so you need banks to do those services in the middle such as KYC and compliance. This is the Chinese model,” the banker says.
