Coming Soon? Developments in Central Bank Digital Currency

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The prospect of central banks issuing central bank digital currency (“CBDC”) has garnered further attention during the COVID-19 outbreak, which has underlined some of the disadvantages and risks of transacting with physical cash. CBDC could be used to further facilitate transactions without the need to exchange a physical item, and could also potentially be used to facilitate an immediate and direct transmission of funds from the government to individuals in times of emergency, be it for fiscal stimulus, small business funding needs or payment of unemployment benefits. Although developments on this front may not be as immediate as needed to add value in the immediate term in the current outbreak, they could lay the groundwork for future use cases.

Canadian Developments

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riksbank and the Swiss National Bank, together with the Bank for International Settlements (BIS), have created a group to share information as they assess the potential cases for CBDC in their home jurisdictions. The group will assess CBDC use cases and economic, functional and technical design choices, including cross-border interoperability. It will also facilitate the sharing of knowledge on emerging technologies. The group will coordinate with the relevant institutions and forums, including the Financial Stability Board and the Committee on Payments and Market Infrastructures.

The Bank of Canada is also implementing a portfolio of initiatives designed to prepare for the future of money and payments, including building, as a contingency, the capability to issue a retail, cash-like CBDC to the public, should the need ever arise. Two scenarios have been identified that could drive such decision, including:

  • the use of bank notes declining “to a point where Canadians no longer have the option of using them for a wide range of transactions;” or
  • one or more alternative digital currencies, likely issued by private sector entities, becoming “widely used as an alternative to the Canadian dollar as a method of payment, store of value and unit of account.”

In these scenarios, a CBDC could be one way of preserving “universal access to secure payments, an acceptable degree of privacy, competition and resilience”. However, a decision to launch a CBDC would require the full support and approval of the Government of Canada and acceptance by the Canadian public, as well as a careful management of the associated risks, notably:

  • the potential adverse effect to the stability of deposit funding for banks or increase of the risk of a bank run; or
  • possibly being used as a vehicle for financial abuses, such as money laundering and terrorist financing.

U.S. Developments

On January 16, 2020, Christopher Giancarlo, former Chair of the Commodity Futures Trading Commission (CFTC), along with Charles Giancarlo and Daniel Gorfine issued a press release to announce the creation of the Digital Dollar Project (the “Project”) in partnership with Accenture. The Project seeks to advance exploration of a United States CBDC. The press release states that, “a dollar CBDC would represent a third format of currency and, similar to paper currency, be backed by (and therefore be treated as a liability of) the Fed.” This would be a key distinction from tokenizing bank money, which is a liability of the issuing commercial bank.

As the first phase, the Project will consider initial designs and proposals for a U.S. dollar CBDC. To this end, it will enlist the participation of individual economists, business leaders, technologists, innovators, lawyers, academics, consumer advocates and ethicists. The research and public discussion is expected to focus on the potential advantages of a digital dollar, the possible avenues to advance U.S. digital dollar tokenization and the related implications on American and global economic and financial systems. The research outcomes will help design a framework for potential practical steps to establish a dollar CBDC.

To facilitate launching the Project, Christopher Giancarlo, Charles Giancarlo and Daniel Gorfine are establishing the Digital Dollar Foundation (the “Foundation”), a not-for-profit organization. The Foundation will help bring together an expert multi-stakeholder community to take maximum advantage of real world experience and the latest technological capabilities.  

Digital Dollar Project Use-Cases

Use-cases for a U.S. dollar CBDC are expected to include supporting retail, wholesale and international payments:

  • Retail payments: A U.S. digital dollar would allow for instantaneous peer-to-peer payments, while providing diversification of payment rails. It could be distributed to end-users through commercial banks and trusted payment intermediaries, thus offering additional mechanisms to ensure and facilitate financial inclusion.
  • Wholesale payments: A U.S. digital dollar would offer more diversified access to large value payments. It would also support the emergence of digital financial market infrastructures without having to rely on inter-bank clearance using central bank money to settle securities and other large value payments.
  • International payments: Using U.S. digital dollars in cross-border and offshore transactions would enable making digital payments in central bank money for remittances and large value payments, including the option to conduct offshore securities settlement. A digital dollar would reduce risks and address persistent deficiencies of the existing correspondent banking model, while advancing financial market integration.

Digital Dollar Project Key Principles

The Project will take into account a range of stakeholder views and needs, and aim to offer solutions that can be implemented by adhering to existing performance standards of U.S. financial infrastructure. Discrete pilots will precede the partial introduction of the dollar CBDC before broadly rolling out across all use cases. Such an introduction would adhere to the key principles outlined below:

  1. Ensuring real-world and inclusive benefits of a digital dollar, which will constitute a liability of the Federal Reserve and form an integral part of the monetary base, and subsequently be made broadly available;
  2. Preserving effectiveness of monetary policy and financial stability, while future-proofing the greenback;
  3. Ensuring requisite privacy and security in payments is preserved;
  4. Adhering to existing know-your-client / anti-money laundering (KYC/AML) requirements while distributing through regulated payment intermediaries and banks;
  5. Facilitating special provisions to on-board parts of the digitally excluded population;
  6. Enhancing economic policy insights through the transparency of digital payments;
  7. Offering comprehensive and seamless integration with the financial infrastructure including through connectivity to existing core banking and payment functions, custody solutions and electronic wallets;
  8. Developing best-in-class technology to support required digital currency functionalities;
  9. Collaborating with public and private stakeholders, leveraging private sector dynamism and innovation; and
  10. Offering flexible development and testing of project elements.

 

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

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