Exploring the future of digital money

By Alistair Jones

SMU Office of Research & Tech Transfer – Central bank digital currencies (CBDCs), such as China’s e-CNY, is the digital version of fiat currency. CBDCs will likely lead to new financial infrastructure and practices, and may be used by businesses and the individuals. The development of CBDCs is predicted to be a game-changer for the international financial system. Some say the monetary competition through the CBDCs of major economies ‘will be the defining development of the next decade’.

According to a 2021 survey of central banks conducted by the Bank of International Settlements (BIS), 86 percent were actively researching the potential for CBDCs, 60 percent were experimenting with the technology and 14 percent were deploying pilot projects.

But do we actually need CBDCs?

“That depends on how a CBDC is designed and whether the benefits exceed the costs,” says Heng Wang, a Professor of Law at Singapore Management University (SMU).

“A CBDC is to be issued by the central bank. As an example of the implications of CBDCs, does a CBDC address concerns ranging from cyber security to privacy protection? This is the reason why many central banks are researching into the value and risks brought by a CBDC.”

Professor Wang notes that, “differing from cash, a CBDC generates a huge amount of data and data is the ‘king’ in the digital age. Moreover, a CBDC requires both software (such as, regulation, technical standards, intellectual property) and hardware (infrastructure).”

“If everything goes smoothly, CBDCs will build a new ecosystem. A CBDC may enable direct exchange of currencies and reduce the need for intermediary currencies such as the US dollar (USD),” he says.

Behaving instrumentally

Professor Wang, with Associate Professor Simin Gao from the law school of Tsinghua University, has been utilising network analysis to explore what kind of CBDC network is likely to emerge, as well as its potential effects and impact on the present global financial arrangements.

The researchers envision CBDCs assembling into an uncoordinated network-as-structure.

“An uncoordinated network-as-structure means a network that may fail to act collectively,” Professor Wang explains.

“This is the form CBDCs will likely take since [we are] far from reaching an international consensus on CBDCs, given the positions of states.”

The researchers also predict states in the CBDC network would behave instrumentally in response to a CBDC’s disruptive effect, and the CBDC network would bring limited cooperation and generate greater conflict. The conflict is likely to bring fragmentation in the international monetary system.

So, how can we approach the collective action problem where the national self-interests of competing economic and geopolitical agendas may hamper effective implementation of cross-border CBDCs?

“Obviously it is not easy,” Professor Wang says. “More dialogues and building of trust are needed, such as through international organisations and forums (the BIS, the Hague Conference on Private International Law, the IMF and the World Bank). It is likely to be an incremental process of searching for common grounds. And this would depend on the willingness of the states.”

Could the US use its financial predominance to be some kind of ‘umpire’ in global CBDC design?

“It is not easy. Some CBDCs might build new systems and standards. In these areas, the USD may not necessarily play the leading role. This may be affected by international relations and issues such as sanctions,” Professor Wang says.

“On the other hand, the digital USD is likely to have strong impacts given the heft of the US and many stakeholders prefer the USD.”

Pressures and costs

Not everyone is convinced by CBDCs. Denmark has decided the potential benefits are exceeded by the effort and cost. And Ecuador’s Dinero Electrónico project failed to attract enough users, given a lack of trust in its central bank.

The challenges of operating an innovative platform were highlighted last year when the Eastern Caribbean Central Bank was forced to crash its digital currency project – DCash – for two months due to technical issues. Bloomberg and various media outlets reported that no transactions were possible during the shutdown for the seven Caribbean nations that use DCash.

“Glitches in CBDCs may cause issues [and] there could be unintended effects that may be difficult to predict as CBDCs are the new digital form of currencies,” Professor Wang says.

In Singapore, the Monetary Authority of Singapore (MAS) has completed the first phase of its CBDC project, which explored the potential use cases for a digital Singapore dollar as well as the infrastructure required to implement one. The MAS found no urgent need for a retail CBDC but said it wanted to be prepared in case that changes.

In Australia, the Reserve Bank has received many use case proposals from the finance industry but has warned that a CBDC could displace the Australian dollar and result in people avoiding commercial banks entirely.

The retail application of CBDCs by individuals poses the biggest threat to commercial banks, which could face fierce pressure to reduce costs and banking fees, or to provide better services to retain their customer base. And there's the possibility of a run on the banks.

“Depositors may withdraw their deposits in a time of economic stress and use CBDCs. This explains why central banks are thinking of preventive measures such as a cap on CBDC holdings.” Professor Wang says.

“Moreover, it is yet to be seen how commercial banks [could] make profits in the CBDC ecosystem. This involves business models. For instance, CBDCs are demanding for technology and this may involve investments of commercial banks.”

Active piloting

China is expected to become the first major economy to issue a CBDC.

“China is leading in the use of FinTech and mobile payment,” Professor Wang says. “Also, China started its CBDC research in 2014. It is actively piloting its CBDC in the recent years. All these help China to become a first mover.”

Several Chinese cities such as Shenzhen and Suzhou have been using CBDC in retail payments and the pilot is to be expanded to more regions. China is working with several regulators and the BIS in a pilot of possible cross-border use of CBDC in contexts like trade.

“China’s experience in CBDC may help it to shape standards and practices relating to CBDC. This is a new area in which international standards are lacking. Countries that explore CBDC may learn from the experience of China when applicable. The US does not move as fast as China in CBDC,” Professor Wang says.

“However, it also depends on whether there would be first-mover advantages or later-mover advantages. And the trust and transparency of a CBDC are crucial.”