Since 2016, about a hundred central banks have been considering the introduction of a Central Bank Digital Currency (CBDC). It began as central banks watched the development of new technology and the growth of Bitcoin, followed by Alt coins and then stable coins. When Facebook announced the birth of Libra, later Diem, as a possible international currency and payments system in June 2019, interest and concern was intensified. The initial project was later abandoned in May 2021, partly because of the long delays in obtaining a payments license from FINMA, the Swiss Financial Markets Supervisory Authority. The Swiss were being advised by twenty central banks, so it was unlikely from the start that a payments license would be granted. Central banks were no doubt relieved when Facebook withdrew the application. Facebook’s project then moved back to the U.S. in the form of a payments system with a single stable coin, USDP. That did not work either, so Facebook gave up entirely and sold the remaining assets to Silvergate Capital in May 2022.

Central banks were indeed opposed to the development of a digital currency which could compete with sovereign currencies, especially given that Libra/Diem would provide Facebook with even greater access to data of its over two billion users. But that was not the only reason for the failure. A currency can only work if it commands the trust of the users of the currency. Facebook had a history of misusing data, and that was the underlying cause of its failure. The importance of trust in the issuers of a currency should be a vital element in the development of a CBDC.

Central banks have spent several years considering the principles which should apply to CBDC, its functional and economic design (should CBDC accounts bear interest?), and the technology to be used. Research continues together with the development of proof of concept and pilot projects. The leading central banks have conducted many pilot projects, usually focusing on the use of the new technology in the wholesale markets with the aim of speed, efficiency, and the tokenization of wholesale CBDCs often in domestic markets. Wholesale CBDC refers to a type of liability on a central bank’s balance sheet, designed to settle wholesale (large value) financial transactions, such as interbank transfers and securities transactions. These could then become “bearer instruments” so that whoever holds the token, as recorded on the digital ledger, is presumed to be the rightful owner.

The years following 2016 saw a large number of pilot projects, such as Project Jasper (Canada), Project Ubin, (Singapore), Project Stella (EU and Japan), and Project Jura (French and Swiss commercial banks as well the Banque de France, the Swiss National Bank, and the BIS Innovation Hub).The various “proof of concept” pilot projects have been concerned with clearing and settlement of the capital markets, but they have not yet been implemented, as they raise questions of “governance and ownership,” and the “regulatory, legal and monetary issues,” as well as issues of transparency and enforcement. None of the leading central banks have agreed to or encouraged the tokenization of assets for these reasons and especially for Anti-Money Laundering/Countering the Financing of Terrorism (AML/CTF) considerations and the delicacy of providing access to their CBDC by non-resident financial institutions, especially in a time of heightened geopolitical risks.

Nevertheless, central banks continue their research and have either completed or are in the process of carrying out cross border projects, such as Project Helvetia, completed in January 2022. It successfully integrated the wholesale CBDC to the core banking infrastructure of the country. In June 2022, the Bank of England commenced work on Project Rosalind, which is aimed at understanding how central bank ledgers can successfully communicate with private sector vendors. Part I was due to be completed in Q1 2023, but now Part 2 is under way, involving the development of an API platform to distribute retail CBDC. Many of these projects are being carried out in conjunction with BIS Innovation Hub.

Payments Canada’s research team is still working together with the Bank of Canada to understand the implications of a CBDC for Canada and the role of Canada Payments. Sweden was generally expected to be one of the first to introduce its CBDC, the e-krona, but in December 2020, the Minister for Financial Markets announced a review of the possibility of introducing it. This review became an investigation into the role of the state in the payments market and what its role should be in the future. The outcome was finally announced on March 31, 2023. The inquiry did not find “sufficiently strong societal needs” for an e-krona, leaving it open for the Riksbank to come back during 2024 with an assessment of whether there are sufficient reasons to introduce the e-krona. But given the retirement of the previous Governor of the Riksbank, Stefan Ingves, in 2022, enthusiasm for the project may well have waned.

Some central banks have engaged in consultation with the public about the introduction of retail CBDC, notably the European Central Bank and the Bank of England. One of the key issues which emerged during the EU consultations was privacy of transactions. The design proposals for both the UK and the EU will include approved intermediaries (payment service providers) to conduct the customer checks during onboarding with personal and transaction data accessible to intermediaries to ensure compliance with AML/CFT requirements. If the Eurosystem decides to carry out settlements, it should only be able to see the minimum transaction data required to validate digital euro payments and anonymized data for statistical, research, supervisory, and oversight purposes. The EU’s third report on the design of the digital euro was approved by the ECB and was published on April 24, 2023. The EU Commission is expected to publish its Regulation in the next two months, but the EU Parliament will have the final decision, perhaps later this year.

The Bank of England and HM Treasury published a consultation paper on the digital pound in February 2023. The model has certain similarities with the EU’s approach. The central bank would provide the digital pound and the infrastructure, including the core ledger. Private sector companies, including banks and non-banks, the Payment Interface Providers, provide the “wallets,” which simply pass instructions from the user to the core ledger. End users would interact with the wallets rather than directly with the Bank. This is designed to preserve their privacy. More work needs to be done to ensure this is the case. The user’s holdings of digital pounds are recorded anonymously on the BoE’s core ledger.

What is of direct concern to UK commercial banks is the amount individuals can hold in their digital wallets. The Bank of England proposes between £10,000 and £20,000 per digital pound wallet—enough to enable users to receive salaries with headroom to cope with bonuses or overtime payments, but still a limited amount of holdings of digital pounds. When it comes to corporates and digital pounds, the BoE effectively gives up on finding a one size fits all. Commercial banks must keep watch since digital pounds will reduce deposits, and the issue is—by how much? Will banks have to turn to the wholesale market for funding, which will not only increase costs but also require careful asset/liability management? The role of banks in providing credit is essential for economic growth, and for helping to finance innovative projects. Issuing credit should never fall into the hands of bureaucrats at a central bank. Such bureaucrats are unlikely to be risk takers by nature.

Both the Bank of England and the ECB believe they have proposed a structure which will never allow that to happen. The ECB is probably over-optimistic about the time-scale. The UK is more realistic—maybe by 2030, but that will require an assessment of the way in which the payments landscape evolves in the coming years, and especially “whether new forms of privately-issued digital money emerge and how they interact with existing forms of money and payments.” That is an interesting reference, since the UK appears to take the view that with regulation, stable coins could be incorporated into the payments structure in the UK. Such regulation is not yet in force. Nor has the technology for delivery of CBDC yet been designed or built. The choice is not as obvious as it might appear. It is often assumed, as one official recently put it, that distributed ledger technologies are the “obvious choice . . . but decentralization may be undesirable for other aspects of the system, such as governance.” Much more thought needs to be given to the way in which the technology will actually work. What will happen if, for example, the central bank fails to make the requisite transfer or fails to transfer the requested amount in what is presumably an immutable core ledger? If that happens, what use is my CBDC money? Many such technical problems need to be sorted out, but the full implications of CBDC, if adopted, have not been taken on board.

Neither the ECB nor the UK has fully examined the issue of privacy for a user’s transactions. Such safeguards would need to be fully in place, if, for example, each euro or pound in its digital form has a unique identification and the central bank maintains the central register of transactions. Even if the current central bank governors exercise restraint, neither the central bank nor the Parliament can guarantee that will not change in the future, but the powers have already been given to the central bank.

In its consultation paper published in January 2022, “Money and Payments: The U.S. Dollar in the Age of Digital Transformation,” the Federal Reserve noted that while no decisions have been made on whether or not to create a U.S. CBDC, the research and analysis carried out so far show that a U.S. CBDC would have to be “privacy-protected, intermediated, widely transferable, and identity-verified.” These are much the same conclusions as those reached in other major jurisdictions, but few are in the process of creating their own CBDC. No one intends the CBDC to replace cash, apart from China. CBDC will not help financial inclusion, since there are other effective ways of achieving that, as the UK has done. Payment systems can be improved and costs can be lowered without CBDC. Many payment systems have already achieved that.

The endless discussion papers, research, and analysis have failed to come up with good reasons for introducing CBDCs. Even China is finding it difficult to replace Alipay and WeChat Pay with the digital yuan. These two payment platforms are widely used and immensely popular. China has tried to bribe the public with millions of yuan to encourage people to use the digital yuan, controlled by the government, but it has not been a success. The major effort to popularize the digital yuan is currently taking place in Changshu. All public sector workers in the city, including staff at state-owned companies and public institutions such as schools and hospitals will be paid only in the digital yuan, also known as e-CNY. Cash will disappear entirely. Every transaction is recorded and traceable in a digital ledger, thus giving the government unprecedented power over each individual, as part of “social policy.”

But it is difficult for a central bank to announce that it is no longer examining the potential value of CBDC while it is continuing to research and analyze the issue and carrying out various limited projects, often in the wholesale rather than the retail sector. Even in the wholesale sector, key issues of anonymity and privacy have not been solved, and that is the most likely arena for CBDC. The attendant risks have not gained sufficient attention, including the huge cyber security risk of using a single technology in the transfer and recording of most of the transactions in the domestic economy, never mind in international transfers. The technology to be used has yet to be selected, built, maintained, and protected against major cyber attacks. Such attacks could mean the domestic economy grinds to a halt, inevitably affecting other countries with whom the targeted country trades as well. Every choice of technology has serious issues, and no major country has decided what and how to build it.

Effective private national and international transfer systems already exist. Sweden once again leads the way by simply seeing that there are no good reasons for introducing CBDC and so postponing the project. Others should follow suit.

Note from the Editor: The Federalist Society takes no positions on particular legal and public policy matters. Any expressions of opinion are those of the author. We welcome responses to the views presented here. To join the debate, please email us at [email protected].