Central Bank Digital Currencies: Policies and Progress

Precious metals served as the first means of making payments and currencies followed later on. Many national and local rulers have sought to monopolize the right to issue their own currency，but their efforts were largely unsuccessful until they established a single standard for legal tender.  While ushering in the new digital age，the rise of private encrypted digital technology has once again raised the challenge of denationalizing currency issuance. As an effective response to private encrypted digital currencies，CBDC embodies the state's currency sovereignty in the age of the digital economy.

What is CBDC?

Around the world，there is growing interest in Central Bank Digital Currencies (CBDC)，but what exactly are they? What's the difference between them and other types of currencies? Before answering these questions，we need to examine digital currencies from the following four aspects: Who is the issuer – is it a central bank or commercial banks? Is the currency electronic or a physical unit of exchange? Is the currency issued to the general public or to specific institutions? And what is the transfer mechanism – is it centralized or decentralized?

The renminbi banknote is a physical currency issued by the People's Bank of China for use by the general public，but the reserves on deposits that commercial banks must leave at the central bank can be considered as an electronic form of currency issued by the central bank to designated institutions. Before central banks begin issuing retail digital currencies，the general public does not have direct access to any electronic currencies issued by a central bank. Deposits in accounts at commercial banks are in a sense a digital currency，however. They are not issued by the People's Bank of China but are electronic currencies issued by commercial banks and used by the general public. They also have a centralized transfer mechanism as they can be shifted from bank to bank. The use of CBDC in retail applications would be a breakthrough. For the first time，it would allow the general public to make the central bank the indebted party for the electronic currency. This would have a profound impact on the financial markets and the economy overall.

Strictly speaking，CBDC refers to various forms of electronic currencies issued by central banks. They can be divided into retail currencies (issued to the general public) and wholesale currencies (issued to specific institutions，such as commercial banks). If we distinguish them by their transfer mechanism，they can be divided into account-based CBDCs and token-based CBDCs. The technical aspects of the former are similar to the deposit account management of commercial banks，while those of the latter are more like private encrypted digital currency.

Additionally，based on the sovereign nature of central bank currencies，CBDC can also be divided into domestic-use ones and CBDC for cross-border payments. The latter are mainly used among financial institutions and should be seen as wholesale CBDCs. These would pose a direct challenge to the SWIFT system that currently dominates cross-border payments and settlements but would have little impact on the legal tender of other sovereign nations. However，if cross-border CBDCs can be used in retail payments，they will have a significant impact on the legal tender of other sovereign countries that use them. In a worst-case scenario，retail users might be encouraged to abandon an unstable currency that is the legal tender of their own country in favor of the digital currency.

For CBDCs issued for domestic use，those used for inter-institutional payments would optimize the account system that institutions currently rely on. In this regard，a decentralized solution such as blockchain technology would be the proper choice. Whereas if they are to be used in domestic retail scenarios，there would be more choices based on technical considerations. That is the major focus of the current theoretical and practical research being conducted in China.

Policy Considerations

There are divergent opinions on why central banks of various countries need to issue CBDC，especially for retail use. In terms of the incentives for the issuance of CBDC，the major viewpoints can be summarized as follows:

According to proponents，one benefit is stabilizing seigniorage. Those who hold this view contend that the wide use of private electronic money，represented by electronic bank deposits，has greatly reduced our need for cash. This reduces the seigniorage of the central bank and forces central banks to rely on government financial support for their own expenditures. In order to stabilize seigniorage and maintain the financial independence of central banks，it is necessary for central banks to issue CBDC.

Another benefit that is often cited by proponents is improved monetary policy efficiency. At present，central banks of major economies such as the United States and in Europe are using zero or even negative interest rates to stimulate the economy. However，the existence of banknotes and cash allows the general public to hedge against such policies by holding onto cash. That in turn makes it difficult to maintain a negative interest rate monetary policy. But if cash is replaced with CBDC，central banks might be able to limit the amount of cash held by residents by applying negative interest rates to CBDC，thereby achieving real negative interest rates throughout the banking sector.

Enhancing the competitiveness of the payment system is another advantage that is often cited by proponents. In some developed economies，the payment cards created in an oligopoly market have led to excessive retail payment rates. This has adversely affected economic development. Being independent from the existing payment and settlement system，the issuance of CBDCs would help stimulate the retail payment market.

Financial inclusion is seen as another benefit. Due to an insufficient financial reach of the central bank，disadvantaged groups in certain countries are unable to enjoy basic financial services as they are not covered by the banking system. Instead of relying on bank accounts，token-based CBDCs rely on a digital wallet. In that way they can fill the gap in the market to a certain extent and expand the availability of financial services.

CBDCs are also seen as helpful in fighting financial crime. Due to the complete anonymity of transactions，excessive use of cash is often associated with terrorist financing，tax evasion，and money laundering. This leads to a  number of economic and social problems. In contrast，CBDC is anonymous but also more controllable. While trading parties can remain anonymous when dealing with their peers，the central bank as a third party has the right to see who the parties are. This greatly facilitates the prevention of tax evasion，terrorist financing and money laundering.

Another argument for CBDC is to cope with the challenge to sovereign currency from encrypted digital currency. Private encrypted digital currency like bitcoin have already posed challenges to the local legal tender of certain countries that are experiencing hyperinflation or have strict foreign exchange controls. Global central banks displayed a sense of impending crisis when online social media company Facebook tried to issue a super-sovereign currency – Libra - directly to billions of its retail customers.

The reasons for interest in CBDC issuance vary considerably from country to country. Developed countries in general focus more on improving the efficiency of monetary policy，while developing countries emphasize financial inclusiveness and more convenient retail payments. Countries or territories that have a currency with a poor reputation mainly hope to use CBDC to deal with the challenge of private digital currencies. Reducing the use of cash and strengthening control over the flow of funds are of practical value to all countries. Relatively speaking，seigniorage is the least important factor as far as central banks are concerned.

However，CBDC brings both benefits and challenges to economic development. Many experts contend that CBDCs might actually make the financial system more fragile. In extreme cases，every citizen and enterprise could directly open an account with the central bank and have a direct borrowing relationship with the central bank. That would inevitably pressure the deposit and loan business of commercial banks. Even if the CBDC issued by the central bank is not allowed to be used for lending purposes，it will still threaten the demand deposits of commercial banks. Especially when financial risk arises，people will convert their bank deposits endorsed by commercial banks into CBDC which in turn would be backed by the central bank's credit