Central bank digital currencies were a curiosity five years ago. They’re now a fad. In addition to the 11 that are already using them, more than 40 economies are running pilots or are in the preliminary development phase. As interest in these new-age payment tools grows, previously unasked questions about them begin to surface. Some appear to be simple, but getting the answers right could be critical.
Begin with a simple question: physical representation. The Reserve Bank of India raised the issue in October, ahead of a retail e-rupee trial that began this month. To put it simply, there are two design options. One approach would be to set a minimum value — say, 1/100th of a rupee — and allow tokens of any amount that can be composed without exceeding the floor.
So, if a consumer wishes to pay someone 825.05 rupees ($10) in central bank digital currency, or CBDC, the consumer will notify their bank, which will debit the person’s savings balance and request the RBI to issue a coin for the exact amount. After the RBI deducts 825.05 rupees from the requesting bank’s account with it, the token will appear in the user’s wallet.
All of this should only take a few seconds. However, there is some friction in public money, and we probably don’t want to lose all of it. Physical cash, for example, comes in fixed denominations. As a result, it may make sense to require the consumer to request one 1,000-rupee e-rupee coin from the RBI. She can then spend a portion of it, leaving an unspent balance in her digital wallet. It can simply be left there for later use or transferred to a regular savings account.
What makes this a better design?
In the digital world, a fixed denomination is a completely artificial construct. However, to the extent that it convinces users that what they’re using is simply an online version of familiar sovereign money, safe even if their bank or wallet provider fails, it may be reassuring. (The advantage that shoppers have over bank notes is that they won’t have to return home with unwanted candy that Indian merchants pass on when they don’t have change.)
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As insignificant as they may appear, decisions like these will shape our cashless future. Some of the early CBDC experimenters, such as China, Sweden, and South Korea, have already moved away from physical cash. There, the authorities are concerned that unless they devise a solution, national money will be reduced to the status of a unit of account — yuan, krona, or won — with no physical presence. This could have unanticipated consequences. If a few powerful private-sector platforms control the payment market, they may levy hidden charges and fees. People will find it difficult to continue believing that their deposits and wallet balances are worth what their account statements indicate if there is no testable way to obtain a more trustworthy public-sector representation of the same value in exchange. If all you have is a thermometer, you won’t know if water actually boils at 100 degrees C.
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There are also countries at the opposite end of the spectrum. Japan will begin CBDC trials in the spring and wait two years for the results before deciding whether to launch a virtual currency in 2026. The issue in Japan — or India — isn’t that physical cash is becoming extinct. The opposite is true: Japan’s cash culture is so entrenched that the government wants to encourage wage earners to receive a portion of their pay in digital wallets. Despite shocking the world six years ago by cancelling 86% of the then-existing cash in the economy, India has failed to break the addiction to banknotes. According to a central bank index, digital payments have increased 250% in four years. Nonetheless, the use of paper bills is increasing.
Distributing cash to consumers and collecting notes from businesses is a time-consuming task that does not sit well with Japan’s shrinking workforce. Fewer notes will save the public $600 million in annual printing costs in India. However, neither country lacks private-sector digital payment options. Given the abundance of options, users are likely to ask CBDC a second question:
How valuable is this money if you can see what I’m spending it on?
Digital payment trails are a feature, not a flaw. One approach to addressing privacy concerns is to include an anti-money-laundering authority as a kind of class monitor. Anyone who requests cash from the central bank will also receive a set number of “anonymity vouchers” at no cost from the monitor. These will not circulate among people but will need to be spent in order to keep transactions private.
This European concept could work in situations where the central bank’s assurance that it will not lift the veil of anonymity around small payments carries weight. Where trust between citizens and the state is low to begin with, technology may offer better solutions than institutions. One such concept comes from the polling industry. The election officer (read: monetary authority) signs a sealed envelope containing your secret ballot (payment details); carbon paper (cryptography) carries your signature to the vote inside. When the envelope is opened (the payee is credited), the receiver’s bank only sees the signature attached to the ballot, not the source of the vote (the funds). You, on the other hand, will be aware of what you did or did not intend to do. If a terrorist financier steals your wallet, you’d go to the police and show them where your tokens are. You might even be able to get them back.
Another issue that authorities must consider is speed. It has the potential to be a show-stopper. Remember that the catalyst for CBDCs was advancements in blockchain technology. However, as demonstrated by the Korean pilot programme, an Ethereum-based network may not be the best solution for crowds of office workers trying to pay for their lunch. If this issue is not addressed, most daily users, despite the bankruptcy risk, would gladly stick to near-instantaneous private-sector digital payment options.
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