Digital currencies of central banks (CBDC) and their impact on the financial market
Movchan's Group
Jan 1, 2024One of the most anticipated events in the global financial market is the emergence of central bank digital currencies, which regulators in 86 countries are working on. Central banks have high hopes for digital currencies. They are expected to significantly accelerate and reduce the cost of international settlements, prevent misuse of funds, and most importantly, compete with cryptocurrencies, whose issuance and circulation are not controlled by regulators. However, in practice, countries that have already launched their digital currencies have faced numerous problems, and no project has not only failed to integrate into the global financial system but also has not been in demand even at home.
By the end of 2030, more than 20 central bank digital currencies (CBDCs) could emerge worldwide. This conclusion was reached by the Bank for International Settlements (BIS), after surveying 86 central banks from 28 developed and 58 developing countries. The survey participants represented countries where 82% of the world's population resides and whose combined contribution to global GDP reaches 94%. More than half of the BIS respondents admitted that they have already started piloting the new, third form of money.
It is assumed that digital currency should complement the two existing forms of money. These are cash, which is issued by central banks in the form of small denomination coins and larger banknotes with a unique number, as well as non-cash money, which are account records.
Unlike them, the nature of the new form of money is a unique digital code. Depending on the configuration chosen by the regulator, digital currency can function as a central bank obligation to a wide range of holders or be used exclusively for settlements. For example, between the regulator and banks, other regulators, banks among themselves, etc. That is, the functionality of digital currencies, regardless of the choice of configuration, will at least partially duplicate already existing forms of money.
Regulators associate the need for digital currency with technological progress, which requires the creation of faster, safer, and cheaper payment alternatives. For example, the Bank of Russia in its 2020 report "Digital Ruble" provided two simple examples that explain the usefulness of the third form of money. First, digital currency will allow the population and businesses to make settlements in difficult conditions — in the simultaneous absence of cash, the internet, and mobile communication. And secondly, if the platforms of different countries are integrated with each other, such money can be used for direct cross-border settlements, bypassing existing financial messaging systems, primarily the dominant SWIFT in this market.
In essence, SWIFT, like other systems, works as a secure messenger that transmits encrypted payment instructions between banks. This process can be delayed because intermediary banks often participate in the chain: not all commercial banks have direct correspondent relationships. In this case, each intermediary checks the entire transaction. Due to numerous intermediaries, whose work is not free, and currency conversion, often double, the cost of such transfers can be high. In the digital code, all the terms of mutual settlements of the parties can be immediately "embedded," and its transfer from sender to recipient can be carried out using blockchain technology — a decentralized digital record of transactions. Blockchain, on the one hand, allows multiple checks of the operation simultaneously, making it resistant to fraud and hacker attacks, and on the other hand, excludes intermediaries from the chain.
However, regulators' attention to digital currencies is not so much driven by the goal of increasing public welfare as by the risks of the absence of a digital form of money in their issuance. In fact, in the matter of digital currencies, central banks are more likely to act on the principle of "if you can't prevent it, lead it."
Why central banks need digital currency
In 2019, Facebook (now Meta Platforms, recognized as extremist and banned in Russia) announced that it plans to launch the global digital currency Libra in a year, whose value will be tied to a basket of stable fiat assets. Their list was initially not disclosed, but later Facebook founder Mark Zuckerberg admitted that the basket would mainly consist of US dollars. Facebook's partners in the project included 27 organizations, including Visa, Mastercard, PayPal, and Stripe. They all became members of the Libra Association and promised to integrate the new digital currency into their services and test transactions with it.
It was planned that all participants of the Libra Association would initially gather a pool of assets that would form reserves for the new currency. The Association intended to invest these reserves in low-risk assets. Income from investments was supposed to cover both their operating costs and provide rewards to the founders. The reserves were to be replenished through authorized sellers: they pay for digital money with fiat assets in exchange for the right to sell Libra to end consumers. At that time, according to FT's estimate, Facebook's global audience was 1.7 billion people. This means that if the project were implemented, approximately every fifth person on the planet would have the opportunity to conduct cheap, fast, and uncontrolled transactions on Facebook and partner services through electronic wallets not tied to any bank.
By that time, central banks had accumulated enough problems. First, the cryptocurrency market was actively developing, where several thousand digital coins were already being traded, including stablecoins pegged to the US dollar, and digital asset owners could invest them in liquidity pools for interest, from which digital loans were provided to borrowers. Second, big tech and telecom companies were actively striving to enter conventional financial markets. For example, in Africa, the Kenyan mobile operator Safaricom, in partnership with Vodafone, launched the M-Pesa payment system, which was stepping on the heels of banks. Currently, 60 million people — almost every second resident of the continent — and 5 million businesses use the service. In China, big tech companies WeChat Pay and AliPay dominated the payment services market, controlling 94% of all non-cash payments in the country, offering users convenient smartphone payments.
These problems seemed relatively solvable to central banks. For example, regulators viewed the cryptocurrency market as a decentralized quasi-financial system with high risks of volatility and scams. Some of them advocated for its complete ban in their jurisdiction (e.g., Russia, China), while others tried to introduce regulation for them (EU countries, USA). Central banks also brought local non-bank payment giants under control. For instance, the People's Bank of China not only forced AliPay and WeChat Pay to reserve client funds like banks do but also refused to pay interest on them.
The idea of launching Libra was the last straw for central banks and governments of many countries. After all, if the project succeeded, the Libra Association would effectively become an international private central bank that could conduct its own monetary policy without regard to monetary regulators, decide on Libra's issuance, determine its exchange rate against traditional currencies, and conduct local and cross-border settlements between people, businesses, and institutions. Mark Zuckerberg spent six hours answering questions from US congressmen about Libra but failed to convince them that Facebook's digital currency would not undermine the authority of the Federal Reserve and the US currency and would not become a hub for illegal transactions and money laundering. EU finance ministers banned Libra's circulation in the European Union. Libra faced a wave of criticism from financial institutions and regulators. For example, the Federal Reserve accused the project of creating US national security risks, and the Bank of England doubted the stability of the Libra ecosystem. The IMF warned about the risks of transaction privacy in Libra and the inability to guarantee consumer rights protection. Partners began leaving the Association. Renaming Libra to Diem did not help relaunch the project: it officially closed in 2022.
The Libra case became a turning point for central banks. They decided: they still need their own CBDCs to maintain monetary sovereignty, control, and transparency of settlements. If in 2020 only 56 central banks participated in the BIS survey on digital currencies, by 2021 their number grew to 81, with 90% of respondents reporting varying degrees of development of their own digital currency.
What are the risks of digital currency
Will the issuance of digital currency have any adverse consequences for the economy and financial stability of a particular state or the world? Economists most often discuss such potential negative consequences as the withdrawal of cash from circulation and the outflow of funds from banks into CBDCs. The natural redistribution of money between its various forms is currently almost impossible to predict: too few states have launched CBDCs, and the financial preferences of citizens and businesses in different countries can vary significantly. For example, in 2023, only 10% of payments in Sweden were made in cash, while Germans used cash in more than 50% of transactions. For example, the Bank of Russia believes that the digital ruble in Russia will "likely partially replace both cash and non-cash bank money," but this will only affect the structure of its liabilities — the share of cash issued by it will decrease, and the issuance of the digital ruble will increase.
However, the replacement of non-cash money with a digital counterpart will negatively impact the balances of commercial banks: their account balances and correspondent accounts with the central bank will decrease. In such a case, banks may need liquidity. In the worst-case scenario, it could even lead to a structural liquidity deficit — a chronic need for liquidity from the regulator. Moreover, any crisis could trigger a "flight to quality," where businesses or the population, having access to the digital form of currency, may start massively transferring funds from banks to reserve accounts in the central bank.
The good news for banks is that regulators will be able to set negative rates on such accounts and impose limits on CBDC transactions, which will help contain flows. The bad news is that the dilution of depositors' funds between digital currency and non-cash money may remove the "too big to fail" question from the regulator's agenda for some banks — in a crisis moment, it will not save it but simply allow it to go bankrupt. In addition, central banks may be tempted to independently lend to businesses or institutions in CBDC. For example, for fulfilling a government order: by funding the borrower with digital currency, it is easy to track the targeted use of funds and "embed" prohibitions on other expenses in a smart contract. Then banks may face a strong competitor in the lending market.
For businesses and citizens, the main risks of digital currency may be fraud and hacker attacks. The fact that such episodes are possible even in highly secure central bank systems is acknowledged by the BIS. It urged regulators to pay increased attention to cybersecurity when piloting and launching CBDCs.
How central banks will configure CBDC
According to the BIS publication for 2024, central banks are discussing three CBDC models. In one, digital currency is proposed to be used exclusively for settlements between banks and the regulator as a tool that accelerates and reduces the cost of cross-border settlements. Only 2% of respondents are focused on this model. In the second, citizens and businesses will be able to access CBDC as a third form of money. It is being developed by 30%. The remaining banks intend to combine this functionality.
Regulators also have different views on the architecture of CBDC. Some central banks intend to be the operators of the digital currency platform themselves and accumulate obligations to non-financial organizations and the population on their accounts, independently conducting KYC (Know Your Client) procedures. Others, on the contrary, would like to outsource platform management or at least get rid of some "intermediary" concerns — opening and replenishing wallets, conducting AML/CFT procedures.
Another important question is where the data will be stored. On the one hand, when using a distributed ledger, the risks of data loss and hacker attacks are lower. On the other hand, there are risks of third-party access to such data.
Answering all these questions and implementing the necessary configuration of digital currency in practice is very difficult, which is why so few regulators have reached its actual launch.
What was the first experience of launching CBDC
The first country in the world to officially launch a CBDC in 2014 — Dinero Electronico (DE) — was Ecuador. The country had a unique economic situation: since the early 2000s, it had effectively abandoned its national currency, the sucre, and conducted dollarization due to high inflation, sucre devaluation, and recession. DE accounts at the Central Bank were also denominated in US dollars, and citizens of the country could open and replenish them at special centers, and conduct transactions through a mobile payment system. However, the project did not take off: at its peak popularity, it had only 500,000 users out of a population of 17 million. DE faced a trust crisis when the population decided that keeping their funds in central bank accounts was riskier than in commercial banks, as in case of disputes, the regulator would have immunity in court, suggested the Cato Institute. The national Association of Commercial Banks questioned the 100% reserve backing of the digital currency. The project was closed in 2018.
In 2018, Venezuela launched its CBDC — El Petro — which has been experiencing a political and economic crisis since the beginning of the 21st century, accompanied by hyperinflation, devaluation of the national currency, the bolivar, rising poverty, and emigration from the country. Caracas is currently under extensive US sanctions, which have closed Venezuela's access to international financial markets, banned operations with Venezuelan government debt and the state oil company Petroleos de Venezuela. In addition, the EU has imposed targeted sanctions. El Petro was conceived as a tool to bypass sanctions. According to the words of the country's president, Nicolas Maduro, Venezuela allocated 5 billion barrels of oil to back the new digital currency and pegged its value to the price of a barrel of Venezuelan oil. However, at the time of launch, Maduro did not disclose the details of El Petro's backing, in particular, whether the specified volume of oil was indeed in the country's storage facilities, and whether the digital currency could be immediately exchanged for oil in case of force majeure. Over time, estimates of the physical assets that could back El Petro changed. For example, in 2019, Maduro reported that El Petro, which fell under US sanctions, was backed by only 30 million barrels of oil, which was in the country's storage facilities and could be used for commercial purposes.
Some economists did not believe that El Petro was indeed physically backed. For example, the founder of the Institute of Applied Economics, Global Health, and the Study of Entrepreneurship at Johns Hopkins, Steve Hanke, called it a scam. Trust in El Petro was further affected by Venezuelan specifics: the country's president could influence El Petro's exchange rate, and the exchange of CBDC for fiat bolivars occurred at a discount, wrote the Brookings Institution. In 2024, after attempts to force citizens and businesses to use El Petro to pay for government services and fines, as well as orders for airlines departing from Caracas to pay for fuel with it, Venezuela closed the project.
Which other countries have tried to develop their digital currencies
Currently, only a few countries have operational CBDCs, but there have been no high-profile success stories yet. For example, the Bahamas introduced a CBDC called the Sand Dollar in 2020. In 2024, its share in the country's money circulation was only 1%, and the volume of electronic wallet top-ups fell fourfold year-on-year. The launch of Nigeria's CBDC eNaira in 2021 also did not succeed, despite Nigerians' high loyalty to cryptocurrencies and a shortage of cash banknotes, as well as the central bank's desire to integrate eNaira into interbank settlements. "Nigerians are still wary of eNaira and do not want to use it. The official ban on cryptocurrency in Nigeria to "protect" citizens from the volatility and scams of the cryptocurrency market did not add popularity to eNaira and was ambiguously received by the population," — writes Pratham Rawat, a staff member at the Samuel Curtis Johnson Graduate School of Management at Cornell University.
Launched in 2022, Jamaica's CBDC Jam-Dex managed to reach only 0.001% of the total volume of electronic transactions in the country within a year. Trade and service enterprises were reluctant to work with the new form of money, and the population had nowhere to spend it, wrote FT. The National Commercial Bank Jamaica Limited, the only lender in the country offering the service of opening an electronic wallet, in 2024 stated that its clients showed no interest in digital currency. Dcash, the digital currency of the Eastern Caribbean states, also faced low demand: sellers did not accept digital currency for payment, and the population was poorly informed about Dcash's capabilities, concluded the IMF.
The People's Bank of China became another CBDC pioneer, but its eCNY has been in the pilot stage since 2019. China chose a two-tier system where banks became intermediaries that open electronic wallets for users. Payment giants WeChat Pay and AliPay were also required to work with the digital yuan. To popularize eCNY, China uses a carrot-and-stick method. The country conducted free distribution of digital yuan, which can be spent but not converted into other forms of money; lotteries with prize funds in eCNY; promotions with discounts when paying with digital yuan. Unemployed people began receiving benefits in it, and civil servants — salaries. It can now be used to pay for public transport, taxes. In mid-2024, the People's Bank of China reported that transaction volumes in eCNY had grown to 7 trillion yuan, or about $1 trillion.
In Russia, the digital ruble has been piloted since 2023 in a two-tier configuration where the Central Bank becomes the issuer of the CBDC and the operator of the digital ruble platform. Banks act as intermediaries that open electronic wallets for clients, execute payment instructions, and conduct compliance procedures. According to the Bank of Russia's plan, the functionality of the digital ruble will be diverse — from retail and budget operations to potential cross-border settlements. The tests involved 15 banks and 30 companies, as well as the Ministry of Finance and the Federal Treasury. It was planned to start its widespread use by July 1, 2025, but it was postponed indefinitely. According to the official version, due to unresolved issues of integration and technological security. Russian payment market experts suggested that the regulator is still unclear about the potential demand for the digital ruble.
The ECB also has no certainty about the launch date of the digital euro. In the latest report of the European regulator (December 2024), it talks about an upcoming tender for infrastructure component suppliers for the digital euro, plans to conduct focus groups for target and potentially vulnerable audiences on the impact of the digital euro, testing the currency with trading enterprises, payment service providers, and fintech, as well as a series of consultations with national banks of eurozone countries. The test result report will be published in mid-2025. Based on the collected data, the regulator will decide on the feasibility of the digital euro. However, not all EU residents are loyal to this initiative. For example, half of German citizens are not ready to use the digital euro, and in Austria, Slovakia, and Malta, the role of cash in daily expenses is also high, writes Bloomberg.
The Bank of England also reported progress in developing the digital pound in early 2025. The regulator is still in the process of finding the optimal configuration of the digital currency and its ecosystem, analyzing potential limits for corporate and private users, and the impact on cash and non-cash currency. In the technical part, APIs for testing the retail digital pound have already been developed, and the possibilities of its offline operation and integration into existing POS terminals in the country have been studied.
In the US, however, there has been a 180-degree turn on the digital dollar issue. President Donald Trump fulfilled one of his campaign promises and signed an order that effectively banned the development of a digital dollar. "Such a currency would give the federal government — our federal government — absolute control over your money. They could take your money, and you wouldn't even know it was gone," — he explained the logic of his decision. The previous administration of President Joe Biden, on the contrary, encouraged the study of the issue of creating a digital dollar. In addition, Trump announced the creation of a US cryptocurrency reserve, which will include Bitcoin, Ethereum, Solana (SOL), XRP Ripple, Cardano (ADA), and other assets.
Regulators in some countries have opted for cooperation on digital currencies. For example, the central banks of China, Hong Kong, Thailand, the UAE, and Saudi Arabia, with the participation of the Bank for International Settlements, launched the mBridge project. On a specially created blockchain for the project, it became a testing ground for cross-border transfers with multiple digital currencies. The first transactions on mBridge took place in 2024, and the project reached minimal viability, reported the BIS. Existing financial messaging systems are also exploring the issue of digital currencies, striving to retain the market and clients. For example, SWIFT also considered integrating CBDCs into its services.
