Pressure mounts on advanced economies as race to digital currency heats up

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Competition among global central banks is heating up, as pressure mounts to develop and launch central bank digital currencies (CBDCs). Fueled by the aggressive push towards CBDCs from China, advanced economy central banks around the world are finding themselves increasingly driven towards embracing the technology, which could have profound effects on the global financial system.

China has pulled out in front in the race to launch a major global CBDC, though their initiatives post significant questions for open, democratic economies. As a result, other economies will likely approach with more caution than China, despite the pressures to move forward with research and development.

Since early 2019, central banks around the world have been engaging in active policy discussions around CBDCs. A cross-border working group between central banks in Sweden, the United Kingdom, Japan, Switzerland, Canada and the European Union was established earlier this year to advance the cause further, with a focus on ironing out the remaining policy problems around CBDCs.

Even during the COVID-19 pandemic, the U.S. Federal Reserve has taken steps further towards a CBDC, setting out in detail its research efforts into the technology, in conjunction with MIT and the BIS Innovation Hub. The Fed also said it was moving towards instant digital payments by 2023 or 2024, which indicates the level of commitment to the ultimate policy goal.

Now, with competition between central banks increasing month on month, progress is beginning to move at a much quicker pace. Competition also exists from the private sphere, with private stablecoins posing an alternative to CBDCs within the wider blockchain payments ecosystem. Sitting on the fence is no longer an option for major advanced economies looking to stay relevant in an increasingly digital world.

The first key objective for central banks to grasp is the need for fast transaction speeds, with instant value transfer an essential component of any successful CBDC. The European Union (EU) has already realized this goal with the launch of its instant payments service in 2018. The Federal Reserve is now expediting its own instant payments network, noting that consumers are no longer prepared or able to wait any length of time for payment processing.

While obstacles exist in terms of technology for developing a functioning CBDC, they are far from insurmountable.

Barbara C. Matthews, nonresident senior fellow at the Atlantic Council and CEO of BCMstrategy, said that while technical challenges exist, they could be overcome by a digital currency that can be interoperable cross-border.

“To be clear: major technological hurdles do indeed exist to launching a credible, secure, and reliable CBDC. But these challenges can be addressed. The more difficult issues to address are policy and policy coordination in nature. While distributed ledger technology may incorporate some inherent safeguards against hacking, central banks seeking a digital version of their national currency will require adjustments. Those changes may delay deployment in order to complete the development work.  It will take time for central banks to solve issues regarding anonymity, data privacy, and regulatory reporting.”

“Again, these are surmountable issues. But for any digital currency to operate at scale, it must be interoperable on a cross-border basis. An elaborate cross-border payments system already exists to support international payments (large and small).”

While central banks have so far, on the whole, been cautious in their approach to CBDCs, growing pressure from the private sector, with the likes of Facebook’s Libra, and from China with its advanced plans for a digital yuan, means the imperative to compete is ever more pressing.

While China will likely be the first to get its digital currency out the door, speed is not the only ingredient for success. Incumbent central banks can still maintain their position by pivoting to address the needs of the market.

And with a growing emphasis on CBDCs at central banks around the world, the race to that pivot is, for many central banks, already well underway.