The viability of central bank virtual currencies as legal tender 

Legal tender is anything recognised by law as means of payment. The national currency is legal tender in every country and is fiat money. It means the government creates it, backs it, and citizens have confidence in its value. 

In recent years, there is growing research and pilots to create a new form of currency or a new type of legal tender i.e. 'virtual currency' which is available in electronic or digital form and also called digital currency, electronic currency, or cyber cash. 

It is not about the existing form of virtual or cryptocurrency, rather a transformed and regulated version of virtual currency called Central Bank Digital Currency (CBDC). To be more precise, today's versions of CBDCs are much more engineered. 

Conceptually, CBDC is a new form of money issued digitally by the central bank that is denominated in the national unit of account intended to serve as a medium of exchange and a store of value. Very importantly, it has to be a direct liability of the central bank. 

We are aware that like any bank, the central bank's balance sheet is composed of assets and liabilities. Its assets are similar to those of common banks and include government securities, however, the central bank's liabilities differ fundamentally from those of banks. Its most important liabilities are currency in circulation and reserves, and if adopted CBDC would be a new form of direct liability of the central bank. 

The existing arrangement of digital payment transactions and settlement between banks/financial service providers and the central bank (also called wholesale transactions) are not generally direct liabilities of the central bank. The popular digital payment transactions by the common people (also called retail transactions) and business entities are again not direct liabilities of the central bank. And thus these digital and online payment transactions are not exactly what is conceptually meant by CBDC.    

A concept was born 

Ben Broadbent, the Bank of England's deputy governor of monetary policy, appears to be the first user of the phrase CBDC in March 2016. However, the concept of CBDC is said to start evolving in the 1990s when the Central Bank of Finland directly released Stored Value E-Money Card. 

The proposition of James Tobin's publication on 'financial innovation and deregulation' in 1985 also resembles the notion of CBDC that suggested creating several categories of deposit liabilities by the central bank. The present concept of CBDC however received real push with the emergence of Bitcoin and similar block chain-based cryptocurrencies. 

The growing number of cryptocurrencies and privately introduced asset-backed e-money created further momentum as central banks and monetary authorities around the globe started fearing that private e-money might gain supremacy over the public money, and they may lose control over the financial and payment system over time.   

Available published literature reflects that over 80% of the world's central banks and jurisdictions have engaged in investigating potentials of CBDC and a good number of them have progressed past conceptual research to experimenting and running pilots. 

During the Covid-19 pandemic, social distancing measures, public concerns that cash may transmit the Covid-19 virus, and new government-to-person payment schemes have further sped up the shift toward digital payments and has given further impetus to CBDC. 

Starting with the Central Bank of Ecuador, central banks around the world have been researching the concept and design of digital currencies for several years. Some are working primarily on the wholesale side, and some primarily on retail, but the largest number are looking into both. 

Countries working on the CBDC concept 

The first publicly announced work on retail CBDC was however conducted by the Swedish Riksbank in 2017 and has initiated a societal discussion on access to a central bank payments instrument for the general public. Bank of Canada has also been conducting work on retail CBDC however as a contingency plan. 

While announced somewhat later, perhaps the most advanced CBDC project at present is that of the People's Bank of China. The Covid-19 pandemic has accelerated work on CBDCs in some jurisdictions. Like in the United States, early versions of Congress bills on fiscal stimulus included references to a 'digital dollar' as a means of quickly executing government-to-person payments, and corresponding to that the Federal Reserve has continued its ongoing research on retail CBDC. 

The Bahamas is the first country to officially launch a CBDC in October 2020 beyond a pilot program that is yet to receive expected response. However, considering the size of the economy and the complexities involved, three approaches are considered most crucial to draw lessons: Chinese (DC/EP), the Swedish e-krona, and Canada's CBDC contingency plan. 

To date, South Asia remained slow in exploring the CBDC potentials. In January 2021, the Reserve Bank of India stated that it is examining if there is a need to introduce CBDC in India, and in case, the need for a digital currency arises, the RBI would look for ways to operationalize it. 

Global economies are also coming up with collaborative attempts.  In 2020, BIS and a group of central banks of the advanced countries created a common platform and identified common foundational principles for installing CBDC: one, a central bank should not compromise monetary or financial stability by issuing a CBDC; two, a CBDC would need to coexist with and complement existing forms of money; and three, a CBDC should promote innovation and efficiency. These fundamental principles are implicitly or explicitly recognized in all cases of ongoing experimentation and piloting of CBDC. 

Types of CBDC

Based on the ongoing experimentations and the concepts of legal tender, the engineered version of CBDCs that are taking shapes as CBDC models may be categorized under three titles: Direct CBDC, Hybrid CBDC, and Intermediate CBDC.  

Direct CBDC is a payment system operated by the central bank, which offers retail services. It is a direct claim on the central bank where the central bank maintains ledger of all transactions and executes retail payments. 

Hybrid CBDC is an intermediate solution that runs on two engines- central bank handles wholesale payment, and intermediaries (banks/financial service providers) handle retail payments. The CBDC is a direct claim on the central bank, which also keeps a central ledger of all transactions and operates a backup technical infrastructure allowing it to restart the payment system if intermediaries fail. 

Intermediated CBDC is an architecture similar to Hybrid CBDC where the central bank maintains only a wholesale ledger, rather than a central ledger of all retail transactions. Private intermediaries execute payments, and the CBDC is a claim on the central bank. Central banks' direct liabilities (same as fiat money or legal tender) are being created in the case of all these three models.  

Another seemingly similar model called Indirect or Synthetic CBDC is not recognised as a CBDC model. It is also called Quasi CBDC under which consumers have claimed not on the central bank rather on intermediaries that operate all retail payments, and intermediaries need to fully back all liabilities to retail clients with claims on the central bank. Very specifically, the central bank has indirect liabilities in this payment structure. 

There is no doubt that the model selection is not that straightforward for a jurisdiction. It is also early to draw firm conclusions on the net benefits and associated risks of CBDC. Research and experimentation and the derived dilemmas pose huge difficulty and complexity for central banks to strike a balance between potential benefits and prospective risks to reach an end from the whole range of choices that are widely acceptable to both the advanced and emerging economies.

Time will say whether the benefits of a choice would outweigh the costs or not. However, in this enduring global drive of CBDC, Bangladesh cannot keep itself aside. The country needs to be ready and start researching and piloting guided by the commonly recognised fundamental principles that intend to complement cash, make public-private partnerships, and not endanger the capacity of the central bank to safeguard its central goals of monetary and financial stability. 

Dr. Shah Md Ahsan Habib

Professor Shah Md. Ahsan Habib [finbislesh.com]