CBDCs are neither the threat nor the panacea that many believe

Buried in the limited support of central bank digital currencies, or CBDCs, especially in developed markets, is a somewhat blinkered take on the concept: Not all CBDCs have the same objective.

A central bank digital currency can take many forms, but most involve the issuance by a country’s central bank of currency tokens on a blockchain or other type of distributed ledger. Retail-facing CBDCs aim to gradually replace cash, retaining the same central bank guarantee as bills and coins, while offering the convenience of digital money.

A few examples have already launched, such as the Nigerian eNaira and the Bahamas sand dollar. Others are in advanced pilot phases, such as the Chinese e-CNY and the Indian digital rupee.

All of these examples are struggling to gain traction, and anti-CBDC activism worldwide is strong, triggered by fears of centralized control and a loss of financial privacy. In Europe, which will decide in October whether to launch development of a retail-facing CBDC, there is notable opposition, including among some legislators. And in the U.S., the House of Representatives passed an anti-CBDC bill which would bar the federal government from ever issuing a digital currency; a similar proposal is working its way through the Senate.

The fear overlooks an entire segment of the economy in which the central bank already controls movements of funds, and in which privacy is not an expected feature: interbank transfers, known as “wholesale” payments.

These easily account for the bulk of global transfers in terms of volume. And yet they still encounter significant frictions when they involve correspondent banking networks, currency exchange and different operating hours. Given the amount of money involved, the frictions add up.

In this light, a wholesale CBDC makes sense.

Like a retail CBDC, a wholesale CBDC, or wCBDC, would be issued by a central bank as a currency token on a blockchain. Unlike a retail CBDC, it would only be made available to commercial banks and other institutions with central bank accounts.

One of the key advantages is more streamlined settlement, as wCBDCs could, in theory, move directly between banks via a shared ledger — no correspondent accounts necessary. What’s more, depending on the platform design, an on-chain transfer could compress messages (sent by banks via SWIFT) and payments, further reducing the number of necessary steps and the overall cost.

Another is the potential for smart contracts to handle complex and costly processes such as currency conversion and escrow.

And there’s the direct connectivity with on-chain marketplaces for tokenized securities, digital trade invoices and more. Today, clearing and settlement involve reconciling various layers of information across different data systems. In an on-chain network, everything moves on the same layer, and while systems may differ, connectivity generally involves tweaking formats or adding a bridge rather than reengineering structures.

The opportunity is compelling, especially given the emergence of new trade barriers and geopolitical fragmentation — smoother cross-border payments could lead to smoother and more flexible supply chains.

Yet here, too, there are deep misunderstandings about blockchain potential.

Frictionless transfers between global banks can only happen on a shared ledger. Arriving at that happy state would require consensus among nations as to the ideal technology (there are many different types of distributed systems) as well as the platform’s design, smart contract parameters, compliance requirements, legal status and governance. Getting nations to agree on anything so systemically significant would be a tall order, especially as it would mean giving up some sovereignty over how national currencies move.

Of course, each country could have its own blockchain system on which to issue a wCBDC, and they could connect with each other via a neutral shared platform. But this not only introduces some friction, it also raises a similar set of questions. Who would design it? Who would run it? In recent months, the BIS, IMF and some private entities have published proposals for a “unified ledger” on which all on-chain currencies can move. Would any of those invite universal trust? The BIS, as the “central bank’s central bank,” could perhaps be a contender — but it recently withdrew from the multi-CBDC pilot mBridge after contemplating shutting it down to prevent Russia using a similar system to avoid sanctions. In this increasingly fractious world, “neutral” quickly becomes elusive.

What about bilateral or group networks? For instance, a distributed ledger platform shared between China and Saudi Arabia for oil trade settlement, or one to boost financial flows among Latin American countries. This could solve some frictions but would introduce others: Would platform members want to hold each other’s volatile currencies, or would they sell them in the market, depressing their value? There is a reason most global trade uses the dollar for at least one leg: It removes liquidity risk.

Perhaps smart contracts could ensure a measured currency conversion or lockup? But then the wCBDC would not be fungible with fiat, creating domestic monetary as well as legal complications. There’s also the potential for national CBDCs to have embedded functionality, such as an “off switch” — trust, even among trading partners, is a scarce commodity.

And there’s the need to trust the platform itself, which could run into network stability issues, especially in the early days or after upgrades. This happens in traditional systems today — but with greater connectivity, the disruption could spread.

In sum, public rejection of CBDCs due to fear of privacy erosion and greater government control overlooks the potential for a significant efficiency boost in a key economic segment that does not expect privacy or freedom from oversight — the technology is not necessarily the problem, it’s the way it’s applied.

And conviction that wholesale CBDCs will smooth away interbank transfer frictions overlooks the complexity of connecting a constellation of distributed ledgers, each with their own design, priorities and rules — the technology is not necessarily the solution, it’s the way it’s applied.

Zooming out, new technologies always run up against exaggerated expectations of both benefit and harm — in that regard, blockchains and distributed ledgers are no different.