Our lives are digitized; why not our money? Exploring the route to digital currencies

17.12.2021
Cryptocurrencies
Cryptocurrencies
Cryptocurrencies

Cryptocurrencies have forced their way from the private sector into the global, government-issued, monetary system. Now, feeling the pressure but keen to maximise its potential, central banks are exploring the value of creating and rolling out national digital currencies that can provide a stable, digital alternative to cash.

CBDCs – or Central Bank Digital Currencies – are still in their early stages but are being trialled in major economies including China, South Korea and Sweden. Here we explore how CBDCs differ from other forms of digital currency, and look at how the public will be able to store and use it securely for transactions in the future.

The rise of cryptocurrency and the emergence of stablecoins backed by ‘Big Tech’ have got people talking. There is clearly a demand for digital money – and a need for its stability – and Central Bank Digital Currencies (CBDCs) could be the answer.

CBDCs transform traditional fiat currency, such as sterling pounds, dollars or euros, into something digital and programmable for P2P (peer-to-peer) and M2M (machine-to-machine) transactions. It can be seen as an addition to the way we pay, used in place of cash or credit. It remains to be seen whether it will ever replace these payment methods entirely – in the short-term this is unlikely.

In simple terms, CBDC is a digital fiat currency. It’s not a digital token like many cryptocurrencies, and it’s not just anchored to a national currency like stablecoins.

Cryptocurrencies like Bitcoin and Ether are decentralised and can be used anonymously, whereas CBDCs are centralised currencies created and managed by central banks, such as the European Central Bank (ECB), the U.S. Federal Reserve, or the People’s Bank of China (PBOC). These are the ones who will maintain both liability for the CBDC and full watch over its movements.

The purpose of CBDCs

These new digital currencies are a way for governments to directly tackle the threat that cryptocurrencies pose to a stable financial ecosystem.

As it stands, central banks control both the supply and circulation of money globally. But unregulated, freewheeling cryptocurrency effectively operates in ´no man’s land` – nearly untouchable by the government and gaining momentum worldwide. This has ignited concern among central banks, who see it as a risk to a stable financial system and a threat to their authority.

In attempts to ensure they are not left behind as the world becomes more digital, central banks across the globe have compiled taskforces to investigate the opportunities and risks of CBDCs.

The PBOC, for example, has been exploring a digital currency system since 2013, enabling China to become the world’s first major economy to pilot a digital currency. The ECB has now followed in China’s footsteps, launching a 24-month project delving into the potential of the digital Euro.

National banks are also attracted by the ability of CBDCs to provide better governance of the monetary system. They can enable a quicker monetary policy reaction in response to future macroeconomic changes and are a form of programmable currency that facilitates more autonomous transactions for the population.

What value do they provide?

For a start, CBDCs offer a faster, more efficient way to make domestic and cross-border payments. Rolling them out will not only push central banks forward, it will deliver what consumers and businesses need for the increasingly digitised future of payments.

CBDCs are also more cost-effective for governments due to the reduced need to print physical cash. In 2018 alone, the US central bank paid $800 million to cover the cost of printing and handling paper money – vast amounts of money that could be saved and redistributed.

CBDCs payment
CBDCs payment
CBDCs payment

Interestingly, despite the growth of cashless transactions using smart cards, smartphones/wearables or made on the internet, the PBOC reports that cash transactions are still increasing as there are many use cases where cash, or cash-like transactions, are welcomed.

Any new digital currency must be as easily stored and universally accessible as cash, creating pathways into a financially inclusive ecosystem open to everyone. In keeping with this, central banks cannot force an expensive device (i.e., smartphone or PC) onto consumers to access a CBDC. They can, however, utilise security technology and “cold wallets” to support its economical implementation. If the CBDC is deployed as retail currency, the transaction service should also be free of charge.

A “cold wallet”, sometimes known as “cold storage”, “hardware wallet” or “offline wallet”, is a physical device that stores digital currencies completely offline. Many may look like USB storage devices and the technology is seen as providing a high level of security for digital money. However, with many cryptocurrencies today, if you lose access to this cold wallet, you lose your holdings.

Crucially, should consumers around the world adopt CBDCs, they will benefit from the stability and security provided by fiat currency – as opposed to the flux, fraud, regulatory and anti-money laundering (AML) concerns associated with cryptocurrencies.

Establishing trust in a new form of money

As with every form of financial transaction, the key to CBDCs becoming mainstream is trust. Central banks must cultivate consumer trust in the privacy, security, access and interoperability of CBDCs early on, otherwise consumers won’t want to use it.

CBDCs require more hardware and software implementations than cash-based systems, and central banks must carefully define their technology roadmap and be patient with its deployment, or they risk fraud or misuse that damages public trust in the new currency system.

For comparison, this level of trust must be on par with how people currently see and use banknotes. The shift towards online banking and ecommerce has already helped consumers transition from paying with something they can see, to paying with something they can’t.

To be trusted, CBDCs must also be stable – new financial risk should not be introduced into the system. So, if it is rolled out in a region, it must be proven to be stable and error-resistant, i.e., no double bookings, accounting mishaps or issues matching peak transactions per second.

Central banks must then be able to identify any counterfeit digital currency attempts. And this must be possible for years to come. Questions arise on the longevity of CBDCs when we are yet to see the impact of quantum computing on our digital world. To address this now, central banks are turning to advanced cryptography, with various security devices and chips being developed to support such payments way into future.

Where CBDCs are stored and accessed

CBDCs should be as accessible as cash. Cash can go everywhere and be settled immediately – digital currency must be just as – if not more – easily stored, secured and transferred so no-one is left without access to their money. 

This includes enabling people to access or transfer funds offline or in times of crisis, making offline storage well secure while meeting regulatory requirements. This is crucial in establishing a positive end user experience of CBDCs, and something that security experts must enable for everyone.

Storing offline currency for extended periods of time requires security controllers that work in online and offline environments: digital currencies will be used in both worlds. Consumers won’t be connected all the time, so central banks will need to facilitate safe storage of digital money in tamper resistant Secure Elements (SEs) so it can be remitted efficiently, quickly and correctly when the consumer’s digital wallet comes back online. Offloading CBDC transactions, supported by decentralised end-user-secured hardware, will also increase the robustness and efficiency of the system.

High performance cryptographic calculations will be required on low cost, low power devices. The good news is that this high-level performance is already a central foundation for payments on smart cards, mobiles and wearables, making digital payments widely accessible, well-secured and convenient. The semiconductor technology providing trust today is what will help secured digital currency wallets of the future.

When will CBDCs become reality?

Five countries have already rolled out CBDCs, with 16 others currently in pilot mode and more than 80 in various other exploration stages. Fortunately for pilots and launches of CBDC, the tools and technology needed to secure them is already here. Central banks will be able to reuse much of the existing Secure Element technology with CBDCs, limiting effort, minimising risk and providing stability.

Progress may also move fast in countries without a strong financial infrastructure, as digital currencies can provide a boost to the economy by helping the unbanked to transact digitally and improve transactions between businesses across borders. Nigeria, for example, recently launched its eNaira digital currency after just three years in the development phase and early take-up has been high.

CBDCs reality
CBDCs reality
CBDCs reality

The full benefits and use cases of CBDCs are still to be realised. But as pilots from the central banks transition into technology rollouts across the world, it is certain to become a significant transformation in the future of payments – so long as there is unbreakable trust in its stability, security and safe access to money.

TimoLisk
TimoLisk
TimoLisk

Author: Timo Lisk, Lead Principal Secure Transactions

Sun-Ren
Sun-Ren
Sun-Ren

Author: Ren Sun, Senior Marketing Manager Secure Transactions