Today, 130 countries are exploring a central bank digital currency (CBDC) — up from 35 in 2020, according to Atlantic Council’s CBDC Tracker. Using digital twins — replicas of a payment or settlement system — central banks can safely test the design, policies and potential wallet limits that could drive public adoption of CBDCs.
To test the effect of design options on retail CBDC adoption rates, network analytics firm FNA has used an agent-based model to build a digital twin of Spain’s retail payment ecosystem. Learning through simulation, CBDC stakeholders are able to iterate and test design options that support central bank aims, and prove attractive to consumers and merchants, ensuring the stability of the financial system.
Carlos León, director of financial market infrastructures and digital currency solutions at FNA, describes how using a digital twin can offer the first step towards studying and understanding the effects of digital currencies.
Adoption sweet spot
A combination of attractive design options, stimulus policies and specific limits on holding retail CBDCs could offer a “sweet spot of adoption”, Mr León says: adoption rates high enough to enable the effective use of CBDCs, but low enough not to threaten the stability of the financial system.
Mr León describes several tools that central banks have at their disposal in order to understand and manage adoption rates. Remuneration policies — offering consumers an interest rate on retail CBDCs — was discussed in the early exploration of CBDCs. Although still a reliable method to increase adoption rates, Mr León believes it poses risks. He says that central banks have become less willing to include these types of incentives within the design options, aware that offering interest rates comparable to or better than commercial banks’ could force large deposit migration.
Remuneration policies therefore require in-depth evaluation given the risk to commercial banks’ stability and the potential to transform CBDCs into a store of value, according to Mr León.
Further design options tested included the “reverse waterfall” approach, a method that the European Central Bank has explored. This facilitates the use of retail CBDCs by automatically withdrawing money from the end user, likely the consumer’s commercial bank, once their digital currency has been exceeded.
“This is very practical. It makes life easier for consumers because they don’t need to top up their mobile wallet every time they make a transaction,” Mr León says.
Under the modelling test, government assistance payments could also be issued by the central bank using CBDCs, which would reflect different changes in the economy. Those receiving the most government subsidies tend to use cash more, Mr León says, believing that these consumers would quickly switch to using retail CBDCs. Unlike remuneration and reverse waterfall models, in which consumers would likely abandon debit and credit cards in favour of new digital currencies, those receiving financial assistance from the government would likely start to abandon cash instead.
Striking the right balance between the use of cash, ordinary digital card and electronic payments, and retail CBDCs is difficult, Mr León says. “Central banks want to see some decreases in the use of cash, replaced by the use of retail CBDCs, but they do not want to see steep declines in the use of the current digital payment system.”
Privacy and anonymity
FNA’s modelling introduced two kinds of retail CBDCs: one that was completely anonymous and another with the same level of privacy as ordinary digital payment systems today, with differences in preference varying between countries.
“In Colombia, for example, people are not thinking about anonymity that much, but they use a lot of cash. And if you run our model in Colombia, consumers will likely use anonymous retail CBDCs if it is the most similar to cash. Whereas, in the UK and in other countries where the number of people using cash is relatively low, we anticipate that consumers will not massively switch to using anonymous CBDCs because they are already giving their information to commercial banks,” Mr León says.
where the number of people using cash is relatively low, we anticipate that consumers will not massively switch to using anonymous CBDCs
Still, central banks need to address public concerns about privacy, according to a recent CFA Institute report. Mr León acknowledges that retail CBDCs within the payment ecosystem could bolster fears about government monitoring and privacy, but points to regulation and legislation instead. “The risk is not with the CBDC itself, but the legislative system within which it operates. The issue is about whether or not laws and consumer protections are well defined in the country’s regulatory system,” he says.
Moreover, it is unlikely that many central banks will have access to detailed transactional information. Instead, central banks have generally advocated for retail CBDCs to be distributed in the same way as cash, withdrawn from cash machines or used from consumers’ commercial banks, thus mimicking current methods of use, according to Mr León.
Commercial banks will likely provide mobile wallets for consumers which would operate on a similar basis to online accounts with commercial banks. Information about payments would therefore be shared with the commercial bank, as it currently is, not the central bank. Current CBDC design therefore suggests that the central bank will only access general information about trends in spending or consumer performance, Mr León says.
Who should shape the future of money?
The exploration of CBDCs presents the first time in which central banks require a consumer-facing role, whereby they are developing a product for consumers and merchants, Mr León says. Aside from regulatory work, central banks are now designing a new payment instrument and could learn from product-focused models in the private sector which are driven by the needs of consumers.
“Product-led firms such as Apple, Google and Mastercard aim for adoption rates that depend heavily on how they fulfil the end-users’ needs and expectations. These companies devote resources to understand how payment instruments will be used,” Mr León says.
Without building an understanding of consumer and merchant needs, central banks are more likely to face low and slow adoption rates. Mr León points to countries like the Bahamas, Jamaica and Nigeria where this issue is prevalent.
“In these cases, where the adoption of retail CBDCs has been less successful, central banks were too focused on their own motivations, and failed to account for consumer and merchant needs. As a result, adoption is lacking because the retail CBDC does not fulfil peoples’ needs. If central banks want to have successful adoption, they must build retail CBDCs based on the needs of the central bank, the consumer and the merchant,” Mr León says, referring back to the importance of using a digital twin to test needs and outcomes.
Combining attractive design options and stimulus policies with limits to holding retail CBDCs may be the key to achieving optimum adoption rates as central banks decide whose needs will determine the development and use of retail CBDCs.
