I thought I’d put together my latest thoughts on Central Bank Digital Currency (CBDC). This blog is an update to my June 2022 Post – CBDCs: Growth Opportunity for US Banks. 

Challenge – Explain a CBDC to a 10 yr old and describe why it is “better” than using cash or a card. While you can never lose your money. The government has the ability to know the source and destination of every transaction.

Summary View (US Focused)

• No threats to V/MA
• Despite Biden’s Mar 2022 executive order directing the government to “Explore a U.S. Central Bank Digital Currency (CBDC) by placing urgency on research and development of a potential United States CBDC”, there is little prospect for a consumer facing instrument in the next 5 yrs (even in pilot). 
• The effectiveness of Russian sanctions has created an opportunity for China’s digital Yuan (eCNY) to compete with USD as the monetary standard in key trade flows and contracts, with initial focus in oil markets (see CSIS policy paper). 
• This near term threat to USD hegemony in commercial contracts, combined with US retail bank resistance to consumer use, will drive focus of US CBDC toward key [commercial] trade flows.
• Outside of the US, Central Banks have made CBDCs a near term imperative (see McKinsey). Central banks want to be seen as “active innovators”. Unfortunately for CBDC projects, they lack a compelling use case. While eliminating cash, and 0 cost transfer of funds are great goals, there are monumental hurdles and downsides. For example, privacy-conscious Europeans are not crazy about giving the government the ability to track every single transaction and transfer (whatever the proposed safeguards). 
• The federal reserve cares deeply about a healthy US banking system. Payments are a very large part of bank profitability. The US Fed (and member banks) are justified in a very cautious eval. ECB has much different motivations and cares much less about bank revenue streams
• A focus on commercial flows. The eCNY will see traction in ME, China and SE Asia oil contracts. The joint Saudi/UAE central bank project Aber will be a likely success, JPM’s Onyx, and similar bank consortium platforms, will see great success in improving speed of commercial payment flows. Note that commercial flows do not encounter privacy issues as they are reported in the current regulatory environment(s). 
• As a payments innovator, I love the idea of a government-baked asset token. As a banker, I despise the idea. As described in the March 2023 paper from the IMF – Monetary Policy Implications of CBDCs. “CBDCs in digital wallets reside on the central bank ledger and are not available to the commercial banks to lend. All else held constant, the decline in bank deposits and the corresponding decline in commercial bank reserves reduces available bank credit to the economy” 
• The US banking system has clear separation between the role of the central bank and the roles of the independent banks. US banking regulations operate across a array of agencies from state regulators, to OCC, FDIC, CPFB, FinCen, Fed, ….etc. In general, the FED only manages banks and never consumers/businesses nor transactions. While hybrid model CBDCs can provide a role for commercial banks as lead, there is no economic incentive for banks to provide services such as KYC, AML, Fraud, Reporting, Support, Token Issuance….etc. The Fed has always allowed its member banks to price the services it offers (As is the case for FedNow, FedWire, …etc).   
• IMHO US bank participation in a Retail CBDC has 6 primary issues

1. 1. No economic model for bank CBDC participation (ex costs to support hybrid model)
   2. Eliminates the #1 source of retail bank profitability: payments
   3. Impacts liquidity, and reduces capital available for asset growth (ie lending)
   4. Operates in an undefined regulatory environment (ex who owns AML and fraud screening)
   5. Lack of well-defined market need and consumer-facing use case.
   6. Existing consumer behavior and incentives (ex tap to pay and card rewards). 

Predictions

1. US Fed CBDC efforts will be focused on commercial trade flows
2. Europe and the UK will launch retail CBDCs, to the consternation of its banks, with limited success. The economic model and shared investment within the V/MA networks provide value and addresses consumer privacy concerns.  These efforts are yet another effort to eliminate “excess profits” and attempt to end the dominance of V/MA (see blog). 
3. Federal Reserve efforts will compete with bank/bank consortium efforts to build DLT based transaction management (ex JPM’s Onyx). 
4. A very limited pilot of retail CBDCs will launch in the US with a maximum value of ~$500 in 4-7 yrs. Without the support of Banks, Google, or Apple this pilot will see little chance of success. 
5. Biggest unknown the prospect of a large Big Tech (ie Google) to provide platform support for CBDCs which would leverage their amazing success in India with UPI. 

Thoughts Appreciated.