Environmental Impact of Digital Currencies: A Closer Look at CBDCs

This research provides an in-depth examination of the environmental impact associated with digital currencies, with a particular focus on Central Bank Digital Currencies (CBDCs). As the global financial landscape evolves towards digitization, concerns regarding the sustainability of emerging technologies are gaining prominence. The paper explores the environmental challenges posed by traditional cryptocurrencies and delves into the potential of CBDCs to mitigate such issues. By analyzing the energy consumption, technological designs, and regulatory frameworks, the article sheds light on the prospects and challenges of implementing sustainable CBDCs. Through this exploration, the aim is to offer insights into how central banks can harness the benefits of digital currencies while minimizing their ecological footprint, fostering a more environmentally conscious financial future.

• Part I: Digital Currencies & Environment
• Part II: CBDCs: Features, Types, Design
• Part III: Linking CBDCs & Sustainable Development
• Part IV: CBDCs Landscape & Case Studies
• Part V: Challenges & Prospects

Part I: Digital Currencies & Environment

The payment landscape is undergoing swift evolution, driven by emerging digital currencies that present both opportunities and contentious discussions, particularly regarding environmental implications. Whether it involves the printing, distribution, and disposal of physical currency or the handling and sustainability of card and bank transactions, there exists a significant energy and environmental footprint associated with payment methods. However, the payment system is dynamic, and a crucial aspect of its transformation is the ascendance of cryptographic and distributed ledger technologies (DLTs) supporting crypto assets.

Digital currencies are forms of currency that exist electronically, without a physical counterpart like coins or banknotes. They are decentralized and typically use cryptography for secure financial transactions. Digital currencies offer various advantages, such as increased transparency, faster transactions, and potential for financial inclusion. Examples include cryptocurrencies like Bitcoin, which operates on blockchain technology, and central bank digital currencies (CBDCs) issued by governments in digital form.

Key Features

• Digital currencies are currencies that are only accessible with computers or mobile phones because they only exist in electronic form.
• Typical digital currencies do not require intermediaries and are often the cheapest method for trading currencies.
• All cryptocurrencies are digital currencies, but not all digital currencies are cryptocurrencies.
• The advantages of digital currencies are that they enable seamless transfer of value and can make transaction costs cheaper.
• The disadvantages of digital currencies are that they can be volatile to trade and are susceptible to hacks.

Types of Digital Currencies

• Cryptocurrency: Cryptocurrencies are digital currencies that use cryptography to secure and verify transactions in a network. Cryptography is also used to manage and control the creation of such currencies. Bitcoin and Ethereum are examples of cryptocurrencies. Depending on the jurisdiction, cryptocurrencies may or may not be regulated.
• Virtual Currency: Virtual currencies are unregulated digital currencies controlled by developers or a founding organization consisting of various stakeholders involved in the process. Virtual currencies can also be algorithmically controlled by a defined network protocol. An example of a virtual currency is a gaming network token whose economics is defined and controlled by developers.
• Central Bank Digital Currency: A digital payment instrument, denominated in the national unit of account that is a direct liability of the central bank. A CBDC can be a supplement or a replacement to traditional fiat currency. Unlike fiat currency, which exists in both physical and digital form, a CBDC exists purely in digital form. The use of CBDCs has been suggested as a means of enhancing the speed and security of centralized payment systems, lowering the costs and dangers of handling cash, and promoting greater financial inclusion for people and companies without access to conventional banking services. They may also make cross-border payments easier and lessen the need for foreign exchange.

Environmental Concerns Associated with Traditional Financial Systems (Cash & Card)

Traditional financial systems often play a role in environmental challenges through various channels. A significant issue arises from the environmental footprint of physical infrastructure, such as banks and financial institutions, which operate energy-intensive processes leading to carbon emissions. Moreover, the reliance on paper-based transactions and documentation within traditional finance contributes to deforestation. Additionally, the support provided by traditional financial institutions to industries with adverse environmental effects, such as fossil fuels and deforestation, can exacerbate ecological problems. The lack of transparency within these systems further complicates efforts to monitor and address environmental impacts. It is imperative to transition towards sustainable and eco-friendly financial practices to alleviate these concerns and foster environmental responsibility within the financial sector.

In the context of environmental impact, physical currency can be viewed as a traditional form of payment with associated ecological drawbacks. Estimates underscore the environmental burden linked to the production, distribution, and disposal of cash notes and coins. On a global scale, there has been a noticeable shift towards digital payments, surpassing the usage of cash. The adoption of digital payment methods with minimal energy consumption in both core processing and user transactions may represent an environmentally favorable trend. However, it’s important to note that cash might possess unique attributes, which digital currencies may find challenging to replicate, despite the potential environmental benefits of the latter.

De Nederlandsche Bank (DNB), the central bank of the Netherlands, evaluated the environmental impact of debit card payments. According to the World Bank, the DNB found that the total ecological cash effect was 1.5 times that of card payments. Card payments have less of an impact than both cash and blockchain assets such as Ethereum and Bitcoin. Per transaction, the estimated energy consumption of card payments is significantly lower than other forms of payment, ranging between 0.0006KWh and 0.0008KWh, depending on the provider. Cash is around 0.044KWh, while blockchain assets reside in the hundreds.

Indeed, centralized digital payment methods, like card payments, appear to be more closely aligned with environmental goals when compared to traditional payment methods. Leveraging existing technologies and devices, such as smartphones, has the potential to further diminish the environmental impact of digital payments. The International Monetary Fund (IMF) recommends the use of digital wallets stored directly on users’ smartphones for CBDCs, eliminating the necessity for additional devices and potentially reducing dependence on card payment networks. It’s worth noting, however, that some offline solutions may still require the use of physical cards, introducing a potential environmental consideration in specific contexts.

Environmental Concerns Associated with Digital Currencies

Payments carry an environmental footprint, and it is crucial to examine how digital currencies may impact this aspect. Traditional payment systems like cash and credit cards are recognized for their non-negligible energy consumption. Digital currencies exhibit a wide range of energy costs based on various technologies.

The energy consumption of digital currencies, including both crypto assets and CBDCs, is largely influenced by two factors:

• The first factor is the consensus mechanism used to establish agreement on the network’s current state. Energy requirements vary widely, with proof-of-work (PoW) algorithms, such as the one employed by Bitcoin, being highly intensive, while non-PoW mechanisms result in orders of magnitude lower energy consumption.
• The second factor is the access model of distributed-ledger systems. This element pertains to the level of control exerted over the underlying architecture, including aspects like the number of nodes, assignment of roles to participants, node locations, and code update procedures. Some systems are permissionless, allowing open participation and validation of transactions by anyone. Others are permissioned, requiring approval from a central authority, which provides greater control over energy-related factors such as the number and geographic location of network participants. Permissioned networks, in contrast to permissionless systems, offer more control over parameters influencing the energy consumption of the core processing infrastructure by allowing stronger controls on who can participate as a validator.

Transitioning away from energy-intensive PoW mechanisms to more efficient consensus mechanisms represents a significant step forward in reducing the energy footprint of digital currencies. Additionally, the use of permissioned systems, where access is controlled by central authorities, further contributes to lowering energy consumption. By implementing these advancements, the energy consumption of digital currencies can be substantially reduced, positioning them as a more environmentally friendly option compared to traditional credit card transactions.

Power hungry. Payment systems involve more than just processing technologies; total energy consumption varies based on technology, payment-chain size, and additional features. This consideration is particularly relevant for central banks exploring digital currencies. Source: IMF calculations.

A notable environmental concern linked to specific digital currencies, particularly Bitcoin, is the substantial energy consumption associated with their mining process. The PoW consensus mechanism employed by Bitcoin mandates miners to solve intricate mathematical problems, resulting in elevated electricity consumption. Critics contend that this energy usage contributes to carbon emissions and worsens environmental challenges.

In response to these concerns, initiatives are underway to explore alternative consensus mechanisms, with proof-of-stake (PoS) being considered as a more energy-efficient option. As the digital currency landscape continues to evolve, there is an increasing focus on identifying sustainable solutions to mitigate the environmental impact of diverse blockchain technologies.

As payment systems increasingly embrace distributed ledgers, the case for more energy-efficient, permissioned options becomes evident. However, in the ongoing debate on the future of money, power usage is just one of many factors. Policymakers must carefully balance energy needs with other benefits and risks when designing CBDCs or shaping the regulatory environment for cryptocurrencies.

The Carbon Footprint of Cryptocurrencies (Bitcoin, Ethereum)

Determining the carbon footprint of cryptocurrency is a complex task. While fossil fuels commonly power cryptocurrency mining in many countries, miners often seek the most cost-effective energy sources to ensure profitability.

The carbon footprint associated with digital currencies varies significantly based on the specific currency and its underlying technology. Cryptocurrencies like Bitcoin, utilizing PoW consensus mechanisms, face criticism due to the substantial carbon footprint resulting from the energy-intensive mining process. In contrast, other digital currencies employing proof-of-stake or delegated proof-of-stake generally exhibit lower carbon footprints, as they do not rely on the same energy-intensive computations. Ongoing advancements in blockchain technology aim to enhance the overall sustainability of digital currencies.

The source of energy used in mining activities is a crucial factor; a higher proportion of energy from renewable sources can reduce the carbon footprint. As the industry evolves, there is a growing acknowledgment of the environmental impact, leading to efforts to transition toward more eco-friendly practices.

It is crucial to make a clear distinction between electricity consumption and environmental footprint in the context of Bitcoin mining. Electricity consumption refers to the total amount of electricity used in the mining process, while environmental footprint encompasses the broader environmental implications of Bitcoin mining. The key factor for environmental impact lies not solely in the level of electricity consumption but in the carbon intensity of the energy sources used for electricity generation. For instance, one kilowatt-hour (kWh) of electricity generated by a coal-fired power station has a substantially worse environmental footprint than one kWh of electricity produced by a wind farm. As a result, rising (or falling) power demand does not automatically lead to a proportional increase (or decrease) in carbon dioxide and other greenhouse gas emissions.

According to study results, published by the United Nations University and Earth’s Future, during the 2020–2021 period, the global Bitcoin mining network consumed 173.42 Terawatt hours of electricity. This means that if Bitcoin were a country, its energy consumption would have ranked 27th in the world, ahead of a country like Pakistan, with a population of over 230 million people. The resulting carbon footprint was equivalent to that of burning 84 billion pounds of coal or operating 190 natural gas-fired power plants. To offset this footprint, 3.9 billion trees should be planted, covering an area almost equal to the area of the Netherlands, Switzerland, or Denmark, or 7% of the Amazon rainforest.

Estimated annualized electricity consumption of BTC and ETH compared with some countries. Source: Cashless articles on the ECB.

In a recent report released by the International Monetary Fund in 2022, it was found that the annual electricity consumption of the Bitcoin network is estimated at 144 terawatt hours (TWh) per year. This amounts to about 0.6 percent of total global electricity consumption, equivalent to the energy consumption of Austria and Finland combined.

In 2023, the Cambridge Bitcoin Electricity Consumption Index (CBECI) was updated to reflect hardware distribution and hash rate increases. Key takeaways from the revised methodology included a focus on recent developments in Bitcoin mining hardware and hash rate and whether the CBECI was accurately reflecting the changing landscape. The researchers honed in on questions about what had driven substantial increases in hash rate in recent years as newer mining equipment eclipsed older models in computing power.

Comparison of annual Bitcoin electricity consumption estimates (as of 15/08/2023). The result for 2023 represents the year-to-date estimate. | Source: CCAF

The 2023 annual Bitcoin electricity consumption estimates contrasts with the annual electricity consumption estimates of previous models. Before 2021, the estimates do not significantly deviate and are largely consistent. This can be attributed to the rapid technological progress made in the early years of Bitcoin mining. These advances rendered older hardware too inefficient to be profitable at reasonable electricity rates, leading to their exclusion in the estimates. Consequently, the previous model has proven reliable in the past. The first and most noticeable discrepancy appears in 2021, where the previous CBECI model estimated an electricity consumption of 104.0 TWh, 15.0 TWh higher than the revised model estimate (89.0 TWh).

Total Bitcoin electricity consumption. Source: https://ccaf.io/cbnsi/cbeci

Currently, industries and companies consume far more energy than Ethereum.

Source: a16z’s Comprehensive Annual Report: The Current State of Web3, Business Boundaries, and Regulatory Innovation

In September 2022, Ethereum switched to a (PoS consensus mechanism, on which many developers choose to build applications), thereby reducing energy consumption by 99.9%. All blockchains require such consensus mechanisms because they are decentralized. The PoS method for network consensus consumes significantly less energy than the PoW method used by Bitcoin

Total Ethereum electricity consumption. Source: CCAF

The example below offers an analogy that elucidates the differences in electricity consumption between Bitcoin, Ethereum 1.0, and Ethereum. In this illustration, if Bitcoin’s consumption were equivalent to the height of Merdeka 118 (the world’s second-tallest building), Ethereum 1.0’s consumption would be comparable to the London Eye (one of the world’s tallest observation wheels), and Ethereum in its current form would be as minuscule as a raspberry.

Source: CCAF

The Carbon Footprint of Central Bank Digital Currencies (CBDCs)

The infrastructure of CBDCs is fundamentally different from that of cryptocurrencies. Alongside cash, CBDCs are public currencies legitimized by central banks. Accordingly, there is no need for the energy-intensive, decentralized mining process, because CBDCs do not require authentication.

The carbon footprint of CBDCs is influenced by various factors, including the underlying technology infrastructure, choice of consensus mechanisms, and the efficiency of data centers hosting CBDC operations. Unlike some decentralized cryptocurrencies using energy-intensive PoW mechanisms, CBDCs, operating on more centralized systems, generally have the potential for a lower carbon footprint. However, the actual environmental impact depends on specific design choices, such as the adoption of energy-efficient consensus mechanisms, the use of green data centers, and the implementation of policies by central banks and governments to promote sustainability.

The new study from the International Monetary Fund emphasizes the importance of considering energy consumption in the design choices of CBDCs, aligning with the global effort to combat climate change. The study acknowledges that central banks, recognizing their role in addressing climate challenges, should focus on reducing both energy consumption and the associated carbon emissions.

Many CBDC projects are leveraging energy-efficient distributed-ledger systems, allowing only permissioned institutions like commercial banks to join and validate without the need for energy-intensive proof-of-work mechanisms. Some alternatives, not reliant on distributed ledgers, are also being explored for their energy efficiency.

The potential of CBDCs to reduce the energy requirements for digital payments, surpassing the efficiency of widely used credit card networks, is promising. While CBDCs are still in early development, their adoption of new technologies will impact power usage. The extent of energy savings will depend on additional design features implemented for compliance, security, integrity, or universal access. For instance, the consideration of providing CBDC access through physical cards, similar to credit cards, raises questions about energy consumption. While card payments typically use more energy than digital wallets (common in most crypto transactions), physical cards can aid adoption and inclusion, especially in areas with concerns about digital literacy or mobile network connectivity.

Advantages Over Traditional Physical Currencies

CBDCs, being digital versions of a country’s fiat currency, are generally considered to have a lower environmental impact compared to certain cryptocurrencies. CBDCs offer several potential advantages over traditional physical currencies:

• Efficiency: CBDCs can streamline payment systems, reducing transaction times and costs. Digital transactions can be processed more quickly than traditional banking methods.
• Financial Inclusion: CBDCs have the potential to improve financial inclusion by providing a digital currency accessible to a broader population. People without access to traditional banking services may find it easier to participate in the digital economy.
• Reduced Counterfeiting: Being digital, CBDCs are less susceptible to counterfeiting compared to physical currency. This can enhance the overall security of the currency.
• Policy Implementation: Central banks can use CBDCs as a tool for more effective implementation of monetary policy. The digital nature allows for real-time tracking and control over the money supply.
• Cross-Border Transactions: CBDCs could simplify and expedite cross-border transactions, reducing the need for intermediaries and potentially lowering transaction costs.
• Financial Stability: CBDCs may contribute to financial stability by providing a secure and reliable form of digital currency backed by the central bank.
• Data Tracking and Compliance: CBDCs allow for improved traceability of transactions, aiding in regulatory compliance and combating illicit activities such as money laundering.

As cash use falls and digital payments rise, CBDC projects are moving ahead. Source: Bank for International Settlements Annual Economic Report.

CBDCs could be designed to use infrastructures that are less energy-intensive than the current payment system. CBDCs that rely on non-PoW permissioned networks could harness the efficiency gains from those networks and from relying on digital means of payments. Depending on the number and location of the nodes of a particular design, CBDCs could further optimize energy use. Non-DLT CBDCs could also be more efficient than the current payment system if central banks select the platform, hardware, and other elements of the CBDC ecosystem with energy efficiency as a criterion.

Such potential for a positive environmental impact will also depend on additional factors. Regulation and compliance costs, for instance, can be an important source of energy spending. It will also depend on whether and how additional features, not commonly part of crypto assets, are deemed necessary for CBDCs, such as increased resilience measures or offline capabilities. Methodologies and data for the full assessment of the payment chain are currently a work in progress.

While CBDCs offer these potential advantages, there are also challenges and considerations, including privacy concerns, cybersecurity risks, and the need to strike a balance between innovation and regulation. The successful implementation of CBDCs requires careful consideration of these factors.

Cryptocurrencies vs. CBDCs

While both cryptocurrencies and CBDCs involve digital currencies, they differ in their fundamental nature, issuance, control, stability, and purposes. Cryptocurrencies emphasize decentralization and innovation, while CBDCs are centrally issued and regulated, focusing on stability, efficiency, and integration with existing financial systems.

A comparative analysis between cryptocurrencies and CBDCs across various dimensions:

Cryptocurrencies vs CBDCs in terms of environmental impact:

Cryptocurrency ecosystems offer a glimpse into an alternative currency system free from cumbersome regulations, featuring security against duplication and counterfeiting through consensus mechanisms. Unlike cryptocurrencies, CBDCs might not necessitate blockchain or consensus mechanisms. Cryptocurrencies remain unregulated and decentralized, their value driven by sentiments, usage, and user interest, making them volatile and speculative. In contrast, CBDCs mirror fiat currency values, prioritizing stability and safety in design for integration into formal financial systems.

Part II: CBDCs: Features, Types, Design

As 2023 unfolds, the future of digital currencies backed by central banks is accelerating. According to a new report from Juniper Research, the global value of CBDCs will grow dramatically from $100 million today to $213 billion by 2030.

What is CBDC

CBDC refers to a digital form of a country’s national currency that is issued and regulated by the central bank. In contrast to cryptocurrencies, CBDC holds the status of legal tender and is government-backed. These digital representations of official currencies are crafted to seamlessly integrate into the existing financial infrastructure, offering flexibility in their formats, such as retail CBDCs accessible to the general public or wholesale CBDCs tailored for interbank transactions within financial markets. The adoption of CBDCs is often motivated by the pursuit of modernizing payment systems, promoting financial inclusivity, and addressing potential challenges posed by private cryptocurrencies. Countries globally are actively exploring or initiating CBDC projects as a strategic response to the changing dynamics of the digital finance landscape.

CBDCs Features

• Digital Representation: CBDCs are the digital equivalent of a country’s physical currency. They aim to provide a secure and efficient digital payment method. A CBDC is designed to perform all the functions of paper money and can perform additional functions. This means that the CBDC can be used as a medium of exchange, a store of value, a unit of account, and for the settlement of debt.
• Centralized Control: CBDCs are issued and regulated by the central bank of a country and are a liability of the central bank. This centralized control distinguishes them from decentralized cryptocurrencies.
• Legal Tender: CBDCs are considered legal tender, just like physical cash. This means that the CBDC is recognized by law. They can be used for various transactions and are generally accepted as a valid form of payment.
• Different Models: There are different models of CBDCs. In some cases, CBDCs are designed for retail use, allowing the general public to have direct access to digital currency. In other cases, CBDCs are more focused on wholesale use, facilitating interbank transactions. CBDC can be used by individuals, firms, and governments to make micro and large payments.
• Policy Tools: CBDCs can provide central banks with additional policy tools. For example, they may enable more efficient implementation of monetary policy and enhance financial stability.
• Transactions Finalty: A CBDC is also designed to offer settlement finality for all transactions. This means that a transfer of funds using CBDC is final, irrevocable, and unconditional.

CBDCs are a response to the changing landscape of payments, to combine the benefits of digital currencies with the stability and trust associated with traditional fiat currencies. Countries worldwide are exploring or piloting CBDCs, but the implementation and features vary across different regions.

CBDCs Objectives

The primary objectives of CBDCs can vary depending on the goals and priorities of the issuing central bank. However, some common objectives include:

• Financial Inclusion: CBDCs aim to provide broader access to the financial system, especially for individuals who may be excluded or underserved by traditional banking services. This can contribute to more inclusive economic participation.
• Efficiency in Payments: CBDCs are designed to enhance the efficiency of payment systems. They can facilitate faster, cheaper, and more secure transactions, reducing reliance on cash and traditional banking methods.
• Monetary Policy Implementation: Central banks can use CBDCs as a tool for more effective implementation of monetary policy. The digital nature of CBDCs allows central banks to have better control over the money supply and more flexibility in responding to economic conditions.
• Payment System Stability: CBDCs contribute to the stability of the payment system by offering a secure and reliable form of digital currency. This can help prevent disruptions and build trust in the overall financial system.
• Innovation and Competition: Introducing CBDCs can stimulate innovation in the financial sector and promote healthy competition among various payment service providers. This can lead to the development of new financial products and services.
• Reducing Cash Usage: CBDCs can help reduce reliance on physical cash, potentially leading to cost savings associated with cash handling, transportation, and security. This shift may also address concerns related to illicit activities associated with cash.
• Enhanced Security and Consumer Protection: CBDCs can offer improved security features, reducing the risks of counterfeiting and fraud. Additionally, they provide an opportunity to implement robust consumer protection measures in digital transactions.
• International Transactions: CBDCs can simplify and expedite cross-border transactions, promoting international trade and financial integration. This may involve collaboration with other central banks to establish interoperability.
• Adaptation to Technological Advances: Issuing CBDCs allows central banks to adapt to the changing technological landscape and evolving consumer preferences. It positions them to leverage digital innovations in the financial sector.
• Policy Flexibility: CBDCs provide central banks with an additional policy tool that can be adjusted to meet evolving economic and financial challenges. The digital nature of CBDCs allows for more dynamic and responsive policy measures.

The specific emphasis on these objectives can vary based on the economic and social context of each country, as well as the central bank’s strategic priorities.

CBDCs Types

There are two types of CBDCs — wholesale and retail. Financial institutions are the primary users of wholesale CBDCs, whereas consumers and businesses use retail CBDCs.

Wholesale CBDCs

Wholesale CBDCs are similar to holding reserves in a central bank. The central bank grants an institution an account to deposit funds or use to settle interbank transfers. Central banks can then use monetary policy tools, such as reserve requirements or interest on reserve balances, to influence lending and set interest rates.

Wholesale CBDCs Features:

• Restricted Access: Wholesale CBDC is designed for use by financial institutions and entities participating in the central bank’s payment and settlement system.
• Interbank Transactions: It is primarily used for large-scale interbank transactions, improving the efficiency of settlement processes between financial institutions.
• Supports Financial Markets: Wholesale CBDC facilitates faster and more secure settlements in financial markets.

Wholesale CBDCs are designed for the facilitation of interbank transfers and associated wholesale transactions, performing a role analogous to reserves held at the central bank but with added functionalities. An illustration of this is the introduction of payment conditionality, where a transaction settles only upon meeting specific predefined conditions. This expands the scope of conditional payment instructions, surpassing the current real-time gross settlement (RTGS) systems’ delivery-versus-payment mechanism. Essentially, wholesale CBDCs have the potential to introduce programmability to central bank money, enhancing automation capabilities and risk mitigation. Additionally, the implementation of wholesale CBDCs would leverage new technology stacks, offering a fresh perspective that enables the design of systems to align with international standards for enhanced interoperability.

Two proofs-of-concept (PoCs) for settling digital assets in central bank money. Source: BIS, SIX Group AG and Swiss National Bank, Project Helvetia — Settling tokenized assets in central bank money, 2020.

Retail CBDCs

Retail CBDCs are government-backed digital currencies used by consumers and businesses. Retail CBDCs eliminate intermediary risk — the risk that private digital currency issuers might become bankrupt and lose customers’ assets.

Retail CBDCs Features:

• Accessible to the Public: Retail CBDC is designed for use by the general public. It serves as a digital version of physical cash that individuals and businesses can use for everyday transactions.
• Direct Liability of the Central Bank: The central bank issues and holds liabilities for retail CBDC directly. Individuals and businesses can hold accounts directly with the central bank or through authorized financial intermediaries.

The monetary system with a retail CBDC. Source: R.Auer and R.Böhme, “Central bank digital currency: the quest for minimally invasive technology”, BIS Working Papers, no 948, 2021.

There are two types of retail CBDCs. They differ in how individual users access and use their currency:

• Token-based retail CBDCs are accessible with private keys or public keys or both. This method of validation allows users to execute transactions anonymously.
• Account-based retail CBDCs require digital identification to access an account.

The distinction between Retail CBDCs and Wholesale CBDCs lies in their respective roles within the financial system. Retail CBDCs are designed to offer the general public a digital equivalent to physical currency, serving as a digital alternative for everyday transactions. On the other hand, Wholesale CBDCs focus on optimizing interbank transactions and settlement processes within financial markets, enhancing efficiency in the broader financial system. The choice to implement either or both types of CBDCs depends on a country’s specific economic and regulatory goals.

In the current financial landscape, digital fiat money is accessible exclusively to regulated financial institutions through reserve accounts held at central banks. Similarly, Wholesale CBDCs would be confined to financial institutions. In contrast, Retail CBDCs are more inclusive, and intended for use by the broader economy. Account-based retail CBDCs would be linked to identification schemes, requiring users to verify their identities. Token-based retail CBDCs, accessed through password-like digital signatures, could potentially offer a degree of anonymity to users.

Forms of digital central bank money. Source: BIS Annual Economic Report.

CBDCs Architecture & Design

The architecture of CBDCs can vary, but generally, it involves several key components:

Central Bank Issuance and Regulation:

• Digital Currency Issuer: The central bank is the sole issuer of the CBDC. It regulates its creation, distribution, and withdrawal from circulation.
• Monetary Policy Control: CBDCs allow the central bank to implement monetary policy more directly by influencing the quantity and value of the digital currency in circulation.

Digital Ledger Technology:

• Blockchain or DLT: Many CBDCs leverage blockchain or DLT for secure and transparent record-keeping. This technology ensures the integrity of transactions and the prevention of double-spending.

Access and Distribution:

• Access Points: Retail CBDCs may be accessed through digital wallets, bank accounts, or other authorized intermediaries. Wholesale CBDCs are typically accessible to financial institutions directly connected to the central bank’s system.
• Authentication and Security Measures: Robust security measures, such as cryptographic techniques and identity verification, are implemented to ensure the integrity and confidentiality of transactions.

Privacy Features:

• Privacy Controls: CBDCs may incorporate features to balance privacy concerns. Some designs allow for pseudonymous transactions, ensuring a level of privacy while still complying with regulatory requirements.

Integration with Existing Financial Infrastructure:

• Interoperability: CBDC systems need to be compatible with existing financial infrastructure, enabling seamless integration into payment and settlement systems.
• Cross-Border Transactions: Protocols for cross-border transactions and interoperability with other CBDCs or payment systems may be considered for international use.

Regulatory Compliance:

• Anti-Money Laundering (AML) and Know Your Customer (KYC): Compliance with AML and KYC regulations is crucial. CBDCs are designed to support regulatory requirements for preventing illicit activities.

User Interface and Experience:

• Digital Wallets: Retail CBDCs often involve the use of digital wallets for individuals to store and transact with digital currency.
• User-Friendly Interfaces: Interfaces for both retail and wholesale CBDCs aim to provide a user-friendly experience while ensuring security.

CBDC Dissemination Architectures. Source: Adapted from Auer and Bohme (2021) and Soderberg and others (2022).

The specific architecture details can vary based on the goals and preferences of the central bank implementing the CBDC. These features collectively contribute to the functionality, security, and effectiveness of a country’s CBDC system.

Opportunities in CBDC Design

The Bank for International Settlements (BIS) identified the design areas for CBDC as the legal claim structure of CBDC: a choice between an RTGS system and blockchain, between an account and token-based method, and between wholesale and retail use.

The European Union Blockchain Observatory & Forum (EUBOF) selected the access method (account-based or token-based), the ledger infrastructure (RTGS or blockchain), and the management (centralist or federalist) as the CBDC design spaces.

In examining the design spaces for CBDCs, particular attention will be directed towards the ledger infrastructure and management structure due to their close association with the consensus mechanism. It’s noteworthy that considerations for constructing the retail CBDC system can be extrapolated to the wholesale CBDC system, making a distinct treatment of the two inappropriate in this context. Additionally, the selection between ownership verification methods, whether account-based or token-based, is deemed to have a minimal impact, including on environmental implications.

Consequently, the upcoming section will delve into the decision-making process concerning RTGS versus DLT/blockchain and determine the participants in the consensus mechanism. The RTGS system, given its capabilities in managing accounts, balances, and settlement processes, emerges as a viable option for CBDC issuance. This exploration will shed light on the critical aspects influencing the overall design of the CBDC system.

The success of a retail CBDC hinges on establishing a well-defined division of labor between the central bank and the private sector. CBDCs have the potential to redefine the balance between central banks and private money, introducing a dynamic where both entities collaborate within a shared ecosystem. This ecosystem may include a variety of private Payment Service Providers (PSPs) that contribute to heightened efficiency without compromising the central banks’ core missions of maintaining monetary policy and ensuring financial stability. In this symbiotic relationship, central banks can continue to provide the foundational infrastructure for the monetary system, while private PSPs leverage their creativity, existing infrastructure, and innovation to deliver tailored services to customers. The collaboration fosters a mutually beneficial approach, with each entity capitalizing on its strengths to create a robust and efficient retail CBDC framework.

In the direct CBDC model (top panel), the central bank handles all payments in real-time and thus keeps a record of all retail holdings. A hybrid CBDC architecture (middle panel) incorporates a two-tier structure with direct claims on the central bank, while real-time payments are handled by intermediaries. However, the central bank periodically updates and retains a copy of all retail CBDC holdings. By contrast, an intermediated CBDC architecture runs a wholesale ledger (bottom panel). In this architecture, PSPs would need to be closely supervised to ensure at all times that the wholesale holdings they communicate to the central bank indeed add up to the sum of all retail accounts. Source: BIS Working Papers, no 948, 2021.

For these reasons, for optimal functionality, CBDCs are most effectively structured within a two-tier system, delineating distinct roles for the central bank and the private sector. In this approach, operational tasks and customer-facing activities are predominantly delegated to commercial banks and non-bank PSPs, fostering healthy competition on a level playing field within the retail services domain. Simultaneously, the central bank assumes a pivotal role in managing the system’s core, ensuring the stability of value, maintaining the flexibility of the aggregate money supply, and overseeing comprehensive system security.

These design choices extend their influence beyond the functional aspects of CBDCs, significantly impacting the industrial organization of the payments market. They dictate the parameters for data governance and privacy considerations, as well as influencing the overall structure of the market. By judiciously distributing responsibilities, the two-tier system leverages the strengths of both central banking institutions and private sector entities, creating a symbiotic relationship that enhances the efficiency and stability of the CBDC framework.

Direct CBDC model

In a Direct CBDC model, user-facing tasks shift from the private sector to the central bank, potentially compromising its lean focus on economic policy. The adoption of this model would signify a significant transfer of operational responsibilities and associated costs related to user-facing activities from the private sector to the central bank. Tasks such as account opening, account maintenance, enforcement of Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) rules, and day-to-day customer service would be taken on by the central bank. This shift, however, could potentially compromise the central bank’s role as a lean and focused public institution primarily steering economic policy.

Hybrid CBDC model

The Hybrid CBDC model fosters a competitive field among private PSPs but concentrates data with the central bank, requiring careful governance. In this model, where the central bank has access to the complete transaction record of CBDC transactions, there is the advantage of fostering a competitive level playing field among private PSPs. However, this comes at the cost of increased concentration of data within the central bank. Such a scenario necessitates careful consideration of additional data governance requirements to address potential privacy and security concerns.

Intermediated CBDC model

The Intermediated CBDC model, akin to current FPS, ensures open architecture, with PSPs safeguarding data and promoting competition and innovation in the private sector. The model mirrors the economic consequences of current retail Faster Payment Systems (FPS). This model operates on an open architecture, allowing PSPs to play a crucial role in safeguarding customer data. Interoperability and data access between PSPs are ensured through APIs, steering clear of closed networks and walled gardens. In this setup, PSPs act as custodians of customer wallets without holding deposit liabilities, simplifying the settlement process. The emphasis on a level playing field promotes network effects, facilitating increased user participation, lower costs, and a virtuous cycle of competition and innovation within the private sector.

However, the architecture of any CBDC raises concerns about data governance, with the risk of data breaches necessitating robust institutional and legal safeguards. While data privacy and cyber resilience are relevant to conventional payment systems, they become particularly crucial in the context of CBDCs, placing an increased responsibility on the issuing central bank. To address these issues, CBDC designs can incorporate varying degrees of anonymity.

A two-tiered architecture stands out as the most promising approach for designing the overall payment system. Here, central banks provide foundational elements, delegating consumer-facing tasks to the private sector. This setup allows PSPs to continue generating revenue through fees and expand their customer base by offering CBDC wallets and additional digital services. Such a CBDC system ensures that commercial banks retain their crucial role as intermediaries in the economy. Both hybrid and intermediated models offer design options for robust data governance and high privacy standards. In either system, CBDCs can be supported by policy tools to mitigate any unintended consequences for the financial system and monetary policy.

Part III: Linking CBDCs & Sustainable Development

CBDC has been a global issue in the financial field and is expected to serve as the core digital infrastructure in the future. The environmental impact of CBDC is essential to sustainable development, and it remains debated by scholars, entrepreneurs, and policymakers. CBDC significantly promotes the issuing of green bonds. Specifically, CBDC increases green bonds issuing more in manufacturing industries, and in state-owned enterprises. CBDC is useful to accelerate green finance and hence advance sustainable development, which needs future robust empirical examination.

The actual impact of CBDCs on sustainability goals depends on the specific design choices, regulatory frameworks, and implementation strategies adopted by central banks. A thoughtful and strategic approach to CBDC development can maximize positive contributions to sustainability. A unique feature of CBDCs is that they can be designed to be sustainable right from the start. This is a milestone in the move toward a future payment and settlement ecosystem. Some aspects of the connection between CBDCs and sustainability include:

• Environmental Impact: The energy consumption of blockchain technologies, often used in the creation and maintenance of digital currencies, has raised concerns about their environmental impact. Some CBDC initiatives are exploring eco-friendly alternatives or sustainable technologies to mitigate these concerns. CBDCs can be designed with more energy-efficient consensus mechanisms compared to some existing cryptocurrencies, contributing to reduced environmental impact associated with digital currency transactions.
• Financial Inclusion: CBDCs can contribute to sustainability by promoting financial inclusion. Digital currencies provide an opportunity to reach unbanked or underbanked populations, allowing them to access financial services more easily and participate in the formal economy.
• Reduced Cash Usage: CBDCs could lead to a reduction in physical cash circulation. As cash transactions often have associated environmental costs (such as printing and transportation), a shift towards digital currencies may contribute to sustainability efforts.
• Efficiency and Cost Reduction: Streamlining financial processes through CBDCs can enhance overall economic efficiency. Reduced transaction costs and increased efficiency in financial systems can positively impact resource allocation and contribute to long-term sustainability.
• Innovation in Green Finance: Some central banks are exploring the use of CBDCs to facilitate and incentivize green finance initiatives. This involves using digital currencies to support environmentally friendly projects and investments. Smart contracts and programmable money features could be used to incentivize environmentally friendly behaviors or investments, fostering sustainability initiatives.
• Transparent and Traceable Transactions: The use of blockchain or distributed ledger technology in CBDCs can enhance the transparency and traceability of transactions. This can contribute to efforts against corruption and illicit financial activities, aligning with sustainable development goals.
• Efficiency in Cross-Border Transactions: CBDCs can streamline and make cross-border transactions more efficient. This can facilitate international trade and economic cooperation, contributing to global economic sustainability.
• Economic Stability: CBDCs offer central banks more direct tools for implementing monetary policy. This enhanced control can contribute to economic stability, which is often a prerequisite for sustainable development.
• Data Privacy Considerations: While CBDCs offer benefits, careful consideration of data privacy is crucial. Implementing robust privacy features in CBDC design can protect individuals’ financial information while aligning with sustainability goals.
• E-Waste and Technology Impact: The shift to digital currencies, including CBDCs, raises concerns about electronic waste (e-waste). Sustainable design practices and responsible end-of-life management of electronic devices used for CBDC transactions can help mitigate this impact.

While CBDCs have the potential to align with sustainability goals, their design and implementation must consider environmental, social, and economic impacts to ensure a positive contribution to sustainable development.

The Role of Central Banks in Addressing Environmental Concerns Through CBDCs

The emergence of CBDCs provides an opportunity for central banks to make an important contribution to the transition to a circular economy and sustainable development. Central banks can contribute to the transition to a circular economy in two ways:

• By making CBDC accessible to circular businesses and other players in the circular economy sector, and
• By looking into how the design features of CBDC can support circular economy goals.

On the role of CBDC in the circular economy, a central bank digital currency offers a better payment option for circular economy financial transactions; central bank digital currency can lead to greater financial inclusion for ‘unbanked’ informal workers in the circular economy; CBDC can create a gateway that allows a central bank to offer financial assistance to distressed circular businesses; using a central bank digital currency can reduce illicit activities in the circular economy; a central bank digital currency can be used to provide stimulus funding to support circular businesses during crises; and, a central bank digital currency can offer low transaction cost for circular economy financial transactions.

Relationship between climate change and CBDC.

Central banks can play a role in addressing environmental issues through CBDCs by incorporating sustainable practices into their design and implementation:

• Green Standards and Criteria: Central banks can establish green standards and criteria for CBDC-related activities, encouraging environmentally friendly practices. This includes promoting energy-efficient consensus mechanisms for blockchain networks and encouraging the use of renewable energy in CBDC infrastructure.
• Carbon Neutrality: Central banks can aim for carbon neutrality in CBDC operations. This involves assessing and minimizing the carbon footprint associated with CBDC issuance, transactions, and related activities.
• Promoting Sustainable Finance: Central banks can use CBDCs to promote sustainable finance by encouraging or incentivizing transactions that align with environmental, social, and governance (ESG) principles. This could include offering preferential terms for sustainable transactions or integrating ESG criteria into CBDC-related policies.
• Data Transparency: Central banks can enhance transparency by providing data on the environmental impact of CBDC operations. This includes disclosing information about energy consumption, carbon emissions, and other relevant metrics.
• Research and Development: Central banks can invest in research and development to explore and implement eco-friendly technologies for CBDCs. This may involve collaborating with technology providers to develop energy-efficient blockchain solutions.
• International Collaboration: Central banks can collaborate on a global scale to establish common standards for green CBDC practices. International cooperation can help create a unified approach to addressing environmental concerns in the implementation of digital currencies.
• Educational Initiatives: Central banks can engage in educational initiatives to raise awareness about the environmental impact of digital currencies and promote responsible use. This includes educating the public, financial institutions, and other stakeholders about the importance of sustainable practices.

By taking these steps, central banks can leverage CBDCs as a tool for promoting environmental sustainability and aligning digital currency operations with broader global efforts to address climate change and environmental challenges.

CBDC and Circular Economy

The relationship between CBDCs and sustainability hinges on the specific design of the CBDC, particularly its influence on transactions contributing to sustainability goals. A CBDC that is designed to support the circular economy and broader sustainability objectives will incorporate features that encourage the use of CBDC for transactions that support environmentally responsible and socially beneficial activities. For example, a sustainable CBDC can be structured to provide transaction cost waivers for activities focused on waste reduction or reuse. It may also feature mechanisms for tax incentives or exemptions for transactions that contribute to sustainability initiatives. Conversely, they may discourage unsustainable practices through higher taxes. A sustainable CBDC not only promotes green business practices but actively contributes to sustainable industry growth. Thus, the direct link between a sustainable CBDC and broader sustainability goals is established by incorporating features that support sustainability while discouraging environmentally and socially harmful activities.

The direct link between circular economy and CBDC. Source.

CBDCs Sustainable Design

The development of CBDC design principles is in its early stages, with governments and organizations actively addressing related issues. The G7 has issued a report, “Public Policy Principles for Retail Central Bank Digital Currencies,” outlining foundational guidelines, including the importance of efficient energy usage (Principle 8: “The energy usage of any CBDC infrastructure should be as efficient as possible to support the international community’s shared commitments to transition to a ‘net zero’ economy”). This underscores the commitment to a ‘net zero’ economy.

CBDC presents an opportunity to shape future payment ecosystems for optimal energy efficiency, leveraging carbon-neutral and sustainable energy sources. The ECB, in its 2020 Report on a digital euro, emphasizes principles such as accessibility, robustness, safety, efficiency, and privacy, with a proactive commitment to lower the ecological footprint (Requirement 7b (R7b): Environmentally friendly. The design of the digital euro should be based on technological solutions that minimize its ecological footprint and improve that of the current payment ecosystem). The Bank of England also aligns future CBDC decisions with its climate strategy and recent policy committee recommendations.

CBDC Sustainable Design Choices

Design choices in CBDCs can contribute to a more sustainable digital currency landscape by addressing environmental concerns, reducing energy consumption, and promoting responsible use. The key design considerations:

Consensus Mechanism:

• Traditional vs. Energy-Efficient: Choosing an energy-efficient consensus mechanism, such as proof-of-stake, over traditional proof-of-work can significantly reduce the environmental impact of CBDCs by minimizing energy consumption.

Blockchain Technology:

• Efficiency and Scalability: Selecting or developing blockchain technologies that prioritize efficiency and scalability helps enhance the overall performance of CBDCs while minimizing resource requirements.

Green Energy Usage:

• Sourcing Renewable Energy: Opting for data centers and infrastructure powered by renewable energy sources can mitigate the carbon footprint associated with CBDC operations.

Smart Contracts and Programmability:

• Efficient Code Execution: Implementing smart contracts and programmability in a way that ensures efficient code execution contributes to the overall energy efficiency of the CBDC system.

Privacy Considerations:

• Balancing Privacy and Transparency: Striking a balance between user privacy and regulatory transparency helps address concerns related to data privacy while still meeting legal and compliance requirements.

Interoperability and Standards:

• Reducing Redundancy: Fostering interoperability and adhering to international standards can minimize redundancy and streamline operations, potentially reducing energy consumption.

Regular Audits and Reporting:

• Transparency Measures: Conducting regular audits and transparently reporting on the environmental impact of CBDC operations helps build trust and accountability within the user community.

Scalability Planning:

• Future-Proofing Infrastructure: Anticipating future growth and designing CBDC infrastructure to scale efficiently ensures sustainability as user adoption and transaction volumes increase.

International Collaboration:

• Global Standards: Collaborating with other central banks and international organizations to establish global standards for sustainable CBDC practices.

By incorporating these design choices, central banks can contribute to a more sustainable digital currency landscape, aligning CBDC operations with broader environmental goals and responsible financial practices.

How CBDCs can leverage energy-efficient technologies and consensus mechanisms

CBDCs can leverage energy-efficient technologies and consensus mechanisms to address environmental concerns associated with traditional blockchain systems, particularly those using PoW consensus. Here’s how CBDCs can incorporate energy-efficient approaches:

Transition to Proof of Stake (PoS):

• Explanation: PoS is a consensus mechanism that doesn’t require miners to solve complex mathematical problems as in PoW. Instead, validators are chosen to create new blocks based on the amount of cryptocurrency they hold and are willing to “stake” as collateral.
• Advantages: PoS is inherently more energy-efficient than PoW, as it eliminates the need for resource-intensive mining operations. CBDCs adopting PoS can significantly reduce their environmental impact.

Hybrid Consensus Mechanisms:

• Explanation: CBDCs can implement hybrid consensus mechanisms, combining PoW with more energy-efficient alternatives like PoS or Practical Byzantine Fault Tolerance (PBFT). This allows for a balance between security and energy efficiency.
• Advantages: Hybrid approaches can enhance the security of the CBDC network while minimizing energy consumption compared to traditional PoW-based systems.

Directed Acyclic Graphs (DAGs):

• Explanation: DAGs, such as the Tangle used by IOTA, are alternative data structures for achieving consensus. Unlike traditional blockchains, transactions in DAGs are interconnected and don’t require miners to solve complex mathematical problems.
• Advantages: DAGs are inherently more energy-efficient, as they allow for parallel processing of transactions without the need for energy-intensive mining activities.

Permissioned Blockchain Networks:

• Explanation: CBDCs can opt for permissioned or private blockchain networks where the consensus process is controlled by a pre-selected group of nodes. This reduces the competition and energy consumption associated with open, public networks.
• Advantages: Permissioned networks provide greater control and scalability for CBDCs, and they are typically more energy-efficient than their public counterparts.

Blockchain Interoperability:

• Explanation: CBDCs can explore interoperability with other blockchain networks, allowing for transactions to be settled on multiple blockchains. This can enable CBDCs to leverage the energy efficiency of other networks for certain transactions.
• Advantages: Interoperability provides flexibility and allows CBDCs to tap into the efficiency gains of various blockchain technologies without being limited to a single consensus mechanism.

By incorporating these energy-efficient technologies and consensus mechanisms, CBDCs can significantly reduce their carbon footprint and contribute to a more sustainable financial ecosystem.

CBDCs Applications for Sustainable Development

CBDCs can play a significant role in promoting sustainable development through various applications:

Green Financing and Sustainable Investments

CBDCs emerge as a superior payment option for those involved in the circular economy, especially in the realm of green financing and sustainable investments. With programmable money features, CBDCs enable the enforcement of environmental criteria through smart contracts, facilitating support for eco-friendly projects. Investors in circular economy initiatives can leverage CBDCs for their payments. CBDC transactions are characterized by being low-cost, fast, flexible, safe, and secure. CBDCs empower direct payments, allowing funds to swiftly reach circular businesses and projects, bypassing financial institutions and reducing transaction costs. The notable rise in assets within circular economy-focused funds, coupled with CBDC advantages, signals the potential for accelerated growth and increased investments in circular initiatives.

Financial Inclusion

CBDCs offer a transformative solution to financial inclusion, particularly for unbanked and underbanked populations, fostering economic growth and aiding in poverty reduction. In many developing and poor countries, informal workers, including those in circular businesses, are often paid in cash due to the lack of formal bank accounts. CBDCs address this challenge by providing employers with the option to deposit wages directly into workers’ CBDC wallets, even if they lack a traditional bank account. This approach enhances financial inclusion by allowing informal workers to participate in the formal financial system through CBDC wallets, bypassing obstacles such as cumbersome documentation requirements for traditional bank accounts. For instance, in the circular economy, employers can leverage CBDCs to pay wages directly into workers’ wallets, overcoming barriers to formal banking.

Microfinance, Financial Assistance, and Small Business Support

CBDCs play a vital role in supporting microfinance initiatives and small businesses, fostering a more inclusive and accessible financial ecosystem that drives grassroots economic development. The use of CBDC for welfare and stimulus payments to distressed firms in the circular economy establishes a direct link between players and the central bank. This direct connection streamlines the process, enabling the central bank to offer loans directly to circular economy businesses, eliminating third-party risks. The advantage extends to distressed circular businesses, allowing them to approach the central bank for financial assistance, such as distress relief loans, bypassing the high-interest rates often associated with traditional lending institutions. While central bank support through CBDC-based digital loans addresses challenges in a high-interest rate environment, it’s essential to note that such assistance is contingent on individual central bank policies and the specific circumstances faced by circular businesses.

Reducing Corruption and Illicit Activities

The transparent and traceable nature of CBDC transactions serves as a powerful tool in combating corruption and illicit financial activities, ensuring funds are directed towards sustainable development projects. Unlike cash, which poses risks for money laundering and other criminal activities, CBDC transactions on a permissioned distributed ledger or blockchain enable tracing to unique sender and recipient IDs. This feature significantly reduces the likelihood of illicit activities in the circular economy, as exemplified by a reported criminal case in China involving the use of the digital yuan. The traceability of CBDC transactions played a crucial role in identifying and apprehending the criminal, demonstrating the effectiveness of CBDC in detecting and preventing financial fraud, thus contributing to a more secure circular economy.

Helping Sustainable Businesses to Cope with Crises

In times of crises causing substantial revenue loss for circular businesses, CBDC proves instrumental in government intervention to support these entities. Using CBDC, the government can provide stimulus funding directly to affected circular economy businesses by making payments into their wallet-based or token-based accounts. This targeted intervention assists businesses in overcoming the challenges posed by crises, including pandemics, economic recessions, or financial downturns. By utilizing CBDC for swift and direct financial support, the government can effectively mitigate the adverse effects of the crisis, helping sustain and stabilize circular economy businesses during challenging times.

Low Transaction Costs and Efficient Cross-Border Transactions

CBDCs play a pivotal role in streamlining cross-border transactions, offering benefits such as reduced costs and faster international trade, fostering economic cooperation, and contributing to sustainable global development. With CBDC’s low transaction costs, circular businesses stand to gain by receiving more affordable donations, funding, and investments from international donors and investors. This cost-effectiveness extends to transactions involving the payment of wages to informal workers and general financial activities within the circular economy. CBDC becomes an economical choice compared to traditional methods like bank notes, cheques, debit/credit cards, or online transfers, as the central bank charges minimal transaction costs for processing CBDC payments. The potential savings, as highlighted by a 2021 JPMorgan report, emphasize the substantial impact CBDC adoption can have on reducing global transaction costs, benefiting both corporations and governments: global corporations pay $120 billion in transaction costs through intermediary networks each year. During crises, such as the COVID-19 pandemic, CBDC adoption could streamline processes, exemplified by the suggestion that circular entrepreneurs could receive government assistance more efficiently through digital dollar payments. For example, the United States Paycheck Protection Program (PPP) is a $953-billion business loan program established by the federal government in 2020 through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).

Digital Identity for Social Services

CBDCs can be integrated with secure digital identity systems, enabling efficient and secure distribution of social services. This ensures that individuals receive the support they need for education, healthcare, and other essential services.

Environmental Initiatives Incentives

CBDCs can incorporate features that incentivize environmentally friendly behaviors or sustainable practices. This could include rewards for carbon-neutral activities or investments in renewable energy.

While the potential applications are promising, successful implementation requires collaboration between governments, central banks, and other stakeholders. It’s essential to consider the social, economic, and environmental aspects to ensure CBDCs contribute positively to sustainable development goals.

Part IV: CBDCs Landscape & Case Studies

A total of 131 countries representing 98% of the global economy are now exploring digital versions of their currencies, with almost half in advanced development, pilot, or launch stages, a closely followed study shows.

Currency Unions Tracked. Source: cbdctracker

The number of CBDCs may grow in the next few years. Since Russia invaded Ukraine and the G7 sanctions response, wholesale CBDC developments have doubled. There are currently 12 cross-border wholesale CBDC projects.

BIS Papers No 136, 2023

CBDCs Landscape

• 11 Launched
• 21 Pilot
• 33 Development
• 46 Research
• 16 Inactive
• 2 Canceled

131 countries, representing 98 percent of global GDP, are exploring a CBDC. In May 2020, only 35 countries were considering a CBDC. A new high of 64 countries are in an advanced phase of exploration (development, pilot, or launch). 19 of the G20 countries are now in the advanced stage of CBDC development. Of those, 9 countries are already in pilot. Nearly every G20 country has made significant progress and invested new resources in these projects over the past six months. 11 countries have fully launched a digital currency. China’s pilot, which currently reaches 260 million people, is being tested in over 200 scenarios, some of which include public transit, stimulus payments, and e-commerce.

China (Digital Currency Electronic Payment — DCEP)

• Status: China has been at the forefront of CBDC development and has been conducting pilot programs in various cities.
• Features: The Digital Currency Electronic Payment (DCEP) system aims to enhance the efficiency of domestic payment systems and reduce the reliance on physical cash.
• Use Cases: China’s DCEP has been used in pilot programs for various transactions, including salary payments and government services.

In 2017, China initiated the Digital Currency Electronic Payments (DCEP) project, later known as e-CNY, as part of its broader efforts to advance high-tech sectors. The digital currency was piloted in April 2020 across four cities, allowing commercial banks to conduct internal tests on cash-to-digital money conversions, account-balance checks, and payments. By August 2020, the pilot expanded to twenty-eight major cities spanning ten regions. As of June 2021, over 20.87 million personal and 3.51 million corporate digital yuan wallets were opened, with a total transaction value of around $5.39 billion. By October 2021, these numbers increased to 123 million individual wallets and 9.2 million corporate wallets, with a transaction volume of 142 million and a value of RMB fifty-six billion (approximately $8.8 billion). Early 2022 reports indicated that more than 260 million wallets had been opened. China is actively integrating existing payment channels with e-CNY, and by 2023, AliPay started offering e-CNY in its express payment category. In January 2023, China included e-CNY in its currency circulation calculations, accounting for 0.13% of cash and reserves held by the central bank.

Sweden (e-krona)

• Status: The Riksbank, Sweden’s central bank, has been exploring the possibility of introducing an e-krona.
• Features: Sweden’s motivation includes addressing the decline in the use of cash and ensuring access to a digital form of the national currency.
• Use Cases: The e-krona is intended to be a digital complement to physical cash and is being tested for various transactions.

The Riksbank, Sweden’s central bank, commenced exploration of a CBDC in 2017. Collaborating with Accenture in 2020, they began developing a CBDC platform. The pilot phase began in 2021, testing the feasibility of the e-krona token’s transactions. Subsequently, the project involved commercial banks, including Svenska Handelsbanken, to assess e-krona’s applicability for large commercial and small retail payments. By April 2022, the Riksbank successfully tested offline functionality and integrated banks and other payment providers into the CBDC system during phase two. Phase three, focusing on governance and programmability, released results in April 2023. In 2022, the Riksbank, in collaboration with the Central Bank of Norway, Israel, and the Bank of International Settlements, initiated a cross-border payments CBDC test to facilitate cross-border retail CBDC payments, concluding in late 2022 with a final report in 2023. Simultaneously, Sweden’s Ministry of Finance conducted an inquiry into launching the e-krona domestically, concluding that further study is needed due to the absence of a clear need as of the initial findings.

Bahamas (Sand Dollar)

• Status: The Central Bank of The Bahamas launched the Sand Dollar, a digital version of the Bahamian dollar, in 2020.
• Features: Sand Dollar is designed to enhance financial inclusion, especially in remote areas, and reduce transaction costs.
• Use Cases: The Sand Dollar has been used for various transactions, including government disbursements and everyday purchases.

In October 2020, the Sand Dollar made history as the world’s first CBDC to transition from the pilot stage to an official launch. Available for use by all Bahamian citizens upon release, its integration with the commercial banking system has been gradually rolling out. The Central Bank of the Bahamas, in announcing Project Sand Dollar, highlighted plans to develop new regulations for the digital currency, focusing on enhancing consumer protection, particularly around data protection standards. As the pilot in Exuma progresses, the Central Bank is actively working towards achieving full interoperability among its different wallet providers, marking a significant step in the evolution of CBDC implementation.

Europe (Digital Euro)

• Status: The European Central Bank (ECB) has been actively exploring the concept of a digital euro.
• Features: A digital euro could provide a secure and accessible form of central bank money for individuals and businesses.
• Use Cases: The ECB has been seeking public input on the digital euro and analyzing the potential implications.

Digital euro project timeline. Source: www.ecb.europa.eu

A digital euro was actively being explored by the European Central Bank (ECB). The digital euro refers to a digital representation of the euro currency, issued and backed by the ECB. The primary goal is to ensure that the eurozone is equipped to meet the evolving demands of the digital age, address shifts in payment behavior, and potentially offer a safe and accessible form of digital currency. The digital euro aims to provide Europeans with a secure and accessible form of digital currency issued by a trusted authority, the ECB. Privacy is a key consideration in the design of the digital euro, with the ECB emphasizing the need to ensure a high level of security and privacy protection for users. The ECB engaged in a public consultation process to gather input from citizens, businesses, and stakeholders regarding the potential features, design, and implications of a digital euro. Efforts are made to integrate the digital euro into existing payment systems seamlessly, ensuring compatibility with various financial services and technologies. The development of a digital euro is an ongoing process, with the ECB carefully evaluating the feedback received during public consultations and conducting further studies on the technical and legal aspects.

United States (Digital Dollar Project)

• Status: Various initiatives and proposals, such as the Digital Dollar Project, have been exploring the feasibility of a digital dollar.
• Features: A digital dollar could provide benefits in terms of payment efficiency, financial inclusion, and monetary policy implementation.
• Use Cases: The Digital Dollar Project and related efforts are in the early stages of research and development.

The United States has been actively exploring the concept of a digital dollar, but there hasn’t been an official launch or implementation. Various U.S. government entities, including the Federal Reserve, have been studying the potential benefits and challenges of a CBDC, often referred to as the digital dollar. There have been discussions in the U.S. Congress about the need for a digital dollar, and lawmakers have introduced bills or proposed initiatives to explore the development of a digital currency issued by the Federal Reserve. Officials from the Federal Reserve, including Chairman Jerome Powell, have provided statements emphasizing the importance of carefully studying the implications of a digital dollar before making any decisions. The global context, with other countries actively exploring or implementing digital currencies, has contributed to the urgency of considering a digital dollar to maintain competitiveness in the evolving financial landscape. Technical and regulatory aspects of implementing a digital dollar, such as security, privacy, and the potential impact on the existing financial system, are subjects of ongoing evaluation.

It’s important to stay updated on the latest developments, as the landscape of CBDCs is rapidly evolving. Central banks worldwide are closely monitoring and experimenting with different approaches to harness the potential benefits of digital currencies.

Part V: Challenges & Prospects

Challenges and Risks Associated with Implementing CBDCs

Energy Consumption and Environmental Impact:

• Challenge: Depending on the technology used, CBDCs may still involve significant energy consumption, especially if they rely on energy-intensive consensus mechanisms.
• Risk: High energy consumption can counteract sustainability goals and contribute to environmental concerns, particularly if the power sources are not environmentally friendly.

Digital Divide:

• Challenge: While CBDCs aim to enhance financial inclusion, there is a risk of exacerbating the digital divide if certain segments of the population lack access to the necessary technology or the internet.
• Risk: Inequitable access may exclude vulnerable or marginalized groups from the benefits of CBDCs, hindering social and economic development.

Data Privacy and Security:

• Challenge: CBDCs involve the processing and storage of sensitive financial data, raising concerns about data privacy and security.
• Risk: Inadequate security measures could lead to unauthorized access, fraud, or breaches, compromising the privacy and financial well-being of users.

Technological Risks:

• Challenge: CBDCs rely on complex technological infrastructures, and technological failures or vulnerabilities could pose significant risks.
• Risk: Technical glitches, cyberattacks, or system outages may disrupt the functioning of the CBDC, impacting financial stability and user confidence.

Monetary Policy and Financial Stability:

• Challenge: CBDCs may impact traditional monetary policy tools, and their widespread adoption could have implications for financial stability.
• Risk: Unintended consequences, such as a shift of funds from commercial banks to CBDCs, may affect the effectiveness of monetary policy and the stability of the financial system.

Cross-Border Challenges:

• Challenge: The interoperability of CBDCs across borders is a complex issue, and achieving seamless cross-border transactions poses challenges.
• Risk: Lack of international standards and cooperation may limit the effectiveness of CBDCs in facilitating cross-border payments and economic cooperation.

Lack of Regulatory Framework:

• Challenge: A comprehensive regulatory framework for CBDCs may not be in place, leading to uncertainties and potential legal and regulatory risks.
• Risk: Insufficient regulation may result in financial crimes, market distortions, or inadequate consumer protection.

Public Acceptance and Trust:

• Challenge: Public acceptance of CBDCs may vary, and building trust in a new digital currency is essential for its successful implementation.
• Risk: Lack of trust or negative public perception may hinder the adoption of CBDCs and their potential benefits.

Addressing these challenges and mitigating associated risks requires careful planning, collaboration between stakeholders, and a thorough understanding of the social, economic, and environmental implications of CBDC implementation. Regulatory bodies and central banks need to work proactively to establish robust frameworks that promote sustainability and inclusivity while addressing potential drawbacks.

Prospects of Implementing Sustainable CBDCs

The implementation of sustainable CBDCs offers various potential benefits and opportunities:

Environmental Impact:

• Prospect: Sustainable CBDCs can leverage energy-efficient consensus mechanisms, reducing the environmental footprint associated with digital currencies.
• Benefit: By adopting eco-friendly technologies, CBDCs contribute to environmental sustainability, aligning with global efforts to address climate change.

Financial Inclusion:

• Prospect: CBDCs have the potential to enhance financial inclusion by providing a digital currency accessible to a broader population, including those without access to traditional banking services.
• Benefit: Increased financial inclusion fosters economic development, reduces poverty, and promotes social equity.

Efficiency and Cost Reduction:

• Prospect: CBDCs can streamline payment systems, reducing transaction costs and enhancing the efficiency of financial transactions.
• Benefit: Improved efficiency contributes to economic growth, making transactions faster and more cost-effective for individuals and businesses.

Innovative Financial Tools:

• Prospect: CBDCs with programmable money features and smart contracts can support innovative financial tools and incentives.
• Benefit: Programmability enables the implementation of sustainable finance initiatives, such as rewarding environmentally friendly behaviors or supporting green investments.

Reduced Dependence on Physical Cash:

• Prospect: CBDCs can reduce the dependence on physical cash, leading to cost savings related to cash production, distribution, and management.
• Benefit: A shift towards digital currencies contributes to operational efficiency and reduces the environmental impact associated with cash production and disposal.

Enhanced Monetary Policy Tools:

• Prospect: CBDCs provide central banks with more direct tools for implementing monetary policy, offering greater control and flexibility.
• Benefit: Improved monetary policy tools can contribute to economic stability, which is foundational for sustainable development.

Transparency and Traceability:

• Prospect: CBDC transactions on a blockchain or distributed ledger offer transparency and traceability.
• Benefit: Enhanced transparency helps combat corruption and illicit financial activities, aligning with sustainable development goals.

Cross-Border Cooperation:

• Prospect: CBDCs can facilitate cross-border transactions and international cooperation.
• Benefit: Improved cross-border payments can enhance economic collaboration and contribute to sustainable global development.

Digital Identity for Inclusive Services:

• Prospect: Integration of CBDCs with secure digital identity systems can enable inclusive access to essential services.
• Benefit: Secure digital identity ensures that individuals, including those in remote areas, can access social services, education, and healthcare.

While the prospects are positive, successful implementation requires careful consideration of challenges, stakeholder collaboration, and a commitment to sustainability principles. Regulatory frameworks, technological choices, and public engagement are critical factors in realizing the full potential of sustainable CBDCs.

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