Q&A: FNA's Carlos León on how digital money can be more efficient and safe

As multiple nations push ahead on the idea of central bank digital currencies (CBDCs), UK-based FNA has been helping them do so. Carlos León, FNA's director of Financial Market Infrastructures and Digital Currencies Solutions, talked about what nations are doing to launch digital currencies and what advantages they might offer.

FinTech abstract / virtual world of dollars, pounds, euros, bitcoins, etc.
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Governments across the globe are exploring or already piloting digital forms of national currencies, which have the potential to enable faster, less expensive retail and corporate transactions — and more secure money transfers.

Central bank digital currencies (CBDCs) can also bolster financial inclusion because customers don't have to have a bank account to hold them; they can instead use encrypted "digital wallets" that exist in the cloud, on a desktop or laptop, or even on USB storage device.

In March, US President Joe Biden issued an executive order calling for more research on developing a national digital currency through the Federal Reserve Bank, or “The Fed.” The order highlighted the need for more regulatory oversight of cryptocurrencies, which have been used for nefarious activities such as money laundering. The Fed has been investigating the creation of a central bank digital currency (CBDC) for years. 

cryptocurrency and blockchain concepts integrated with a close-up of the U.S. one-dollar bill D-Keine / Getty Images

In the US, lawmakers have introduced bills that would allow the US Treasury to create a digital dollar. The electronic dollar, a virtual representation of a US dollar, would allow people to make payments using tokens on mobile phones or through cards versus cash. The US, however, is far behind other nations such as China in developing its CBDC. 

A government-backed digital currency could enable a real-time retail payment infrastructure, meaning funds are available immediately to pay utility bills or split the rent with roommates, or for small business owners to pay their suppliers, and it would allow cross-border payments between banks and corporations. Today, traditional bank payment messaging systems, such as SWIFT, take two to five working days to complete.

London-based FNA provides advanced analytics and simulation technology to financial institutions to demonstrate what CBDC payments would do to the wider financial ecosystem. It's been working with central banks to safely introduce digital money while also improving liquidity. Carlos León,  director of Financial Market Infrastructures and Digital Currencies Solutions at FNA, offered emailed responses to questions from Computerworld about CBDCs and their potential.

carlos leon fna FNA

FNA's Carlos León

Why are nations only now exploring the creation of retail digital currencies when the technology has been available for decades? "Central banks across the world have been researching retail CBDCs for some time. One of the world’s first retail CBDCs was rolled out by Finland in 1992 and by Ecuador in 2014. Although both schemes were put to an end, it is clear that central bank digital currencies have been in research and development for some time now -- although the nowadays popular term 'CBDC' is somewhat new.

"It is most likely that the recent momentum of retail CBDCs followed the rise of projects aimed at new forms of private digital monies. The long-lived reliance on central bank money (central banks' cash and banks’ reserve deposits at the central bank) and commercial bank money (public bank deposits) was questioned after the 2007-2008 great financial crisis. Back then, new technologies, supported by access to flexible and affordable computing services, encouraged the development of novel digital payment solutions that avoided trust in central banks and that were (allegedly) more efficient to make local and cross-border payments. That is, paradoxically, the rise of cryptos and their related technology spurred a new interest in a digital form of claims against the central bank.

"Today, nations are stepping up their research and development in rolling out retail CBDCs. There are many motivations, such as monetary sovereignty -- against unwanted forms of private money -- financial inclusion, payment efficiency, and financial stability. For each country, the weights of those motivations vary. However, it is clear that in most cases, it is not a matter of whether a retail CBDC will be rolled out but how and when."

What are the main advantages of retail CBDCs over traditional fiat currencies and financial messaging systems like SWIFT? "Simply put, 'fiat'  is government-issued money that is not backed by a commodity such as gold. Therefore, it is important to realize that retail CBDCs are a new form of fiat that adds to existing physical (cash) and digital forms (banks’ reserve deposits at the central bank and public bank deposits) of fiat money. In this vein, a retail CBDC is a new form of digital claim against the central bank that is available to the public, somewhat similar to a digital form of cash.

"Retail CBDCs will have several advantages over other forms of fiat money. When compared to cash, a retail CBDC has the potential to make the payments ecosystem more efficient and safe, while, under certain circumstances, it can support higher levels of financial inclusion, enhance the distribution of subsidies, and mitigate shadow and illicit activities. However, cash remains the only form of fiat that is universally accessible to make offline, non-technological dependent, anonymous, and uncomplicated retail payments.

"Vis-a-vis bank deposits, CBDCs are claims against central banks, which are considered the safest money issuers in each jurisdiction. Thus, granting access to retail CBDCs may enable the population to choose among a larger set of forms of fiat, allowing them to avoid commercial banks’ money if desired and without the inconveniences of physical fiat. Also, a retail CBDC could foster financial innovation by allowing non-banking participants in the payment ecosystem access to a new digital form of fiat that does not depend on banking institutions and bank deposits; that is, a retail CBDC could promote a level playing field in the traditionally bank-based payment industry.

"The advantages of CBDCs are country-specific. For instance, in undeveloped countries struggling to achieve higher levels of financial inclusion, increasing transactional efficiency and enhancing the distribution of subsidies could yield higher levels of financial inclusion and well-being for the population; yet, this is strongly dependent on the financially excluded population accessing the technological requirements of a CBDC. On the other hand, in a developed country, with a widespread and vibrant digital payment ecosystem, it is most likely that a CBDC will not make a significant contribution to financial inclusion, but could enhance the redundancy of the entire payment system. Therefore, the true advantages of a retail CBDC depend on the jurisdiction where it will be rolled out."

What does liquidity optimization mean in terms of CBDCs? "Large-value payment systems are usually owned and operated by central banks, whereas retail payment systems are owned and operated by central banks or private institutions. In both systems, financial institutions must have balances that allow them to continuously make timely payments, without distorting the safe and efficient functioning of the payment system; a financial institution not being able to make its payments promptly could jeopardize the well-functioning of the payment system and, eventually, the stability of the financial system.

"Liquidity optimization is a process by which a payment system pursues the less amount of liquidity required to settle a certain number or value of transactions. That is, liquidity optimization aims at reducing the balance of digital fiat (reserve deposits and bank deposits) required to settle transactions. Liquidity optimization processes are customary in large-value (wholesale) and retail payment systems, which settle transactions among financial institutions and among financial and non-financial institutions, respectively.

"Rolling out a retail CBDC could require a new retail payment system that settles transactions among its users. Alternatively, it could work on an existing large-value or retail payment system owned by the central bank. Either case, regulation and operational features of the system will determine whether CBDC transactions could benefit from liquidity-saving mechanisms such as netting. For instance, if the CBDC settlement system works based on a pure real-time gross settlement (the standard for most large-value payment systems), each transaction will require the sender of the payment to have a balance equal to or higher than the amount of the transaction; in this case, counter-party risk is minimum, but liquidity demand is maximal. On the other hand, if the CBDC settlement system works on deferred-net settlement, transactions could be settled later after being offset against other transactions in the system; in this case, compared to real-time gross settlement, liquidity needs are lower but counter-party risk is higher. Hybrid settlement models that mix real-time gross settlement with netting are common.

"Nevertheless, the extent to which offsetting transactions with CBDCs reduces liquidity needs is uncertain: it will depend on the existence of transactions that could be netted among two or more users during a short period. As CBDCs are expected to work as P2P and P2B networks of instant payments, with most individual transactions not sharing common users and a similar timeframe, netting opportunities should be rather scarce and liquidity optimization should be somewhat low — unless the adoption is massive."

What banks/governments have you worked with to introduce CBDC? "Non-disclosure agreements with our clients in the CBDC environment do not allow revealing their names at the moment."

What are some of the technical and regulatory issues you’ve run into? "In the case of CBDCs, the devil is in the details. Technical specifications, including design choices such as remuneration of balances, caps on balances and transactions, and layers of anonymity, determine how the CBDC would eventually roll out and its adoption.

"That is precisely the aim of FNA’s work regarding CBDCs: To provide central banks and other stakeholders with a software solution that enables them to rapidly and flexibly test, model, and simulate the economic and financial stability implications of introducing a CBDC. The main inputs for FNA’s CBDC Simulation Solution are the technical design choices of the issuer, the key features of the economy where the CBDC is rolled out, and a set of rules that determine how users (customers and merchants) will choose among different payment instruments (CBDC, cash, bank deposits) in their daily purchases of goods and services.

"Regarding regulatory issues, as regulation of CBDCs is currently being discussed, at FNA we have not encountered any."

In what way will the country that creates the first widely used digital currency have a significant advantage in setting standards and adoption? "When it comes to a retail CBDC, there is no apparent ‘first mover advantage.' Getting it right is far more important than getting it first. As this is a major evolution of money and the way people make their payments, central banks are cautious about CBDCs’ successful adoption and its potential impact on the wider financial system. The reputational risk of a failed rollout or a negative impact on financial stability significantly surpasses the uncertain gains from eventually setting standards for CBDCs. Further, most countries envisage retail CBDCs as designed for domestic retail payments–including China’s e-CNY–, thus a calculated, early CBDC rollout to set standards and become an international leader seems an unlikely scenario.

"All in all, there is no evidence that countries with an up-and-running retail CBDC have any financial advantage over countries that do not. What is true, is that many countries that have already rolled CBDCs out have much greater social factors making them fast-track this process–such as increasing financial inclusion and facilitating the distribution of subsidies."

China is one of the leaders in creating a CBDC — e-CNY. At the same time, it has banned cryptocurrencies. What is China getting right, or wrong, with its CBDC? "One of the motivations for designing and rolling out a CBDC is monetary sovereignty in the form of protecting the payment system and the economy from unwanted forms of private money. Therefore, successfully rolling out a CBDC that satisfies the public’s demand for digital money goes in tandem with banning cryptos: together, they are a coherent way of deliberately avoiding the entrance of undesired forms of digital private money and preserving China’s monetary sovereignty.

"PBoC (the People's Bank of China) has stated that the main motivation for rolling out a CBDC is 'to create a new form of RMB that meets the public’s demand for cash in the era of digital economy.' Although China has not explicitly declared monetary sovereignty as a motivation for rolling out the e-CNY, it is rather clear that PBoC aims at preserving the current monetary system by digitalizing cash. Hence, rolling out the e-CNY while banning cryptos looks like a reasoned decision to preserve the role of PBoC’s money."

What are the biggest barriers to creating and enabling wide adoption of CBDCs (i.e., regulatory, security, privacy, etc…)? "CBDCs are a new form of central bank money. In their retail form, it is still unclear whether CBDCs will replace cash or not, but a successful CBDC should indeed preserve some (or all) the conveniences of cash while providing new features that correspond to the digital age.

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