When the U.S. and its allies decided to punish Russia for its invasion of Ukraine, they used their power over the global financial system to isolate the nation, crippling its economy and crushing the value of the ruble. But what if, in the future, countries don't need those U.S.-dominated payment networks?
That's one of the big questions also being asked now about China's digital yuan and the European Central Bank's plans for a digital euro, just two of the many so-called central bank digital currencies (CBDCs) that are being tested or studied around the world. CBDCs have emerged amid the rise of thousands of cryptocurrencies, which are quickly disrupting traditional payment systems and pushing central bankers to innovate to compete.
It's not the first time. Consumers and businesses used to transact in numerous privately issued banknotes until central banks ended the chaos by monopolizing currency issuance in the 19th and early 20th century. Today, policymakers face a similar challenge of trying to maintain their footprint in global money supply.
CBDCs aim to make payment systems safer, faster, cheaper, and more reliable. Digital money also can give governments in poor nations an alternative to underdeveloped banking systems or help authorities provide lifesaving funds to citizens quickly during a crisis.
The International Monetary Fund estimates that about 100 countries have either rolled out CBDCs or are considering them. The U.S. is among those with a project that's still on the drawing board, though an executive order by President Joe Biden in March sought to prioritize the study of a digital dollar.
But isn't money already digital? For most of us, our savings or debts are just numbers on a computer or smartphone screen. We perform most transactions without ever touching paper currency or coins.
CBDCs are different in one important respect. The traditional dollars or euros or yuan on our screen today are actually the liabilities of a commercial bank or other financial institution, which makes them vulnerable to that company's financial health as well as to actions taken by governments. But CBDCs, like physical cash, are direct liabilities of the central bank. In theory, a CBDC would allow a central bank to transfer currency directly to the digital wallet of an individual, corporation, or other counterparty without needing any other bank or intermediary. In practice, most central banks aren't willing to cut out the private financial sector completely.
As with most innovations, there are pluses and minuses. Governments will be able to track the movement of central bank digital currencies easily. That will help policymakers better understand how the economy is functioning. But it could also help in the surveillance of citizens. And given the enormous impact that CBDCs could have on economies, they have to work flawlessly if they're to be trusted. In their early days, that hasn't always been the case.
Some of the most-motivated nations are smaller, less-developed countries that aren't worried about sanctions-they're just trying to solve real-world problems for their people. Those issues include the high number of citizens without bank accounts, the costly system for sending money around the world, and even simple geographic isolation. For example, Palau, a cluster of tiny islands in the Pacific that use the U.S. dollar, sometimes runs out of pennies, so merchants have been known to give out pieces of candy as change instead.
What follows is a closer look at six key projects that are up and running, being tested in pilot programs, or close to being rolled out.
CHINA: Digital Yuan (e-CNY)
STATUS: In testing since 2020
USERS: 140 million people, more than 1.5 million merchants
Although the digital yuan is still in the pilot phase, the numbers are staggering: The virtual currency has been tested in about a dozen regions since 2020, with the number of individual users surging by late last year to 140 million, or about one-tenth of the population. More than 1.5 million merchants accept it, according to official data. China hasn't officially set a timeline for a national rollout, but more cities are expected to join the trial.
The central bank adopted a two-tier system for the digital yuan, officially known as the e-CNY. The People's Bank of China first issues e-CNY to commercial banks, which then distribute it to the public. In trials, banks have become partners with merchants, promoting use by handing out free digital cash and consumption vouchers and offering discounts on purchases in digital yuan. China tested the e-CNY during the Winter Olympics in Beijing, though the scope was limited because the games were open to only a small domestic audience because of the Covid-19 pandemic.
Despite making the fastest progress on a digital currency among major economies, China is taking a measured approach in its promotion of the e-CNY. It faces overseas scrutiny and criticism over the possibility that the government may track users' transactions. Domestically, it also needs to overcome challenges posed by WeChat Pay and Alipay, mobile-payment platforms operated by the nation's tech giants that the vast majority of the public relies on for day-to-day transactions. Officials from the PBOC said e-CNY wallets would actually collect less transaction information than private platforms.
Although some U.S. lawmakers worry that the digital yuan could be used to help a nation like Russia avoid sanctions, officials from the PBOC have stressed that the e-CNY is meant primarily for domestic retail transactions. The goal is to allow more people in rural areas to enjoy digital payments while providing a backup to private platforms and making the payment system more efficient.
EURO AREA: Digital Euro
STATUS: Being investigated
In 2018, European banks faced a dilemma. The Trump administration had reinstated sanctions on Iran against the wishes of European governments. One by one, Europe's banks pulled the plug on payments linked to trade with the country, defying the wishes of their own governments in an effort to comply with U.S. sanctions. European governments imposed a blocking rule against Trump's "secondary sanctions," which pressured banks into not cooperating with them, and tried to create a special-purpose vehicle for payments. Still, thousands of businesses were ultimately forced to cut ties with Iran.
The episode showed the leverage that Washington can wield over banks almost anywhere in the world. The European Central Bank took note. Concern over the sovereignty of the euro zone's payment infrastructure was a key reason it began to accelerate efforts to introduce a digital euro when the Covid pandemic struck about a year and a half later.
"We have a responsibility to ensure that our citizens have choice and cannot be excluded from the payments ecosystem due to the unilateral actions of others," ECB President Christine Lagarde said in a September 2020 speech. A digital euro would "ensure that sovereign money remains at the core of European payment systems."
The digital euro would also help bring down costs linked to electronic payments. Although cash use declined somewhat during the pandemic, the share of electronic payments is considerably lower in the euro zone than in other parts of the world-in part because vendors say they're expensive. The ECB doesn't want to let foreign service providers or cryptocurrencies take the lead in technological improvements.
Like other central banks, the ECB is toying with Bitcoin-like distributed ledger technology for its digital currency, but it already has an instant payments system called TIPS, short for Target Instant Payment Settlement, which could be expanded to allow retail use. Unlike the blockchains used by Bitcoin and other cryptos, it's a centralized ledger-and that makes it faster and likely more environmentally friendly. Officials say the plan is to have a functioning digital euro by the middle of this decade.
BRAZIL: Digital Real
STATUS: To begin testing in 2022
Latin America's largest economy is set to test its digital currency in parts of the country by the second half of this year. To Brazil's central bank chief, Roberto Campos Neto, a digital real is the natural next step in the country's evolution toward a faster, cheaper, and more inclusive payment system.
"We hope it will be part of everyday life, to be used in tandem with bank accounts, payment accounts, credit cards, and physical money," he said in late November at an online event.
Brazil's ambition for the digital currency in its initial phases is to promote investment and innovation rather than to serve as a traditional means of payment. Proposals are rolling in from companies in Brazil and around the world for projects that could be facilitated with digital money. Examples include creating digital tokens to represent ownership of vehicles and real estate and financing small businesses and projects in rural areas that would be more expensive or even unfeasible with traditional currency.
"We want to add services that don't yet exist in Brazil, such as new ways of payments and settlements-we see the digital real as the foundation of a smart-payment platform," says Fabio Araújo, who oversees the digital real working group at the central bank.
The digital real would build on existing projects, including Brazil's instant-payments platform Pix and open banking, a data system for financial institutions in which clients can share their personal information. Pix has been a success, with more than 113 million Brazilians and 8 million companies using it to make instant payments or transfers. But the government has ruled out allowing Brazilians to hold accounts directly with the central bank instead of commercial banks.
"We want to maintain the partnership we have with the financial system and open the door to new business and fintechs," Araújo says.
Allowing conversion from digital to physical money is a goal, meaning Brazilians could hold CBDC in their bank accounts or e-wallets and still withdraw cash from an ATM. That won't happen before 2024, because it requires changes in legislation to allow the circulation of digital money.
As of now, the central bank is collaborating with private companies on a set of projects to be implemented in small cities and other locations around the country.
"We want Brazilians to have a very natural relationship with the digital real," Araújo says. "It's not about saying 'now I'm using digital reais.' It's about allowing citizens to do transactions that were very difficult to implement in the past."
STATUS: Introduced in October 2021
USERS: About 700,000 at the end of January
Nigeria hopes its CBDC will bring basic financial services to more of its citizens, but so far it's been slow going. The eNaira went into circulation in October 2021 with the goals of improving monetary policy, boosting financial inclusion, allowing residents to increase remittances from Nigerians living abroad, and completing transactions more efficiently, according to the country's central bank. The regulator accelerated the project last year after banning financial institutions from transacting in cryptocurrencies, which it said posed a threat to the financial system.
The West African nation has been failing to meet its goal to bring more citizens into the regulated financial system. At the end of 2020, almost 36% of adults in Nigeria didn't have a bank account, according to Enhancing Financial Innovation & Access, a development organization that tracks the data. The government's 2013 goal was to cut that proportion to 20% by 2020.
The eNaira has also struggled to meet its objectives. Not enough people know about it, especially in rural areas. And as of now it's only available to bank customers, while the central bank monitors how secure it is before deciding when to extend it to the unbanked. Users need a smartphone and a biometric verification number (BVN) from their bank for the platform's security. Even those who qualify aren't always able to link the e-wallet with their BVN.
The scarcity of individual users has slowed merchant enrollment. About 700,000 customers from a population of 200 million were in the program at the end of January, according to Lagos-based ThisDay newspaper. Fewer than 10% of transactions were person-to-person or person-to-merchant and vice versa, while about 90% involved banks, Central Bank Governor Godwin Emefiele said in January.
For the eNaira to succeed, it "needs more consumers to download and fund the wallet, and the wallet needs to have multiple-use cases that appeal to customers and merchants," says Adesoji Solanke, director for frontier and sub-Saharan African banks and financial technology at Renaissance Capital.
Nigeria is working with banks to resolve the technical issues and make it easier to enroll, including enabling Nigerians who don't have smartphones to use the currency, according to Emefiele. The central bank is working to get more people to understand the eNaira and also engaging fintechs to create products on the virtual platform to increase payments and broaden penetration, the governor said.
EASTERN CARIBBEAN: DCash
STATUS: Pilot launched in 2021
USERS: More than 4,000 people, 120 merchants
In April 2021, La Soufrière volcano erupted, covering many of the islands of St. Vincent and the Grenadines in ash and forcing more than 20,000 people-almost one-fifth of the population-to leave. Evacuees waited in line for hours for money transfers that could take days to clear and came with hefty fees.
The Eastern Caribbean Central Bank, issuer of the Eastern Caribbean Dollar used by eight island nations, had a solution. A month earlier, the bank had become the world's first currency union to mint CBDC. So it expedited its plan for St. Vincent, and by July it was offering suffering residents access to DCash. With DCash, anyone with a mobile phone and a digital wallet could receive e-money immediately at no charge. No bank account, no problem.
The influx of money-particularly from relatives on neighboring islands-helped jump-start recovery efforts. DCash allowed people to pay for services remotely when they were cut off from their communities, says Sharmyn Powell, chair of the Fintech Working Group at the ECCB. As with other central banks, the ECCB's prime reason for introducing DCash was to bring more people into the financial system and to boost the regional economy, Powell says.
"If you want innovation, you have to have a payment platform that supports innovation," she says. "If you want to support competitiveness and trade within countries, you need a payment method that gives people confidence that they can get quick, real-time settlement."
That's especially true during an emergency. When the Bahamas introduced the world's first CBDC, the Sand Dollar, in 2020, one motivation was to be able to get money to far-flung islands after hurricanes. Jamaica and Haiti have similar ambitions for their own CBDCs.
DCash's initial rollout hasn't been smooth. Although more than 4,000 people have downloaded wallets and more than 120 merchants accept DCash, Covid and technical glitches have hampered its adoption, Powell says. In January the currency platform crashed, and it took the ECCB almost two months to fully restore it.
Even so, the e-currency is being used in Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines. Anguilla, the final currency union member, is expected to come online soon. That will be followed by a broader marketing and education push, Powell says.
"In the next six months or so we will see a whole new picture in terms of penetration of DCash across the currency union," she predicts. "We are going to come out of this much stronger than before."
MARSHALL ISLANDS: Sov
STATUS: Made legal tender in 2018, still under development
It's not easy for people-or money-to flow around the Marshall Islands. A population of about 68,000 is spread over 1,100 islands and islets scattered across 750,000 square miles of the Pacific.
The nation passed a law in 2018 making the blockchain-based Sov-short for "sovereign"-legal tender. Supply growth is meant to be limited to 4% each year to keep a lid on inflation. "It's as close to Bitcoin as it gets if you want a decentralized cryptocurrency issued by government," says Henri Arslanian, PwC's crypto leader.
Other countries in the Pacific with dispersed and isolated populations are working on their own projects.
"We've run out of pennies, run out of quarters," says Surangel Whipps Jr., the president of Palau. Sometimes, people even "get a piece of candy as a replacement for a coin."
The Pacific archipelago has formed a partnership with crypto firm Ripple to develop a digital currency strategy. Whipps sees potential for a stablecoin-a cryptocurrency meant to track the value of a traditional currency or other asset-based on the U.S. dollar.
"Innovation is coming from economies that need to create these things," says Josh Lipsky, director of the Atlantic Council's GeoEconomics Center. "Larger economies are looking at them to see whether they could apply that."