CENTRAL BANK DIGITAL CURRENCIES - Six policy mistakes to avoid June 2021 Douglas J. Elliott Larissa de Lima - Oliver Wyman
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CENTRAL BANK DIGITAL CURRENCIES Six policy mistakes to avoid June 2021 Douglas J. Elliott Larissa de Lima
Central Bank
Central Bank Digital Currencies (CBDCs) are coming and it is important to do
them right. There is strong momentum in key nations for central banks to
create digital versions of their currencies for widespread use. The Bahamas
has its “sand dollar”; China is well into its experimentation phase, as is
Sweden; the European Central Bank is seriously analyzing the idea with
President Christine Lagarde indicating a digital euro could be in use by 2025;
and virtually every major central bank is extensively analyzing the possibility
of issuance.
Unfortunately, there is a danger that a number of central banks may make one or more
of six serious policy mistakes, described in this paper. Our concern is based on extensive
discussions with senior central bankers and other relevant officials, as well as experts outside
of the official sector. In essence, these errors all have their roots in bureaucratic and political
constraints, combined with the novelty of this instrument, making them more difficult to
avoid.
Raising these concerns is not a statement of opposition to CBDCs. They are a powerful policy
tool that can be used, in conjunction with other policy tools, to achieve a number of
objectives. It is up to each central bank, and other relevant policymakers, to weigh the pros
and cons and to choose the optimal design and implementation for any CBDC they may issue.
We are simply urging the avoidance of some critical errors.
One note on nomenclature: this discussion focuses on “retail CBDCs,” meaning ones that are
designed for wide use in the economy and to be held by individuals and businesses broadly,
as opposed to “wholesale CBDCs,” primarily used between financial institutions. For
convenience, we will use “CBDC” in this paper, rather than repeating “retail” each time.
THE SIX DEADLY SINS
• Siloed decision-making. CBDCs do not exist in isolation; policy regarding
CBDCs, stablecoins, other digital assets, and the payments ecosystem must fit
together coherently
• Putting off the hard choices about policy objectives
• Ignoring other policy tools to reach these objectives
• Creating the “Swiss Army Knife” of digital currencies
• Downplaying political constraints and forces
• Muddled communications
© Oliver Wyman 2Central Bank
SILOED DECISION-MAKING
CBDCs do not exist in isolation and they are only one policy tool of many to achieve the
various policy objectives for which they might be used. CBDCs will be one part of a complex
payments ecosystem which also overlaps with digital assets, such as Bitcoin, that are not
primarily payments vehicles. Thus, policy choices need to be coherent across at least the
following areas:
• Modernization of payments systems
• CBDCs themselves
• Stablecoins
• Digital assets that are not tied to conventional currencies
Few, if any, countries have one authority responsible for all four of these categories. Even if
they do, the different parts of that authority may not coordinate as well as they should. The
US and the European Union (EU) may be particularly prone to silo problems in this area, as
noted in the box below.
US and EU considerations
The problem in the US is that authority over financial policy is fragmented. The
Federal Reserve (FED) would be responsible for a digital dollar. Regulation of
stablecoins and digital assets is split between at least the Securities and Exchange
Commission (SEC), the Commodities Future Trading Commission (CFTC), the Federal
Trade Commission (FTC), and various state authorities. The Office of the Comptroller
of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) have
important regulatory authorities over other aspects of the digital assets ecosystem.
Payments policy is set by a mix of the Fed and state authorities and even at the
Fed there is some division between authority at the Federal Reserve Board and the
twelve district banks. And, of course, the Administration has an important role,
including the authority of the Treasury Secretary as Chair of the Financial Stability
Oversight Council, which has a coordinating role on financial regulation and related
issues. One can easily imagine a number of ways in which policy across all these
bodies might not mesh well.
The EU has some analogous issues with split responsibilities across different types
of authorities. For example, there is currently a difference of opinion between the
ECB and the European Commission and other Brussels bodies about the ECB’s legal
authority to proceed on its own in regard to CBDCs. Further, the EU has additional
issues resulting from the complexities of the European institutions and their
interactions with national authorities.
© Oliver Wyman 3Central Bank
There are a number of practical reasons why it is important to consider the bigger picture,
of which CBDC is just a part. First, the existing banking and wider financial systems are
built around the current roles of the central bank and commercial banks, including the
importance of deposits as a funding source for banks, much of which is tied to payments
activities that could be affected by CBDC. Every central bank is aware that a CBDC could
cause disruptions, potentially severe ones, to the existing banking system. All the major
central banks have a stated goal of minimizing this disruption, to the extent consistent
with their core reasons for creating a CBDC. The devil, however, will be in the details, as
discussed below.
Second, some of the reasons put forward for CBDCs center on weaknesses in current
payments system and regulation. Therefore, it would be important to look at the full
payments ecosystem, and other proposed changes to it, when considering issuance of a
CBDC or designing the details. We elaborate on this point further below.
A third set of reasons for CBDC issuance center on a preference by many policymakers for
public sector digital currencies over private sector ones. The larger the role for a CBDC,
the less the need for stablecoins that effectively mimic a CBDC. However, one could easily
imagine a scenario in which a central bank chooses to create a very limited CBDC, yet
financial regulators hem in potential stablecoins with a high degree of constraints, leaving
a gap in the regulated system that is filled by neither the public nor private sector, which
could easily encourage unregulated forms of digital currencies. Or the reverse could occur,
where central banks attempt to create an attractive CBDC, but private sector stablecoins
flourish in a lightly regulated environment that enables them to be more attractive than
the CBDC. As one gets into the details, there are many choices which should be harmonized
between the structure of a CBDC and the regulation and supervision of stablecoins and
other digital assets.
PUTTING OFF THE HARD CHOICES ABOUT
POLICY OBJECTIVES
A typical central bank which is seriously investigating the potential for a CBDC has issued a
white paper in which they describe perhaps seven future scenarios in which they would want
to have a CBDC. Implicitly, and sometimes explicitly, these central banks do not feel a CBDC
is currently necessary, but rather that it might be in the future and the very long lead time
needed makes it imperative to investigate now.
© Oliver Wyman 4Central Bank
The future scenarios usually center on some or all of the following trends or issues:
• Severe decline in the use of cash in an economy
• The need for faster, more sustainable and more resilient payments processes
• The need to increase financial inclusion
• The potential for private sector digital currencies to crowd out central bank money
• The need to improve cross-border payments processes
• The need to decrease fraud and illicit activity
• The desire to facilitate innovation and open competition in a more digitized economy
Moving from top-down to bottom-up approaches, a number of central banks are running,
or have run, technical experiments to understand the capabilities and constraints of the
underlying technologies.
This top-down and bottom-up approach has been very reasonable, but will soon hit its limits.
In particular, it is very hard to have an honest debate about moving forward with a CBDC, or
about its detailed design, when the objectives are so unclear. A CBDC is a very powerful tool,
but you cannot know whether it is the best tool for the task, or specifically how to design it,
without knowing its purpose. Most central banks are at the stage of arguing for the need
to be ready to create a tool, without getting into whether that tool should be a hammer
or a screwdriver, much less whether the tasks will require a Philips-head screwdriver or a
standard one, a large screwdriver or a small one, etc.
Central banks need to move from discussing scenarios to choosing specific policy
objectives. If, as is likely, they want to achieve a number of different objectives, then they
also need to prioritize them, at least roughly. Setting objectives is critical to the next two
steps: (1) determining how CBDCs compare with, and interact with, other policy tools and
(2) making specific structural design decisions.
IMPLICATIONS FOR STRUCTURAL DESIGN
There are a host of high-level structural design choices that policymakers must decide. These
are very briefly described below, as full explanations would require much more space.
Who should have access to CBDCs? In particular, will this be a retail CBDC, analogous to
cash, or a wholesale one, limited to use by financial institutions? For purposes of this paper,
we are confining the discussion to retail CBDC.
Will CBDC holders have a direct relationship with the central bank or will
intermediaries, such as banks and Fintechs, be used? Central banks in advanced
economies are generally leaning strongly towards an intermediary model, sometimes
using “digital wallets.”
© Oliver Wyman 5Central Bank
Will the system be account-based, token-based, or some combination? Holders could
be required to prove their identity in order to use CBDC in an account-based model or could
have a digital token, the equivalent of paper money or coins, in which they only need to hold
the token in order to use CBDC — a so-called “bearer instrument” model.
Which intermediaries will be allowed? Most central banks explicitly wish to avoid
disrupting the commercial banking system more than necessary. Does this mean only banks
should be the intermediaries or will Fintechs and Big Tech firms be included?
What capabilities should be built in? Digital currencies can be designed to allow
or facilitate the use of “smart contracts” and “programmable money.” As part of this,
a CBDC could be designed in such a way as to automate the execution of policy, for
example, by delivering “helicopter payments” with automatic expiry dates as a form of
monetary stimulus.
What limits will be in place for users and intermediaries? Some central banks are
exploring caps on the quantity of CBDCs that any specific individual can hold to limit financial
disintermediation. How this is monitored and enforced may have implications to design.
How will data privacy/anonymity be handled? There are a multitude of complex
considerations in this area, revolving around which entities will have which data and how
they are permitted to use it.
How will the system discourage money laundering and financial crimes? This ties into
the data privacy question. At one extreme, digital tokens could be as anonymous as cash,
potentially making money laundering easier. At the other extreme, tokens or accounts could
be tracked closely, reducing crime at the expense of privacy.
Optimal design choices will depend on which policy objectives are seen as the most crucial
and as being consistent with the evolving role of the central bank. For example, an emphasis
on financial inclusion might argue for a tighter relationship between the individual and
the central bank, such as through an account at the central bank itself. In contrast, a focus
on faster payments might put a premium on the use of intermediaries, which are already
experienced at handling customer relationships and whose role would allow the central bank
to avoid building a huge new infrastructure of accounts.
Similarly, if the goal is to mimic features of cash like its anonymity, the choice may be to
ensure clear limits to data collection or guarantee anonymity through technology, for
example, by adopting a token-based system that does not track the identity of the payer.
On the other hand, if there is greater priority on combating illicit financial activities, such as
money laundering and financing terrorism, then a system that collects more information on
accumulation and usage is preferred.
© Oliver Wyman 6Central Bank
IGNORING OTHER POLICY TOOLS TO REACH
THESE OBJECTIVES
There are alternative policy tools available to achieve virtually all of the objectives. For
example, many central banks and private sector providers are in the process of dramatically
increasing the speed of payments or have already done so. In terms of improving cross-
border payments, the Financial Stability Board and the Committee on Payments and Market
Infrastructures laid out 19 tools in their Stage two report on cross-border payments. CBDC
is just one of these 19. Similarly, there are a host of potential tools to improve financial
inclusion, many of them moving forward today.
This is not to argue against CBDCs, but to emphasize that once we know the policy objectives
it will be critical to see what CBDCs are most useful for, either instead of other tools or, more
likely, as a complement to them. There could be specific instances when a CBDC is the ideal
tool. For example, Bahamas adopted a CBDC blockchain structure for its sand dollar to help
manage a specific set of constraints: limited connectivity and sporadic presence of financial
institutions across a widely dispersed archipelago.
CREATING THE “SWISS ARMY KNIFE”
OF DIGITAL CURRENCIES
Unfortunately, there is a strong temptation to proceed forward with design of a CBDC, or
at least publicly floating some specific design choices that may create strong momentum
for those particular choices, prior to accepting the political pain of narrowing down and
prioritizing the objectives. This creates a further temptation to “square the circle” by loading
the technical requirements with a wide array of demands, so that when policymakers
eventually settle on their goals, the CBDC design will support them.
The problem is that this is likely to result in a “Swiss Army knife” approach. The Swiss Army
knife is a brilliant design, allowing the user to access many different tools in a compact
space. However, it has only a very small share of the global tool market because it is virtually
always better to use one or two or three tools that are optimized for the particular task.
As with almost all major policy initiatives, the implementation will be much better if the
objectives are clear from the beginning.
Some may be relying on the magic of innovative technology to rid them of the need to makes
these choices now. As good as our technologists are, it is much more likely that important
design trade-offs will remain. Further, as discussed above, some policy choices are
inherently at odds with others, such as certain trade-offs between anti-money laundering
efforts and privacy requirements. (To be clear, privacy and AML considerations are not
completely in conflict, but there are some aspects where one has to choose.)
© Oliver Wyman 7Central Bank
DOWNPLAYING POLITICAL CONSTRAINTS AND FORCES
Choices about CBDC issuance and design will significantly affect the financial system
and larger society. As a result, central banks will not be able to proceed in isolation or
make decisions purely on their views about the technical merits of different approaches.
Central bankers are aware of this, but there is a danger that they downplay the importance
of politicians and other stakeholders, through a combination of a legitimate desire to
protect their independence in monetary policy and a culture of trying to hold political
considerations at arm’s length.
In general, CBDCs will need to be designed in close consultation with finance ministries and
financial regulators, as well as the broader public, given their potentially large impacts on
the financial system and critical importance of payments infrastructure to the economy. In
this sense, the division of responsibilities and accountability for CBDC design is much more
akin to the situation for financial regulation than for monetary policy. In most countries,
central banks play a major role in regulating and supervising the financial sector and are
more constrained and more closely watched by the political authorities for these activities
than for monetary policy. That said, the consultation will need to be managed carefully
to avoid the appearance or reality of undercutting the independence of central banks in
monetary policy.
Moving on to specific decisions, there are two areas in particular where central bankers may
believe they have more freedom than they will have in practice. First, many central banks
are considering placing limitations on the amount of CBDC that can be held by any one
individual or entity, in order to keep CBDC as primarily a payments vehicle and not a
store of value that competes with bank deposits. However, if the new CBDC works well,
it is difficult to imagine that central banks will be able to resist the high level of pressure
that will arise to raise the limit to levels high enough that virtually any transaction can be
performed with it. The ECB has floated the idea of limiting a digital euro to 3,000 euros
per holder; one can easily see demands to raise that to 10,000 or 20,000 or higher, so
that individuals and small businesses can buy automobiles or pay for an expensive trip.
This pressure will be particularly hard to resist as the main reason for the limit is to avoid
excessive disruption of the current banking system, which can easily be caricatured as the
elites protecting the big banks — never a popular position.
Second, central banks would prefer to pay little or no interest on their CBDCs. This is partly
to avoid disrupting the banking system too much and partly, one presumes, to preserve the
financial benefits to central banks of being able to issue currency for free. If interest rates in
the economy are very low, as they are currently in some countries, this may not be a major
issue. However, any significant difference between what banks pay on deposits and what
CBDCs accrue is likely to provoke anger that the “people’s bank” is treating citizens worse
than the profit-seeking banks are.
© Oliver Wyman 8Central Bank
MUDDLED COMMUNICATIONS
Good communications will be critical, given the importance of money and payments to
the economy and therefore the wide range of stakeholders: the public; politicians; the
media; financial institutions; tech firms; merchants; other types of businesses; etc. This
will be challenging and easy to get wrong, particularly because there is a wide range of
understanding about money across the stakeholders. We have had conversations with
otherwise intelligent and well-informed individuals who literally thought that when a bank
took a deposit, it placed those funds in a safe deposit box. More commonly, the great
majority of the public makes no distinction between “money” they hold in a deposit account
at a bank and “money” that represents a direct liability of a central bank. Further, we have
already seen media coverage that equates CBDCs with Bitcoin, despite the potentially huge
differences between the two types of instruments.
Good communications will be particularly important in driving adoption of a CBDC
once it has been designed. This requirement goes beyond clarity to persuasion. Clear
communications are critical, but a persuasive message also needs to resonate.
The need for good communications is another strong reason why policymakers need to be
clear about their objectives and prioritizations. If policymakers are not clear, how can we
expect the other stakeholders to understand clearly?
Communications choices can have important implications that may not be clear on first
glance. For instance, most central banks are likely to go with an intermediated version
of CBDC, whereby banks and some other authorized intermediaries will have the direct
relationship with the holders of the CBDC. One reason for this choice is to take advantage
of the intermediaries’ abilities to handle AML and other duties. However, if major money
laundering problems occur, it may be difficult for central banks to shield themselves
from blame to the extent they can today, if there has been a strong stress that this is a
central bank digital currency.
As a second example, there is a risk of confusion around the level of privacy of transacting
with CBDCs, as the level of privacy will depend not only on the choices made in its design, but
the country’s broader privacy and data protection regime. While a CBDC may be designed
to be private from central banks, data and metadata may be captured by intermediaries and
combined with other data sources in ways that violate citizen’s perceptions of the CBDC’s level
of privacy.
Additionally, the introduction of CBDCs may also change expectations from the public about
monetary and fiscal policy. If a CBDC is messaged as a way for central banks to respond
more effectively to economic challenges, then it may be more difficult to resist calls for
central bankers to engage in novel monetary stimulus measures, such as helicopter money.
© Oliver Wyman 9Central Bank
CONCLUSIONS
There is clear momentum for retail CBDCs and we believe they are likely to be built in many
jurisdictions this decade. It is important that policymakers design and implement them well,
which is why we have emphasized six areas where the risks of an error are particularly high.
Douglas Elliott is an Oliver Wyman partner focused on the intersection of Finance and public policy.
He is the author of the book, Uncle Sam in Pinstripes: Evaluating US Federal Credit Programs. Prior to his
current position, he was a scholar at the Brookings Institution and a Visiting Scholar at the IMF. Before
that, he was the founder and principal researcher for the Center On Federal Financial Institutions.
He began his career with two decades as an investment banker, primarily at JP Morgan.
Larissa de Lima is a Fellow with the Oliver Wyman Forum, a think tank committed to bringing together
business, public policy, and social enterprise leaders to create innovative solutions to the world’s
toughest problems. She’s part of the Forum’s Future of Data Initiative, focused on enabling responsible
data-driven innovation. Prior to this role, she worked at Oliver Wyman advising financial services clients
on adapting to technological and regulatory change.
© Oliver Wyman 10Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, and organization transformation. For more information, please contact the marketing department by phone at one of the following locations: Americas EMEA Asia Pacific +1 212 541 8100 +44 20 7333 8333 +65 6510 9700 AUTHORS Douglas J. Elliott Partner douglas.elliott@oliverwyman.com Larissa de Lima Fellow, Oliver Wyman Forum Knowledge Services larissa.delima@oliverwyman.com Copyright ©2021 Oliver Wyman All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman. Oliver Wyman – A business of Marsh McLennan www.oliverwyman.com
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