The Evolution of Money-Digital Transformation and CBDCs in Central Banking

Understand the drivers of digital transformation in central banks roles and responsibilities.
Identify the potential benefits and risks of CBDCs.
Examine the contemporary situation in Sweden.

1. S elcen O zturkcan Assoc. Prof. of Business Administration, Linnaeus University, Sweden [email protected] Halmstad University May 2024 The Evolution of Money: Digital Transformation and CBDCs in Central Banking

2. Learning Objectives Understand the drivers of digital transformation in central banks roles and responsibilities. Identify the potential benefits and risks of CBDCs. Examine the contemporary situation in Sweden.

3. Bartering to the first coin King Alyattes, ~7th century BC made from a naturally occurring gold and silver alloy specific standard of size with similar weight

4. nowadays

5. What are the functions of money?

6. 1 - (still) a medium of exchange Used to purchase and sell goods and services. Barter demands double coincidence of wants. Crucial! allows for the efficient exchange of goods and services, especially in a modern economy with a large-scale division of labor. facilitates the division of labor, leading to increased overall efficiency, economic output, and wealth in modern economies.

7. 2 - store of value enables individuals to save and smooth consumption over time earning >> spending: saved for future spending (i.e., retirement income). BUT!!! with high inflation, the purchasing power of money declines making it less effective as a store of value compared to other real assets like stocks, commodities, and real estate.

8. 3 - unit of account provides a common denominator by which the values of other goods and services are measured. In a barter economy, there is no single numeraire. Money serves as a ruler or scale for measuring the values of goods and services. BUT!!! with high inflation is problematic for this function soft currencies may fail to serve as a unit of account, especially for high-ticket items.

9. What is the role of a central bank?

10. Riksbank of Sweden: 1668 as a joint-stock bank Bank of England : 1694, another joint-stock institution most European countries followed…not with same agenda Riksbank lent government funds and became the clearinghouse for commerce Bank of England sought to purchase government debt La Banque de France tasked to combating paper money's hyperinflation that emerged during the French Revolution a bit of history OLDEST CENTRAL BANK

11. monetary authority overseeing commercial banking system managing both the currency and the monetary policy mandate may involve a state or a monetary union (e.g., European Central Bank) monopolistic power to increase the monetary base supervisory and regulatory roles independent institutions free (?) from political interruptions contemporary

12. a state where the value of the currency remains relatively constant over time crucial for the health of the economy promotes certainty and confidence among consumers and businesses Monetary stability

13. Interest Rates 05 determine interest rates to control the cost of borrowing and lending throughout an economy Banker, Agent, Advisor of the Government 04 often act as the banker, agent, and advisor to the government Issuer of Bank Notes 03 monopolistic authority of note issues Financial Stability 02 provide funds when commercial banks cannot cover a supply shortage. efficiency and robustness of infrastructure to support payment and settlement. Monetary Policy 01 control the money supply, often mandated with maintaining low inflation and steady GDP growth Regulation and Supervision 06 set the commercial banks’ reserve ratio and act as lenders of last resort when necessary key roles

14. Cryptocurrency Emergence The rise of cryptocurrencies and private digital payment platforms challenges traditional banking systems. Cash Usage Decline Countries like Sweden are experiencing a significant decline in cash use, prompting a need for digital solutions. Digital Age Stability Central banks face the challenge of ensuring financial stability in an increasingly digital financial landscape. challenges facing central banks today

15. https://www.digitalinformationworld.com/2022/12/the-countries-most-and-least-prepared.html

16. Online Banking Growth There has been a surge in online banking and mobile payment solutions , changing how people interact with financial services. Fintech Disruption Fintech innovations have disrupted traditional banking , forcing central banks to adapt to maintain relevance and control. Central Bank Response Central banks are responding to these changes by considering the introduction of digital currencies like CBDC s. digital transformation in banking

17. what are CBDCs? digital forms of central bank money, designed to complement or replace traditional physical currency. sovereign currencies, centrally issued , and have legal tender status , differentiating them from decentralized cryptocurrencies.

18. CBDC – Central Bank Digital Currency allow individuals to hold liability in a central bank, instead of commercial banks reduce costs and enable financial inclusion, particularly in emerging markets and lower-income countries help satisfy costs of maintaining a payments system most central banks either exploring or piloting a CBDC https://www.imf.org/en/Publications/Policy-Papers/Issues/2019/06/27/Fintech-The-Experience-So-Far-47056 https://businessblockchainhq.com/business-blockchain-news/imf-discusses-central-bank-digital-currency-developments/ The Bahamas: The World’s First Digital Currency (2:58) https://tinyurl.com/3k2umzzk

19. https://www.bis.org/cpmi/publ/d174.pdf key design features of central bank money

20. Term Definition Altcoin A cryptocurrency that is not Bitcoin Bitcoin The first cryptocurrency, launched in 2009 by Satoshi Nakamoto (said to be fictitious) Blockchain Technology Blockchain is a technology-based ‘on-demand’ and highly secure system of recording information in a digital format. It powers cryptocurrency transactions by providing benefits of secure, real time and peer-to-peer transactions. Blockchain uses a distributed (database) ledger that is not controlled by any one organisation or individual CBDC A digital version of a government-issued currency, for example, a US or Canadian dollar, that is not backed by a commodity such as gold Cryptocurrency A digital currency issued by a company or an individual. It is not tied to government-issued money and it may fluctuate considerably Diem Formerly known as Libra and initiated by Meta Platforms (formerly known as Facebook). Diem is a cryptocurrency that uses blockchain technology to ensure security Disintermediation Removal of intermediaries within a channel of distribution or a supply chain. Disintermediation generally creates more direct relationships and cuts costs Ethereum Is both a cryptocurrency and a blockchain network launched in 2015 by Vitalik Buterin Fiat currency Government-issued currency, such as a US or Canadian dollar that is not backed by a commodity, for example, gold. In 1929, Canada stopped using the gold standard; Britain stopped in 1931 and the US followed suit in 1933 NFT Non-fungible tokens may refer to any type of digital assets that are unique, especially in art or in music. See https://www.gap.com/nft/ for global retailer Gap’s first NFT auction Peer-to-peer The ability to move money without going through an intermediary, such as banks. The implication is that money is moved in ‘real time’. There is no waiting period for the funds to ‘clear’. Stablecoins Cryptocurrencies with a pegged market value, for example, backed by a commodity, crypto assets, fiat currency or an algorithm or a process in comparison to a currency or asset. This makes them less price volatile Tokens A digital asset that is built and resides on an existing blockchain. Tokens have a value and may be exchanged Babin, R., Smith, D., & Shah, H. (2023). Central bank digital currency: Advising the financial services industry. Journal of Information Technology Teaching Cases, 13(2), 145-153. https://doi-org/10.1177/20438869221116901

21. Implementation Model – CBDCs are built for either retail or wholesale payments. Retail model Wholesale model This model facilitates payments between individuals or between individuals and businesses This model facilitates payments between commercial banks and central banks . It can improve the development of capital markets, securities trading and settlements This model provides access to corporations, businesses or consumers across the economy In this model, access to CBDC is restricted to a limited group of commercial banks and financial institutions Different CBDC models (1) Babin , R., Smith, D., & Shah, H. (2023). Central bank digital currency: Advising the financial services industry. Journal of Information Technology Teaching Cases, 13(2), 145-153. https:// doi -org/10.1177/20438869221116901

22. Distribution Model – Yet another way of categorising CBDC systems is according to their distribution models. Direct model Indirect model Hybrid model All users have accounts with the central bank , and payments are made directly from one account to another The central bank passes the digital currency token to either a commercial bank or financial institution , which then distributes the currency A big proportion of central banks are working on this model, whereby retail services to end users are provided by commercial intermediaries The central bank will issue currency, manage a permission system for clearing transactions and meet Know Your Customer (KYC) and Anti-Money Laundering (AML) compliance requirements The claim for the currency will not be on the central bank but on the commercial bank or financial institution and that will also handle KYC and AML requirements Commercial intermediaries handle the transaction. However, the central bank retains the ledger of retail transactions Different CBDC models (2) Babin, R., Smith, D., & Shah, H. (2023). Central bank digital currency: Advising the financial services industry. Journal of Information Technology Teaching Cases, 13(2), 145-153. https://doi-org/10.1177/20438869221116901

23. Different CBDC models (3) Account vs Token Model – The transfer of currency can take place through either account-based model or token-based model Account-based model Token-based model It is based on the verification of the users’ identities . This model ensures that a transaction is approved by the originator (payer) and recipient (payee) In this model, the originator and beneficiary would exchange cryptographic tokens in a digital space in a manner similar to the way physical currency is exchanged The central bank would have to create an account for each user and establish the presence of a digital identity system. The identity-based accounts would be linked to all of the transactions Unlike the account-based model, identity is not necessary for payment. But integrity, security and authenticity of the token are important This model resembles the current system for sending digital payments This model resembles physical tokens such as cash and bank notes Babin, R., Smith, D., & Shah, H. (2023). Central bank digital currency: Advising the financial services industry. Journal of Information Technology Teaching Cases, 13(2), 145-153. https://doi-org/10.1177/20438869221116901

24. Increased financial inclusion: Reach unbanked populations Enhanced efficiency and speed of payments Reduced costs of cash handling and management Greater transparency and traceability in financial transactions Potential for programmatic features (e.g., targeted stimulus) 05 01 02 03 04 pros of CBDCs

25. Cybersecurity risks: Vulnerability to hacking and cyber attacks Privacy concerns: Potential for excessive government surveillance Financial stability implications: Impact on commercial bank deposits and lending International coordination: Challenges in cross-border CBDC transactions Design complexities: Balancing innovation with security and privacy 05 01 02 03 04 cons of CBDCs

26. potential challenges ahead

27. Could digital currencies put banks out of business? (11:09 min) https://tinyurl.com/4ynvxey5

28. Financial System Evolution Long-term changes that CBDCs might bring to financial institutions and services. Digital and Traditional Money How digital currencies like CBDCs might coexist with traditional forms of money in the future. potential transformations in the financial ecosystem

29. What about Sweden?

30. Sweden 3rd largest area in the European Union population of ~ 10. 6 M ~USD 5 6 k gross domestic product per capita economy built on engineering , telecommunications , automotive and pharmaceutical industries well developed IT-sector has almost as many tech startups as Silicon Valley https://www.forbes.com/sites/alisoncoleman/2015/10/23/scandinavia-the-coolest-place-for-a-start-up/#28a86a9d32b1 https://www.euractiv.com/section/innovation-industry/news/nordic-countries-lead-eu-in-digital-entrepreneurship/ https://data.worldbank.org/country/sweden Government goal: “Sweden should become the best in the world exploiting the opportunities of digitisation ”

31. Cash Decline indicating a readiness for digital payment solutions. Digital Readiness The Swedish public is increasingly adopting digital payment methods, setting the stage for CBDC . trend

32. https://www.riksbank.se/en-gb/payments--cash/payments-in-sweden/payments-in-sweden-2020/1.-the-payment-market-is-being-digitalised/why-are-people-in-sweden-no-longer-using-cash/cash-is-disappearing-faster-in-sweden-than-in-other-countries/ cashless society Cash is disappearing faster in Sweden than in other countries Countries with the lowest percentage increase of cash in circulation between 2009 and 2019.

33. Banknotes and coins in circulation https://www.riksbank.se/en-gb/statistics/statistics-on-payments-banknotes-and-coins/notes-and-coins/ Counterfeit banknotes discovered

34. https://digital-decade-desi.digital-strategy.ec.europa.eu/datasets/desi/charts digital economy and society index (DESI) 2023 dashboard for the Digital Decade

35. payments https://www.riksbank.se/en-gb/payments--cash/payments-in-sweden/payments-in-sweden-2019/

36. Card fraud risk is low . Most card frauds take place in cross-border online payments (Card Not Present frauds), where card details may have been stolen in a data security breach. The risk of fraud is greatest in Card Not Present payments outside the EEA area . https://www.ecb.europa.eu/pub/cardfraud/html/ecb.cardfraudreport202008~521edb602b.en.html#toc12

37. ensure Swedish public has access to central bank money provide a payment infrastructure and increase payment system resilience provide a means of payment primarily between households and firms, accessible 24/7 to process real-time payments e-krona use of paper cash is quickly dwindling retail payments developments no domestic infrastructure for retail payments due to global card schemes, pan-European clearing and the ECB’s trend towards multi-currency settlement systems

38. https://www.riksbank.se/en-gb/payments--cash/e-krona/e-krona-reports/e-krona-project-report-2/

39. https://www.riksbank.se/en-gb/payments--cash/e-krona https://www.pymnts.com/cash/2024/swedens-central-bank-proposes-rules-to-facilitate-use-of-cash https://www.bis.org/about/bisih/locations/se.htm suggestions to follow

40. Comprehend the Catalysts: Recognize the underlying factors that drive digital transformation within the central banking system. CBDC Pros and Cons: Assess the potential advantages and challenges associated with Central Bank Digital Currencies (CBDCs). key takeaways

41. Do you believe CBDCs are the future of money? Why or why not? What are some potential use cases for CBDCs beyond traditional payments? What potential impact could CBDCs have on the role of commercial banks? How can policymakers balance the benefits of CBDCs for financial inclusion with privacy concerns? How can central banks ensure the cybersecurity and resilience of CBDC systems? discussion

42. Central bank digital currencies: an opportunity for the monetary system (19:37 min) https://tinyurl.com/5ar2kx3h Cryptocurrencies - The future of money? (42:47 min) https://tinyurl.com/x8jwyr98 Discovering Solid Legal Foundations for Central Bank Digital Currencies (CBDC) (6:53 min) https://tinyurl.com/2p9jh93z to learn more Ozturkcan, S., Senel, K., & Ozdinc, M. (2022). Framing the central bank digital currency (CBDC) revolution. Technology Analysis & Strategic Management . Advance online publication. https://doi.org/10.1080/09537325.2022.2099261 Ozturkcan, S. (2021). Conceptualizing consumer paradoxes towards the central bank digital currency (CBDC) in the context of COVID-19 . Paper presented at the AIRSI2021 Conference: Technologies 4.0 in Tourism, Services & Marketing , 12-14 Jul 2021, University of Zaragoza, Spain, pg. 62-68. Ozturkcan, S. (2021). Central bank digital currency in the context of COVID-19: What the future holds for marketers and consumers? Paper presented at the Annual Conference of the Academy of Marketing: Reframing Marketing Priorities , 5-7 Jul 2021, Online . Ozturkcan, S., Kasap, N., Ozdinc, M., & Tanaltay, A. (2019). Digital national currency: Example of Sweden and e-Krona . Paper presented at the 2nd International Conference on Digital Innovation, Entrepreneurship and Financing , 2-3 Dec 2019, Valencia, Spain.

43. S elcen O zturkcan, Assoc. Prof. of Business Administration , Linnaeus University, Sweden [email protected]