Explainer: Central banks eye digital cash to fend off crypto threat

By Francesco Canepa and Tom Wilson
FRANKFURT / LONDON (Reuters) - The world's largest central banks - and even some of the smaller ones - are playing with the idea of ​​issuing digital currencies.
These would enable owners to make payments over the internet and possibly even offline, which competes with existing electronic payment methods such as digital wallets, online banks or cryptocurrencies.
In contrast to these private solutions, an official digital currency would be supported by the central bank, which makes it "risk free" like banknotes and coins.
While most projects are still in the early stages, they moved up a gear last year after Facebook Inc <FB.O> announced plans to create its own virtual token and the COVID-19 pandemic boosted digital payments .
A group of seven central banks coordinated by the Bank for International Settlements set out on Friday how a digital currency could work.
We know the following so far:
WHAT IS A CENTRAL BANK DIGITAL CURRENCY?
Central bank digital currency (CBDC) is the electronic equivalent of cash.
Like a banknote or coin, it gives its holder a direct claim on the central bank, bypasses commercial banks, and offers a higher level of security as a central bank can never run out of the currency it issues.
Access to central bank money beyond physical cash has previously only been reserved for financial institutions. Extension to the general public could have significant economic and financial implications.

WHY DO WE NEED IT?
Authorities say a CBDC would become a basic means of payment for all at a time when cash consumption is decreasing. It would also provide a safer and potentially cheaper alternative to private solutions.
Their main fear is losing control of the payment system when private currencies like Bitcoin or the Libra proposed by Facebook are rampant.
This could make it difficult for authorities to detect money laundering and terrorist financing, but it could also weaken the influence of central banks on the money supply, which is one of the main ways in which they control the economy.
For many emerging economies, where a larger proportion of the population is bankless, a CBDC could be a way to promote financial inclusion and expand the reach of central bank monetary policy.

WHAT WOULD A DIGITAL CURRENCY LOOK LIKE?
The views differ here.
A CBDC can take the form of a token stored on a physical device such as a cell phone or prepaid card, making it easy to transfer offline and anonymously.
Alternatively, it could be on accounts managed by an intermediary such as a bank, which would help the authorities monitor it and possibly reward it with an interest rate.
While the idea of ​​a CBDC was born in part in response to cryptocurrencies, there is nothing to say it should use blockchain, the distributed ledger technology (DLT) that powers these tokens.
People's Bank of China said their digital yuan would not rely on blockchain.

WHICH CENTRAL BANKS LEAD THE WAY?
People's Bank of China aims to be the first to issue a digital currency in order to internationalize the yuan and reduce its reliance on the global dollar payment system.
According to local media reports, large state commercial banks are conducting extensive in-house testing of a digital wallet application.
Some private companies, like China's largest ridesharing app, Didi Chuxing, are also taking part in tests.
In Sweden, already the world's least cash-dependent economy, the Riksbank has also started testing an e-krona.
The European Central Bank and the Bank of England have both launched consultations on the issue, while the Bank of Japan and the Federal Reserve have so far taken a back seat.

WHAT ARE THE RISKS?
Central banks fear that massive migration to the CBDC would undermine commercial banks and deprive them of a cheap and stable source of funding such as retail deposits.
In a crisis this would leave them vulnerable to a run in their coffers as customers would prefer the security of a central bank guaranteed account.
Because of this, most designs put a cap on how much each consumer can hold CBDC, and possibly even a lower compensation to make it less attractive.

WHO IS BEHIND THE TECH?
Some central banks have hired large consulting firms to develop pilot projects. For example, the Swedish Riksbank has teamed up with Accenture Plc <ACN.N> to carry out tests on their E-crown.
Others, mostly in smaller countries, have tapped into cryptocurrency and blockchain startups.
Lithuania turned to Gibraltar-based blockchain company NEM to issue the first CBDC in the euro area.
The Bahamas hired local tech company NZIA to design and implement its Sand Dollar CBDC platform, while the Marshall Islands turned to New York-based blockchain company SFB Technologies.

(Reporting by Francesco Canepa and Tom Wilson; additional reporting by Alun John in Hong Kong, Leika Kihara in Tokyo, Bill Schomberg in London, Colm Fulton in Stockholm; editing by Lisa Shumaker)

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