8 highlights of Canada’s central bank digital currency plans

The Bank of Canada is looking at how CBDC can drive innovation in all financial services.

Canada's central bank has no plans to launch a central bank digital currency (CBDC), but it does plan to be able to launch one.

"The Bank [of Canada] currently has no plans to launch a CBDC," it says. "Rather, the Bank will build the capacity to issue a general purpose, cash-like CBDC should the need to implement one arise. Because it will take several years to build this capacity, the Bank cannot wait until the need is evident before launching preparatory work."

There are two main scenarios which could render CBDC necessary, it says.

• The first is if cash use continues declining to a point where Canadians are no longer able to use them for a wide range of transactions.
• The second is if alternative digital currencies, such as cryptocurrencies, privately-issued stablecoins like Libra or foreign central bank digital currencies, become widely used as alternatives to the Canadian dollar.

"Either scenario could materialize very quickly, warranting vigilant attention to evolving developments in payments. Because of this and given the time required to create a viable CBDC, the Bank has decided to pursue a contingency strategy designed to create a state of sufficient policy and operational readiness to launch a CBDC relatively quickly should that decision be made," the Bank says.

This carefully-planned tack means there are a number of notable things to pick out of the Bank's digital currency plans. Here are eight of them.

1. It's being deliberately designed for an unknown release date

The Bank of Canada's central bank digital currency, which we'll just call the Maplebuck for brevity's sake, could be rushed into existence two years from now, or it might not be released for another decade.

This variability means the Bank has to build a digital currency without knowing whether people will be mostly paying with phones, smartwatches or chips implanted in their brains, whether cash is still being used, what Canada's Internet coverage is like, whether DeFi has taken off, how widely used blockchain will be in payments, and so on.

That's a tall order.

One of the ways the bank is adapting to this is by specifically looking at designs that minimise interdependency between front-end interfaces, and core technologies on the back-end.

This is because "core technologies, such as Internet protocols and server hardware, evolve very slowly once they become pervasive", while "end-user interfaces tend to evolve much more quickly" the Bank says.

The Maplebuck and its modular design will evolve over time through a series of experimental pilot projects.

2. The central bank can use CBDC to increase competition and spur innovation in financial services

One thing the central bank will have to do after printing Maplebucks is to ensure that they arrive in the hands of the general public.

How you do that has profound impacts on banking services and financial innovation in a country. You could, as China is reportedly planning to do, issue the digital currency to commercial banks which can then make it available to customers. This is essentially the way money is currently distributed.

"One business model to consider is the current approach to producing and distributing banknotes: a public-private mix involving partnerships with security feature providers, banknote printers, regulated financial institutions and others," the Bank of Canada says. "However, other business models may be viable and offer advantages in a digital era with consumer expectations of innovation."

The Bank cites a working paper suggesting that, by distributing digital currency through more participants than just commercial banks, a central bank can introduce more competition and innovation to financial services.

"By offering a token-based system to a wider set of participants, which could include individuals but most likely new financial firms, central banks could increase competition and spur innovation. Although this could have been done even before by opening the high-value payments systems to non-traditional financial institutions, the new technologies make the entrance of the central bank a real possibility," the paper says.

3. The Bank is more worried about competition from other CBDCs than cryptocurrencies

One of the triggers for the Bank of Canada to go ahead and release the Maplebucks is if alternative currencies start substantially replacing the Canadian dollar domestically. But it probably won't be cryptocurrency that does it, the Bank says.

"There is little chance that Bitcoin and other similar cryptocurrencies will play a large role in Canadian payments due to their high transfer costs, lack of scalability and unstable purchasing power," it observes.

Stablecoins are "perhaps a more plausible disruptor" it says, but they only solve the volatility problem, while leaving the other two.

Libra was one of the most credible instances where a "ready-made platform, with an established network of users, could quickly establish a measure of confidence and global footprint. A similar scenario could arise if a CBDC issued by a foreign central bank had extensive cross-border use in Canada."

In the absence of another Libra, most countries might get their first real digital currency competition from another country's CBDC leaking into everyday use via cross-border payments.

4. The Bank will need to make a compelling case for CBDC issuance to the government

The Bank of Canada does not have the legal authority to issue CBDC. This is probably the norm among central banks, most of which still aren't sure whether or not they have the legal authority to issue a CBDC, according to the latest BIS central bank survey.

Some uncertainty is still present though, and the Bank expects it will need to make a compelling case to the government in order to obtain that approval.

"Government policy support for a CBDC would be required to provide the Bank clear legal authority to issue the CBDC," it says. "This implies that the case for a CBDC would need to be not only valid but also straightforward, compelling and compatible with other government priorities."

For the central bank to release a digital currency, it needs to have a compelling case for doing so.

5. The bank will be educating the public on CBDCs and soliciting feedback

The correct form of CBDC will be something users will actually adopt. This means simultaneously educating the public on CBDCs, and learning what the public wants from a currency.

"The Bank will also need to understand the priorities of Canadians with respect to their currency," it says. "The next rounds of consultations will aim to educate the public about a CBDC and its differences from other forms of digital money, to understand their preferred currency traits and model attributes and to gather their views on the possible adoption of a CBDC."

This is important, because Maplebucks need to be a competitive product in order to see uptake, and although we don't often think of money that way, different people actually have very different money needs and preferences.

Someone living hand-to-mouth can't afford to wait two days for their pay cheque to arrive so they need fast money. Different countries have different norms around privacy and public displays of wealth, which may affect how anonymous a currency should be and what it's like to use; merchants don't want chargeback functionality but shoppers do; a country with a large unbanked population needs a system that ropes in non-bank financial services and so on.

A really good example of how central bank digital currency design can benefit from consumer feedback is visible in the design of the Bahamian Sand Dollar CBDC. There, one of the first steps in designing the new digital currency was to understand why cheques are so popular in the Bahamas, because that tells you what people want from money.

And now it's Canada's turn. This is also a great time to imagine focus groups reacting to different currencies.

"Oh, I don't like the bolívares soberanos – I'd want something with a bit more spending power," one respondent says. "And I've never liked spicy food," they add.

"Queen Elizabeth looks... annoyed," muses another participant, squinting at a banknote. "Do you have something a bit more fun?"

"We hear you," a Bank of Canada rep says. "And we think you folks are gonna love this!" With a flourish, he pulls a cloth off a pallet of Chuck-E-Cheese tokens. The focus group gasps approvingly.

6. The currency needs to be a competitive product

The consumer feedback is part of designing a competitive product, and it probably does need to be thought of as an actual product, the Bank of Canada says. The product needs a set of functions to support government policy in order to get legal approval, and it also needs to be something consumers actually want.

"A successful CBDC would need wide public adoption and government support. In fact, to meet the policy objectives of providing universal access and improving resilience, acceptance of the CBDC would need to be near complete," the Bank says. "The product would therefore need to be competitive relative to alternative methods of payment in terms of access, convenience, safety, versatility, portability, ease of use and cost."

"Unique features in terms of being risk-free, functioning off-line and being available to everyone will help drive public demand relative to private sector services. This will require careful design and implementation choices."

It's also worth noting that, if history is any indication, any released CBDC will continue changing and innovating over time. After all, the current generation of central bank money – banknotes – are in constant change. Australia was the first country to introduce polymer banknotes in 1988, and they're still being gradually introduced around the world. As recently as 2017, Australia updated its $10 note, adding raised bumps to make them more friendly to visually-impaired people and adding a new transparent window to better deter the latest generation of counterfeiting technology.

Two likely areas for future evolution are the way CBDC can or can't earn interest, and how private it is.

This is because...

7. In its initial form, the CBDC can't be allowed to out-compete bank deposits

For the sake of financial stability, the Bank of Canada would much prefer it if Maplebuck holdings didn't take the place of commercial bank deposits.

Firstly, because a bank run on the central bank itself would be quite devastating, if unlikely. Secondly, because volatile Maplebuck inflows and outflows could trigger unwanted shifts in the central bank's balance sheet, causing almost Libra-like financial stability concerns.

And thirdly, because customer deposits are an important source of funding for commercial banks. If Maplebuck holdings start replacing consumer bank deposits, those banks might have to "resort to more expensive and fragile forms of funding to replace funding from deposits," the Bank of Canada says, which could cause "adverse financial stability consequences."

In extreme cases, this could lead to wild, purely theoretical scenarios like banks pouring money into mortgage-backed securities during a housing bubble.

Either way, the Bank of Canada would prefer for the nation to keep their money in commercial banks for now.

However, this is also an opportunity. Canada's banking system is sufficiently robust to tolerate a mild shift from commercial bank deposits to CBDC, it muses. So when these shifts occur it can prompt commercial banks to start offering better rates, or improve their services, in an effort to claw back their customers.

"Banks will need to be prepared to take these steps whether or not a CBDC is issued because other developments are likely to increase competition for deposit funding and payment services in Canada," the central bank says. "These developments include payment system modernisation, new policies on access to consumer data and new competition from technology-focused financial companies."

As such updating the CBDC by slightly bumping up its ability to earn interest, central banks could encourage commercial banks to raise the bar, preparing them for mandatory fintech innovation.

Initially though, the "CBDC would be designed to limit its attractiveness as a competitor for bank deposits," the Bank of Canada says. "To achieve this, it would resemble cash in its attributes and would not earn interest."

The level of privacy offered by the Maplebuck could similarly be subject to change.

8. The Maplebuck will be more private than card, but less anonymous than cash

"While a degree of privacy is a core attribute of money, it would almost certainly be unacceptable for a CBDC to provide a cash-like degree of anonymity," the Bank says. "For example, if a CBDC were implemented as a public, permissionless blockchain, it could be a vehicle for abusive transactions, facilitating money laundering, terrorist financing, criminal activity and tax evasion."

"So, a CBDC could be designed to implement a form of privacy rather than cash-like anonymity, allowing it to satisfy anti-money laundering, anti-terrorist financing and other regulations that require disclosure of certain kinds of private information."

It's not yet clear exactly how to do this, the bank says, but "our initial research indicates that it would be possible to achieve both a high degree of privacy and well-controlled disclosure of information, for example, only with the presentation of a court warrant."

The exact type of privacy a CBDC provides is likely, as in guaranteed, to change over time.

This is because privacy technology is a rapidly-evolving area, which hinges on developments in myriad other areas such as cryptography, computing, cybersecurity and more, all of which intersects with equally fast-moving areas like digital identity and regtech. There will always be room for improvement, and evolution will be necessary in the arms race of privacy.

AML/KYC regulation is in a similar state of flux, and these changes may require the same flexibility from CBDC.

And if it all goes horribly wrong, and CBDC ends up ushering in a new era of digital authoritarianism, privacy coins might eventually come out of the shadows and have their day in the sun... so to speak.

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Disclosure: The author holds BNB, BTC at the time of writing.

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