Why central banks need to engage the private sector on CBDCs

Companies can help policymakers evaluate technology choices and design incentives to foster innovation and competition.

Private enterprises will be critical to the success of CBDCs

As more governments consider launching a central bank digital currency (CBDC), they face many important questions: Why create a digital dollar, euro, or rupee? What technology best fits that purpose? How might a CBDC affect competition in the market?

Policymakers also need to think about another vital question: How to engage the private sector to partner in the project?

Private enterprises will be critical to the success of CBDCs, especially ones intended for retail use, we show in a joint research paper with Amazon Web Services (AWS). They have the technological expertise to help design, build, and manage a new digital currency, whether in partnership with the central bank or on an outsourced basis. Private firms also have ongoing connection to businesses and consumers to deliver CBDC services effectively and innovate in response to market signals.

To get the full benefits of that expertise, central banks should give the private sector an early seat at the table when evaluating technology design choices. Private enterprises can provide valuable insight into the kind of incentives and business models that can foster innovation and competition in financial services and ensure the system’s maintenance, resilience, and continued enhancement. Central banks can help by providing as much clarity as possible about the requirements firms may face.

Where the private sector can play

Most central banks considering a digital currency envisage a two-tier system in which private firms play a critical role in distributing a CBDC to the public and serve as a gateway for accessing the system. Many types of firms may be interested in this role, including commercial banks, payment processors, fintechs, telecom operators, and large merchants.

At a minimum, a distributor will serve as a gateway for accessing the system.  However, the private sector also could play other major roles: managing the currency’s core ledger and processing infrastructure, creating and managing accounts for end users, and providing payment services.

Distributors, especially those playing a role in infrastructure, will need to invest in technology and fulfill regulatory requirements around operational resiliency, data protection, and cybersecurity. Those demands may be high, but such standards also create barriers to entry that limit competition. Policymakers will want to closely monitor the market to strike the right balance between protection and competition.

Distributors also can play a role in managing accounts for end users. At a minimum, they would need to authenticate users’ identities and perform know your customer (KYC) checks to open accounts. This may be sufficient if policymakers want to enable individuals to have more autonomy in managing their accounts and taking custody of their assets in non-custodial wallets.

Alternatively, policymakers may want to let distributors have custody of user funds and process their transactions. That could provide users with some recourse in case of errors or loss of wallets. It also would reduce the load on the core system, which would have to process only distributor-level transactions.

Payment services can be performed by distributors or non-distributor firms. These customer-facing services include user interfaces such as a mobile app, merchant services, customer support, and other value-added functionality, potentially including programmable payments. These services are the main way that consumers will experience the use of a CBDC, so it’s vital that they work effectively and that service providers respond to evolving market demands to encourage widespread use.

How incentives and design can foster innovation and competition

CBDCs may be prone to network effects just like existing technology platforms in areas like social media, search, and e-commerce. Central banks need to be mindful of these potential effects and look to embed mechanisms and incentives into any CBDC system that can foster continuous innovation and competition.

The aim should be to encourage distributors and non-distributor payment services providers to innovate within the system rather than outside it. If the latter occurs, it could steer growth and data flows into privately owned silos, impeding interoperability across the system and exacerbating winner-take-all dynamics.

One possible way of encouraging innovation within the CBDC system would be to give distributors a clear ownership stake in the core processing system. That would give them an incentive to ensure that the system adapts to meet changing demands from the market. Yet an ownership stake also could have adverse effects, such as enabling distributors to make self-serving changes to core processing functions or to create frictions for payment service providers. Central banks will want to guard against any such anti-competitive behavior.

Policymakers should seek to maintain low entry barriers for firms looking to become non-distributor payment service providers. That can help encourage innovation, more inclusive finance, and good integration with other payment systems. Decisions about how much autonomy individuals should have to control their funds without relying on a distributor can have a big impact on competition as well. A system that enables users to directly control their funds through non-custodial wallets, for example, may make it easier for users to change distributors, and encourage payment services providers to attempt to grow their market share by providing innovative and competitive services.

Central banks must make numerous decisions as they consider whether and how to launch a CBDC, but the ultimate success of any project will depend in large part on the participation of a broad set of stakeholders, including the private sector. That’s why policymakers should work proactively with industry, technologists, and civil society to build scenarios that can help them assess likely market dynamics, and to design a digital currency system that can evolve over time.

About the author

Larissa de Lima is a senior fellow with the Oliver Wyman Forum and co-leads the Future of Money initiative. The Oliver Wyman Forum is a think tank of international consulting firm, Oliver Wyman.