Digital Currencies - Challenges in the Implementation of CBDC

Details

• Authors: Lorent Shabani
• Title: The Emergence of Central Bank Digital Currencies - "An Exploration of Motivations and Implications"
• Supervisior: Prof. Dr. Jörg Osterrieder
• Degree: Bachelor of Science
• University: University of Applied Sciences Bern, BSc Business Administration
• Year: 2023
• Status: Working Paper

Summary

This thesis aims to investigate the development, motivation, and implementation of Central Bank Digital Currency (CBDC) through a comprehensive literature review. It will analyze existing research and publications to assess the potential advantages and disadvantages of CBDC, while exploring associated risks such as financial stability, monetary policy, and security concerns including cyberattacks and data protection. The main research question of the thesis focuses on central bank motivations, and several sub-questions will support the analysis, addressing security risks, privacy challenges, the impact on financial stability and monetary policy, as well as the current state of CBDC development globally. Key findings from the literature review indicate that the development of CBDCs is driven by factors such as the declining use of cash, the emergence of decentralized cryptocurrencies, the pursuit of financial inclusion, and the desire to improve payment systems and monetary policy execution. However, a balanced and well-regulated approach is crucial for successful CBDC implementation. Further research, collaboration, and policy formulation are necessary to fully leverage the benefits of CBDCs while mitigating associated challenges and risks. CBDCs offer several advantages that can reshape financial systems and enhance economic activities. CBDCs hold a significant advantage in promoting financial inclusion by bridging the gap between traditional banking systems and underserved populations. Through their widely accessible digital currency, CBDCs provide individuals who lack access to traditional banking or have limited banking options with the opportunity to access financial services, thereby fostering greater financial participation and empowerment. Moreover, CBDCs can revolutionize payment systems with immediate settlements, efficient peer-to-peer and cross-border transactions, improving speed, convenience, and cost-effectiveness. Nevertheless, CBDCs present risks that require careful management. Financial stability concerns arise from the potential for digital bank runs during economic uncertainty. Security and privacy risks include cyber threats and data breaches. Robust security measures and privacy regulations are crucial to protect against unauthorized access and preserve user privacy while complying with anti-money laundering requirements. The design and implementation of CBDCs should consider potential impacts on monetary policy, interest rates, and other factors. Research and analysis are necessary to address any unintended consequences on financial systems and economic stability. The global status of CBDCs varies, with some countries making significant progress while others are in the early stages of exploration. Continued research, collaboration, and monitoring are essential to inform the design, implementation, and regulation of CBDCs.

Data

1. Introduction 1.1. Background and Motivation Digitization is increasingly affecting various areas of our lives, and money or the financial sector is no exception. The rapid technological progress and new digital business models have led to many innovative products in payment transactions in recent years. The quick shift in focus from fintech to cryptocurrencies and then to digital central bank currencies shows that the digital financial landscape is changing very rapidly (Ozili, 2022a). These developments in recent years have led to a growing number of electronic payment methods that are available to consumers for everyday transactions, which raises questions for policymakers about the role of the public sector in providing a digital payment instrument for the economy. Although cash is still widely used, the way people pay and manage money is being transformed. The COVID-19 pandemic may have also accelerated this shift towards cashless transactions. Private companies currently dominate the digital payment landscape, which has led central banks to seek ways to ensure that the public can still access legal tender if cash becomes less prevalent. One solution gaining momentum is the Central Bank Digital Currency (CBDC). However, it is crucial to fully understand the risks, benefits, and costs associated with CBDCs, as they could have implications for privacy and macroeconomic factors. These implications could blur the lines between payment and financial systems, challenging the fundamental functions of our economy and society. To continue effectively fulfilling their core functions in a changing environment, an increasing number of central banks are exploring the introduction of digital central bank currencies. Looking at the international market, it is noticeable that the first pilot projects for digital central bank currencies have already begun. Digital central bank currencies are expanding existing payment instruments in countries such as Sweden, China, and the Bahamas. At the same time, other economic regions are deciding to recognize existing cryptocurrencies, such as El Salvador's acceptance of Bitcoin, as legal tender (Alvarez, Argente, & Van Patten, 2022). However, the implementation of CBDCs raises significant concerns regarding monetary policy, financial stability, and privacy, among other factors, which must be carefully addressed prior to their adoption.

1.2. Objective and Research Question The implementation of Central Bank Digital Currency (CBDC) offers significant social and economic advantages, making the question of whether they will be introduced irrelevant. According to CBDC Tracker (2023), fifteen pilot projects are now being carried out globally, with China leading the way due to its large economic importance. The US central bank is still investigating the advantages and disadvantages of CBDC, while top regional banks and central banks from numerous nations continue their ongoing research. The European Investment Bank (EIB) has issued the first-ever digital bond using blockchain technology to prepare for the digitalization of financial markets, selected as part of the CBDC sphere by the Banque de France (EIB, 2021). However, the introduction of CBDC must be closely monitored by central banks, as it may threaten monetary sovereignty. Despite ongoing research, many questions regarding the design of digital currency remain unresolved, and regulatory frameworks are uncertain.

The objective of this thesis is to delve into the development, motivation and implementation of Central Bank Digital Currency (CBDC) while conducting a comprehensive analysis of its potential advantages and disadvantages. Furthermore, the research will thoroughly evaluate the associated risks of CBDC implementation, encompassing financial stability, monetary policy implications, and security concerns such as cyberattacks and data protection. The primary aim of this study is to offer valuable insights into the future of money by thoroughly examining the impact of CBDC on the financial industry, encompassing both its potential benefits and drawbacks. To achieve this, ongoing retail CBDC projects initiated by central banks worldwide will be carefully examined to gain a deeper understanding of the driving forces behind their development.

Therefore, the aim of the thesis is to answer the following research question: • What motivates central banks to develop or introduce their own digital currencies?

The thesis is also supported by a some sub-questions that aid in addressing and resolving the main research question: • What are the security risk and privacy challenges associated with CBDC? • What is the impact on the financial stability and monetary policy • What is the current state of CBDC adoption and development worldwide?

1.3. Thesis Method In the thesis, a thorough literature study will be conducted to define and clarify the basic concepts and terminology linked to CBDC and to offer an overview of the most recent research based on theoretical foundation. Using a series of four pre-made questions, specific elements will be focused on, and findings from relevant academic articles and case studies will be presented. The three additional questions will augment and support the major question, which will serve as the central investigation of the thesis.

Due to the speculative nature of the topic, qualitative research is well-suited for obtaining in-depth information about research results. Qualitative research offers several advantages, including adaptability, use of natural settings, production of fresh ideas, and valuable findings. However, it can also have disadvantages such as unreliability, subjectivity, limited generalizability, and labor-intensity. To address these limitations, the data for this thesis was carefully selected according to specific criteria. The data had to be created by a reliable and professional entity and based on current scientific research. Primary sources were used in the study, while secondary sources were used for matters that are considered common knowledge. The research approach for this thesis is qualitative and does not involve a hypothesis.

The literature review aims to offer a comprehensive understanding of the subject, identify potential research gaps and requirements, and establish the groundwork for future research and practical applications. It presents concise and reliable information about digital currencies and their relationship with the financial sector, drawing on academic articles from reputable sources. To grasp the research topic fully and appreciate the potential impact of various factors on the findings, it is essential to familiarize oneself with the fundamental theories and concepts of finance. Moreover, gaining insights into the historical trends of each aspect can provide readers with a more profound comprehension of the subject matter.

2. Theory 2.1. Definition of Currency Within a particular nation or region, currency is a standardized type of money that is extensively used as a medium of exchange for goods, services, and debts. Its main goal is to encourage trade by giving buyers and sellers a common unit of value to indicate the price of goods and services. It can take on many different forms, such as coins, paper notes, and digital money. Bartering was the first method of trade thousands of years before the invention of money. As a method of trade, however, it has drawbacks since it necessitates a double coincidence of demands, where both parties must possess what the other wants, and it is difficult to divide or transfer. The necessity for a standardized medium of exchange increased in importance as societies got more complex, prompting the creation of currency. The use of metal as a medium of exchange can be traced back to the Babylonian civilization. However, the standardization and certification of currency through the minting of coins took place in the 7th century BC, with Lydia producing the first recognizable coins. Over time, the development of paper money and the widespread use of banknotes in the 18th and early 19th centuries paved the way for credit cards introduction in the 1950s, followed by online payments, mobile payments, and virtual currencies in the 21st century (ChatGPT, personal communication, 10th February 2023). Adam Smith, regarded as the father of modern economic theory, proposed in his seminal work that barter was the prevailing form of exchange in pre-money societies (Strauss, 2016). While Strauss challenges Smith's theory of solely barter-based societies with historical evidence, bartering has indeed existed historically and continues to be practiced today (Ammous, 2018). However, Jevons (1898) argued that the inherent challenge of a "double coincidence of wants" renders direct barter exchange impractical. Thus, for goods and services to be exchanged, both parties must desire the exact items or services that the other possesses (Kasper, 2017). Furthermore, determining the value and divisibility of exchanged commodities poses additional challenges. Therefore, a barter-based system without a common medium of exchange would only be viable in early-stage economies (Issing, 2011). Larger economies provide greater opportunities for specialization and exchange, but the problem of coinciding desires becomes more pronounced (Ammous, 2018). According to Issing (2011), the current form of specialized economies is made possible by the use of money as a medium of exchange. From a macroeconomic perspective, an asset qualifies as money or currency if it performs three essential functions: serving as a standard unit of account for stating the value of other goods and services, functioning as a store of value, and being widely accepted as a liquid form of exchange and payment (Sixt, 2017). These three functions will be explored further in the subsequent sections.

2.2. The Functions of Money Money is a broad and adaptable concept that acts as a store of value, a unit of account, and a medium of exchange in both tangible and intangible forms. Throughout history, people have represented money with numerous physical objects such as commodities, coins, and paper, as well as non-physical forms such as account balances and digital currencies. With the growing prevalence of digital payment methods, there has been a rethinking of what constitutes money. Money's primary function is to facilitate transactions by allowing parties to trade without requiring a direct coincidence of wants, a concept known as the "double coincidence of wants." Money's fundamental functions are separated into two categories: a medium of trade and a store of value (Friedman & Meltzer, 2022). 2.2.1. Means of Exchange and Payment According to Jarchow (2010), money or payment methods are generally recognized within a nation's payment system for the purpose of purchasing goods and services or fulfilling economic obligations. The primary and most widely recognized function of money is as a medium of exchange or means of payment. In contrast, in a barter economy, individuals exchange goods directly without the use of money. This implies that a situation must occur in which two parties exchange their goods while simultaneously desiring the goods of the other. Jevons refers to this unique situation as the "double coincidence of wants" (Jevons, 1898). More fully describing the coincidence, Carl Menger distinguishes between three market, spatial, and temporal variables. According to the market determinant, there must be a specific quantity of consumers who desire a given commodity and are prepared to pay for it. To meet various requirements, this product must be available in a specific quantity and be divisible into smaller units (Menger, 1892). Factors such as the durability of the commodity, the opportunity cost of storage and foregone interest, as well as seasonal dependence, all influence its portability both geographically and temporally (Menger, 1892). Due to the need to find a suitable exchange partner, the availability of items both physically and temporally, and the transportation of goods with varying sizes and quantities, the double coincidence of wants leads to significantly high transaction costs in a barter system. The exponential growth of the number of exchange relationships (ATB) in relation to the quantity of traded items (n) serves as an example of the effort involved (Hardes, 2002).

By using a medium that is fundamentally equally valuable to everyone, the double coincidence is changed into a single coincidence. Money fulfills the purpose of this medium in a labor-divided economy. Using money as the universal barter goods drastically reduces transaction costs and streamlines transaction procedures. All currencies are accepted, making it simple to find a reliable trade partner. Space and time issues, as well as the number and size of the good money, are all gradually getting better thanks to its small, light, and portable form. The number of exchange conditions is thus only (Hardes, 2002):

In this case, money plays the role of a good (n). Money can be used to pay for taxes or settle debts, making its role as a payment method even more varied than that of a cash instrument (Issing, 2010). 2.2.2. Unit of Account The third function that money is intended to fulfill is that of a unit of account. One of the greatest difficulties in the absence of a universally recognized medium of exchange such as money is the measurement of the value of a good or product (Mill, 2009). In a natural economy, transaction costs would be enormous if the values of two goods were not standardized but resulted from the subjective value of their respective owners consideration. Moreover, this value would fluctuate greatly as it would be variable depending on the good it is to be exchanged for and the varying degrees of desire for that good. The problem of relative prices is solved by the unit of account function. With money as a universally recognized medium of payment, all goods present on a market can be related to each other and the value of each good can be expressed as an absolute price in monetary units. The accounting in monetary prices that arises from the unit of account function is the cornerstone of all forms of economic calculations in modern economics: profit and loss statements, balance sheets, the determination of the wage bill or the gross domestic product (Issing, 2010). Money as a unit of account in a specialized economy is an essential necessity for reducing specialized goods and services to a common denominator and thus making them universally comparable. The use of money can therefore be compared to the introduction of a uniform measure for length, weight, force, and others. (Issing, 2010). 2.2.3. Store of Value Another important function of money is the function of store value. It solves the temporal and spatial problems that often arise in a natural economy. For example, if a food item were used as a commodity currency in a natural economy, its value would decrease during times of high supply. However, if these resources were to become scarce, the value would increase. The value of this commodity currency would be highly volatile and therefore would not fulfill the function of store value (Jevons, 1898). With the use of money, however, it is possible to sell a good to purchase another good at a later time without the value of the medium of exchange changing. The function of store value is of great importance in a specialized economy as it allows, for the storage of purchasing power obtained from the sale of goods and services in the form of a money balance until an appropriate time arises for its expenditure (Jarchow, 2010). There are numerous other forms of asset storage such as securities, tangible assets, real estate, or land, which are very suitable for storing value. However, money has the decisive advantage of having the highest liquidity (Issing, 2010). This allows for payment obligations to be met much faster and more flexibly than, for example, through securities or tangible assets. Alternative forms of investment for store value, on the other hand, often have the advantage that they can generate profits in the form of rent, interest, or dividends and can therefore produce profits beyond the function of store value (Jarchow, 2010). However, they also carry the risk of value loss, such as natural disasters affecting tangible assets or real estate. Money's potential to serve as a store of value depends on its stability, of course. The acceptability of this good likewise decreases and ceases to serve as a store of value when the value of money drops, as might happen with inflation. This ultimately results in the loss of money's ability to serve as a medium of trade (Hardes, 2002). For instance, hyperinflation occurred in Germany following World War I. The introduction of the "Rentenmark" in mid-November 1923 to restore stability was ultimately a result of the paper mark's rapid decline in value and declining desire to exchange products for it. On that day, one "Rentenmark" was equal to one billion paper marks on November 20, 1923 (Graham, 2009).

2.3. Cryptocurrency Cryptocurrency is a digital or virtual currency that relies on encryption techniques to ensure the security of transactions and to control the creation of new units (Nakamoto, 2008). Cryptocurrencies are decentralized and operate independently of a central bank, which means that they are not subject to government or financial institution regulations. In addition, all cryptocurrency transactions are recorded on a public ledger called a blockchain, which allows for transparency and accountability (Swan, 2015). According to The State University of New York users can store and manage their cryptocurrencies using cloud-based crypto wallets that can be accessed from a desktop or mobile device (Oswego State University of New York, n.d.) Cryptocurrency is a relatively new innovation, but the concept of digital currency can be traced back to the 1980s. David Chaum, an American computer scientist, developed a digital currency system known as "e-cash" in 1983 (Chaum, 1983). However, it wasn't until the introduction of Bitcoin in 2008 that the idea of a decentralized digital currency began to take shape. The founder of Bitcoin, who used the pseudonym Satoshi Nakamoto, published a paper outlining the concept of a peer-to-peer electronic cash system that operated without the need for a trusted third party (Nakamoto, 2008). According to recent data, cryptocurrencies have seen significant growth in popularity and number in the past decade (Feder et al., 2018). As of May 2023, the total number of cryptocurrencies listed on CoinMarketCap is over 12,000, with a total market capitalization of around $2 trillion USD (CoinMarketCap, 2023), see the market cap percentage in Figure 1 on the next page (Pavithra, 2023). However, it's important to note that many cryptocurrencies are either worthless or have no active movement, with around 4,000 active cryptocurrencies after removing the "dead" ones (CoinMarketCap, 2023; Feder et al., 2018). The blockchain system is made up of blocks, which are individual records, and a chain, which is a collection of records that form the complete ledger. As transactions occur, computers on the network authenticate these blocks and the resulting chain. Rather than relying on a single, centrally managed large database, the goal of blockchain is to safeguard data integrity in a decentralized manner. The technology offers two main features: embedded privacy protections and data integrity safeguards (Crosby et al., 2016; Swan, 2015). Blockchain technology, which serves as the foundation of cryptocurrencies, relies on encryption to guarantee the security and legitimacy of transactions. It uses distributed ledger technology along with several procedures to validate transactions. The blockchain is a decentralized digital ledger, which is stored on numerous nodes and contains a complete history of all past transactions. As new transactions take place, the data is chronologically updated to form an incremental chain of records. The ledger's history is openly distributed to all blockchain users, providing them with equal access to the latest data updates (Zohar, 2015; OECD, 2018). Despite being called "cryptocurrencies", these digital assets do not function as traditional forms of money. Cryptocurrencies have not yet fulfilled the necessary functions of money, such as serving as a reliable medium of exchange, a store of value, and a unit of account Moreover, the absence of central control, support, and regulation makes it uncertain if cryptocurrencies will be accepted as legal tender or if they can be easily converted to traditional currency (Thiele, 2018). The Bank for International Settlements (BIS) also stated that cryptocurrencies cannot be considered currencies as they lack a stable value and widespread acceptance as a medium of exchange (BIS, 2018a).

Even stablecoins, which use comparable technologies to attempt to provide less volatile digital assets, are not as stable as they advertise. The unique promise given by a private corporation serves as the foundation for a stablecoins value (ECB, 2022a). Furthermore, no central entity is backing or managing these assets. There is no assurance that you will be able to convert them into cash in the future. This is why some countries and institutions are exploring the possibility of issuing central bank digital currencies (CBDCs), which can offer the benefits of blockchain technology while maintaining stability and legal recognition (Panetta, 2022).

2.3.1. Characteristics of Virtual Currencies A new platform for the sale and promotion of commodities has been introduced since the internet first appeared in the late 20th century (He et al., 2016). A number of innovative technologies have emerged in the area of online payment systems, along with the growth of internet-based e-commerce and the use of mobile devices. While networks like PayPal offer a platform for safe online payments made in fiat money (inconvertible paper money made legal tender by a government decree), some other networks have taken things a step further by establishing their own currency-like unit that is traded on their platform (He et al., 2016). According to Dabrowski & Janikowski (2018) and He et al. (2016), virtual currency is a digital form of money that is created by private developers and predominantly circulated globally with few to no constraints. Virtual currencies have developed as a substitute form of payment for goods and services, especially in online communities like gaming platforms and websites (Segendorf, 2014). These virtual currencies differ from one another in terms of how easily they can be exchanged for commodities, services, national currencies, or other virtual currencies (He et al., 2016). According to Segendorf (2014), closed currency systems are virtual currencies that may only be earned and used on a single platform and which are not exchangeable for fiat money. Contrarily, convertible virtual currencies allow for the bidirectional exchange of virtual currency units for other assets, making it possible to buy the currency with fiat money and sell it for the same (Segendorf, 2014; He et al., 2016). Another method to group virtual currency schemes is according to their centralized or decentralized systems. In a centralized system, a single entity is in charge of verifying and carrying out transactions, whereas in a decentralized system, this responsibility is shared among the network's participants (Segendorf, 2014). The creation and enforcement of rules, as well as the issuance and redeemability of virtual currency, are additional crucial tasks that can either be carried out centrally by a dependable party or decentralized by all participants (He et al., 2016).

2.3.2. Differences between CBDC and Cryptocurrencies Cryptocurrencies and central bank digital currencies (CBDCs) are both digital forms of money, but they differ significantly in a number of ways. First of all, unlike cryptocurrencies, which are decentralized and not guaranteed by any central authority, CBDCs are issued and supported by a central bank. This means that while cryptocurrencies are completely independent of central banking institutions and are not subject to government restrictions, CBDCs are and can be used to undertake monetary policies like interest rate adjustments (ChatGPT, personal communication, 15th March 2023). The degree of anonymity that CBDCs offer is another distinction between them and cryptocurrencies. CBDCs are made to be traceable, and the central bank or other authorized organizations can access transaction data. However, because transactions are recorded on a public ledger and users identities are not always made public, cryptocurrencies offer a higher level of anonymity (Crosby et al., 2016). Cryptocurrencies and CBDCs also have different underlying technologies. The restrictions on CBDC networks are set by a central bank. On crypto networks, decision-making power is given to the user base, which reaches consensus through voting (The Shrimpy Team, 2023). The goal of each is another distinction between CBDCs and cryptocurrencies. By giving people and businesses a safe and affordable payment option, CBDCs are primarily made to increase the effectiveness of payment systems and promote financial inclusion. Contrarily, cryptocurrencies were first created as a rival to conventional money, with an emphasis on decentralization, security, and anonymity (Swan, 2015). In conclusion, while both CBDCs and cryptocurrencies are digital forms of money, they vary in terms of their foundation, laws, degree of anonymity, underlying technology, and goals.

2.4. Central Bank Central banks are public institutions responsible for managing a country's currency and monetary policy, with the main objective of maintaining price stability, supporting employment, and promoting sustainable economic growth. According to the European Central Bank, central banks are distinct from commercial banks as they do not offer services to the general public and are not-for-profit entities (ECB, 2015; ECB, 2022b). In addition to monetary policy, central banks also conduct economic analyses, provide financial services to the government and other financial institutions, and regulate the banking industry. Their goals include maintaining low inflation, stable currency, and low unemployment rates for the country. (Heakal, 2021) While central banks are typically government-owned entities, they have varying degrees of independence from political influence (Goodman, 1991). 2.4.1. Function of Central Bank Central banks act as the government's bank and manage the money supply, primarily by changing interest rates and engaging in open market operations, such as buying or selling government securities (Mishkin, 2021). In addition, they establish capital and reserve criteria for member banks, regulate savings and loan institutions, and act as a lender of last resort for governments and financial institutions (Board Of Governors Of The Federal Reserve System Washington D.C., 2019). Central banks have a monopoly on the monetary policy of the region and play a critical role in controlling the flow of money. They have the power to increase the monetary base if needed and have complete control over inflation, currency rates, and the money supply. To maintain this control, they use various tools, such as setting interest rates, performing open market operations, and controlling the value of the domestic currency by buying foreign currencies (Ajayi, 1999). Central banks also conduct economic research, collect statistics, and provide advice on financial policy to the governing bodies to ensure sound economic decision-making (Bordo & Levin, 2017). Moreover, central banks act as the government's fiscal agent and a commercial bank's bank. They manage the country's international reserves and exchange rates, ensuring that there is enough currency in circulation to keep the economy running smoothly. Unlike the government of a developed country, which has power over fiscal policies, the central banks of developed nations are institutionally independent from political changes and influence (Bordo, 2007). Overall, the central bank plays a vital role in maintaining economic stability and ensuring that financial institutions operate correctly (Ajayi, 1999).

In summary, these are the main functions of a central bank: • Central banks are responsible for implementing monetary policy and regulating the supply of money in an economy. • They serve as the lender of last resort to commercial banks and other financial institutions. • They hold the government's reserves and manage the country's foreign exchange reserves. • They play a crucial role in maintaining financial stability and preventing economic crises. (ChatGPT, personal communication, 17th March 2023).

2.4.2. Central Bank Objectives Since the early 1900s, the objectives of central banks have evolved and expanded. According to Bordo (2007), the main objectives of central banks during the early part of the 20th century were to maintain the gold standard and to act as lenders of last resort. However, after the Great Depression, central banks began to focus more on price stability and macroeconomic stability (Weidmann, 2015). In the latter half of the 20th century, the objectives of central banks continued to shift, with an increased emphasis on inflation targeting and maintaining financial stability (Gali, 2015). According to Boyce (2022), the role of central banks has evolved over time, with an increasing focus on financial stability and monetary policy. Boyce argues that central banks have a critical role to play in promoting economic growth and stability through their policies. In addition, central banks must focus on achieving multiple goals rather than a single one (Boyce, 2022).

Several goals of the central bank include: • Maintaining price stability and controlling inflation. • Supporting full employment and economic growth. • Maintaining financial stability and managing systemic risk. • Conducting monetary policy to regulate the money supply and interest rates. • Providing a stable and efficient payments system. • Acting as a lender of last resort to banks and financial institutions in times of crisis. • Managing the exchange rate and foreign exchange reserves. • Conducting research and analysis on economic trends and conditions. (ChatGPT, personal communication, 17th March 2023).

2.4.3. Blockchain Applications in Central Banking The use of blockchain technology is believed to be the foundation for contemporary digital currencies. Central banks worldwide are currently researching the potential applications of blockchain in Central Bank Digital Currency (CBDC). Central banks have launched CBDC projects that incorporate blockchain since 2016, and proof-of-concept prototypes have been completed to demonstrate the need for a digital euro (Zhang & Huang, 2022). Several central banks, including the Bank of England, Bank of Canada, and the Federal Reserve System, have already started researching digital currencies. In June 2020, the Federal Reserve Bank of Philadelphia stated that the introduction of CBDC would put commercial banks in direct competition, enabling the central bank to compete with financial institutions for deposits and engage in some deposit lending, thus making large intermediation possible (The Economist, 2018). CBDC can be distributed via a distributed ledger technology (DLT) system, as in China, or a centralized database system. The European Central Bank (ECB) has developed a retail CBDC prototype using the Corda DLT system to ensure some payment privacy. Blockchain technology provides high data privacy, and a CBDC has the potential to develop into a cash-like anonymous payment system. Due to the underlying encryption, DLT systems are highly secure and difficult to hack (Klein, Gross & Sander, 2020). In a blockchain-based CBDC system, the Euro may theoretically be programmable with the help of devices such as machines, cars, and sensors that utilize Euro-denominated smart contracts to provide pay-per-use leasing and factoring services. As blockchain technology is suitable for providing billions of devices with a wallet and computer chip, it has favorable implications in the machine economy. In addition to enabling millions of devices to join a payment network and be included in automated business processes, this allows devices to accept payments, transfer funds, generate invoices, and keep accounting records in the Euro currency (Klein et al., 2020).

3. Central Bank Digital Currency (CBDC) A central bank issues and backs central bank digital currencies (CBDCs), which are digital representations of a nation's currency. CBDCs offer a new type of digital currency that may be used for quick and secure transactions in addition to serving as an electronic substitute for traditional currency. CBDCs are closely related to the central bank and are bound by government rules, in contrast to cryptocurrencies, which are decentralized and run without the involvement of a central authority or the government. Compared to existing digital payment systems, CBDCs seek to be more accessible, secure, and stable. They also hope to contribute to the implementation of monetary policy and the promotion of financial stability. Cross-border payments may also become more accessible and affordable thanks to CBDCs' lower transaction costs (Seth, 2022). According to Meaning et al. (2021) general definition of CBDC, it is any electronic, fiat obligation of a central bank that can be utilized as a store of value or to settle payments. CBDC can therefore be thought of as electronic narrow money and in some ways already exists in the shape of central bank reserves (Meaning et al., 2021). Cash is losing popularity as a convenient form of payment in an increasingly digital economy. Managing and handling cash is costly, and its traceability is limited, making it susceptible to various financial crimes such as tax evasion, supporting terrorist groups, and money laundering. To address these issues, governments and individuals could benefit from a safer payment method that generates more tax revenue for efficient funding of public services (Ward & Rochemont, 2019). The decline in cash usage has been further accelerated by the COVID-19 pandemic, leading to a shift towards contactless payment methods, as observed in China (CNNIC, 2019; CNNIC, 2021), and a significant reduction of 20-25% in cash utilization in the Euro area (Panetta, 2021). In response, central banks are now exploring the feasibility of introducing Central Bank Digital Currencies (CBDCs) as a potential alternative (ECB, 2022c). In addition to the financial advantages of transitioning to a cashless or at least less cash-based society, recent data in Figure 2 and 3 below show that there is a general trend favoring the use of electronic payment systems and that cash use has fallen on its own (BBC News, 2019; Sveriges Riksbank, 2020).

Figure 2: Cash versus debit cards UK

Figure 3: Percentage of people paying in cash in Sweden, Riksbank 2020 3.1. Types of CBDC To fully understand the potential impact of a central bank digital currency (CBDC) in the banking industry, it is important to differentiate between retail and wholesale banking (Majaski, 2021). Retail banking provides banking services to individual consumers, while wholesale banking serves large businesses and institutions. CBDCs would need to perform in both areas.

3.1.1. Retail Retail banks offer services such as checking and savings accounts, personal loans, credit cards, and mortgages to consumers. They may be part of a large commercial bank or a small community bank with physical branch offices, or a newer type of bank that operates online (Majaski, 2021). The central bank acts as the "bank of the banks" and controls the money base, including deposits by commercial banks and currency in circulation. Retail banks create money by loaning to consumers, subject to reserve requirements set by the central bank (Burda & Wyploz, 2017). Retail CBDCs provide a variety of advantages over conventional payment methods, including the promotion of financial inclusion, the reduction of transaction costs, and the enhancement of the performance of the payment system (BIS, 2021a). They might also be able to solve issues with financial stability, such as reducing the likelihood of bank runs (Barrdear & Kumhof, 2016).

3.1.2. Wholesale Wholesale banking is the practice of providing services to substantial clients, such as governmental entities, multinational enterprises, and financial institutions. These services, which are frequently absent from retail banking, can include mergers and acquisitions, currency exchanges, underwriting, or consulting. While many banks do provide both retail and wholesale services, this blurs the distinction between the two industries (Kahn, Rivadeneyra & Wong, 2018). Because it frequently involves borrowing and lending between institutional banks, which may provide significant counterparty credit and settlement concerns, wholesale banking is crucial in the context of a central bank digital currency (CBDC). The efficiency of the wholesale banking industry might potentially be improved and these risks decreased by a CBDC. This industry is linked to a number of entities that have an immediate impact on a nation's financial stability, such as governmental bodies and pension funds (Kagan, 2020). Increased effectiveness and risk control in the wholesale payments system are just two advantages that wholesale CBDCs provide. In large-value payment systems, they might also lessen the requirement for central bank intermediation (Panetta, 2022). However, there are worries that wholesale CBDCs could have detrimental effects for financial intermediaries, such banks, by decreasing their position in the payment system and altering the way they conduct business (Kahn et al., 2018).

3.2. CBDC Design There are various designs of CBDCs, and each design has a special set of features. The way that transactions are confirmed varies between CBDCs, and they can either be token-based or account-based. Account-based systems rely on account holder identification verification while token-based systems require payment recipients to confirm payment legality (Kahn & Roberds, 2009). While central banks record and debit/credit the proper accounts in account-based systems, token-based CBDCs can be freely transferred between users (Meaning et al., 2021). Distributed Ledger Technology (DLT) can be used by token-based CBDCs to lower the danger of counterfeiting. Account-based CBDCs, on the other hand, lack anonymity, and verification outcomes might only be available to central banks. Shirai (2019) further divided CBDCs into DLT-based and non-DLT-based types, pointing out that DLT-based CBDCs might be easier to track than cash because account-based CBDCs make full transaction histories available. CBDCs can be made available in a variety of ways, and central banks can decide to make them accessible permanently or just during certain hours (BIS, 2018b). According to Bech and Garratt (2017), CBDC trials can assist central banks in examining usage and acceptability trends as well as isolating the financial effects of issuing CBDCs. The CBDCs anonymity has raised concerns from central banks that it may encourage illegal activity and money laundering. With transaction histories geo-tagged to the recipient/sender, DLT-based CBDCs may, nonetheless, be more traceable than cash. Given the inherent hazards of producing digital-only money, an intermediary-based CBDC seems to be the most efficient model (Bech & Garratt, 2017). Users of CBDCs may also be required to pay interest at non-zero rates that reflect monetary policy goals like inflation targeting or controlling CBDC demand (BIS, 2018b). Under the effective lower bound, negative interest rate policy is a well-known weapon for monetary policy, and an interest-bearing CBDC would provide agents with yet another practical alternative to deposits in the event of negative interest rates. To solve the interest rate conundrum, CBDC interest rates might be tied to reserve interest rates, and a cap on CBDC production would prevent negative effects and utilization in retail and wholesale transactions (Kiff et al., 2020).

According to the Committee on Payments and Market Infrastructures (CPMI), CBDCs can be classified into three categories: general-purpose token-based CBDC, general-purpose account-based CBDC, and wholesale token- or value-based CBDC (Barontini & Holden, 2019). The design features of CBDCs may vary depending on the needs of the monetary authority see Figure 4: The Taxonomy of money by Bech & Garratt (2017) bellow:

3.3. Monetary Policy and CBDC The increasing use and acceptance of privately created cryptocurrencies could have significant implications for the effectiveness of monetary policy and financial stability (ECB Crypto-Assets Task Force, 2019). If widely adopted, these cryptocurrencies could potentially undermine central banks control over the monetary transmission system. This has led to a growing interest among states in developing central bank digital currencies (CBDCs) that can be regulated (BIS, 2021a). In recent years, the concept of CBDCs has gained significant attention from policymakers, academics, and industry experts. The potential benefits of CBDCs include increased financial inclusion, reduced transaction costs, and improved efficiency in the payments system. However, the design of a CBDC must carefully balance these benefits against potential risks to financial stability, such as the impact on monetary policy transmission, the potential for bank disintermediation, and the potential for cyber risks. Therefore, it is essential to carefully consider the implications of CBDCs on monetary policy and financial stability (Bordo & Levin, 2017). One potential impact on the monetary policy is the increased efficiency of monetary transmission systems, which would enable central banks to implement monetary policy more effectively (Mishkin & Schmidt-Hebbel, 2006). CBDCs can also reduce the need for banks to hold reserves, which can free up capital for lending and stimulate economic growth (Jun & Yeo, 2021). However, there are also concerns that CBDCs could disrupt monetary policy and financial stability. The implementation of CBDCs could lead to a shift in the composition of money and cause central banks to lose control over the money supply (Bordo & Levin, 2017). Furthermore, CBDCs may pose a risk to the traditional banking system, as consumers may choose to hold their funds in CBDCs rather than in bank deposits, which could result in a reduction in bank lending and deposits (BIS, 2021b).

3.4. Development of CBDC and current Status around the World CBDCs may seem like a recent development, but their origins can be traced back to the 1990s. The Bank of Finland introduced the Avant smart card in 1993, which was a type of electronic money and can be considered the first CBDC ever created. Although the Avant smart card was discontinued in the early 2000s, it paved the way for the development of CBDCs (ChatGPT, personal communication, 24th April 2023).

Recently the financial world has been shaken by the collapse of the cryptocurrency exchange FTX. Digital platforms are being examined and cryptocurrencies are being questioned once more (Rohner, 2022) Although it has become quiet about digital currencies, work on CBDC continues. It is being worked on in more than 100 nations globally; see Figure 5 (CBDC Tracker, 2023). Two CBDCs, the Nigerian eNaira, introduced in October 2021, and the Bahamian sand dollar, debuted in October 2020 were the only ones that were fully functioning as of 2022. Nearly a hundred CBDCs were either being considered or were in the development stage. Investigating and releasing CBDCs is done for a variety of reasons in various countries (Stanley, 2022). China's development is also very advanced; the E-Yuan pilot project, which began at the end of 2020, will be expanded the following year. Sweden is moving quickly with its E-Krona across Europe and is currently looking into how it might be used for cross-border transactions. Midway through the 2020s, the eurozone plans to introduce the digital euro as a replacement for paper money (Rohner, 2022) Since 2020, Switzerland has been investigating potential uses for central bank digital currency (CBDC). Many things have already been fully built technically. It was demonstrated that the trade of tokenized assets with a digital currency operates effectively within the provided framework in the joint project "Helvetia" of the Swiss National Bank (SNB), the Bank for International Settlements (BIS), and the Swiss stock exchange (SIX). The process of creating a digital representation of an asset on the blockchain is referred to as tokenization (Rohner, 2022) The potential uses of CBDC for cross-border payments with France were looked into in the "Jura" follow-up study. Going even farther is the most recent project, "Mariana," which was overseen by the BIS and included the SNB and other central banks. It investigates the application of decentralized financial protocols to settlements and foreign exchange markets automation (BIS, 2023). It specifically investigates whether computerized market makers could effectively price CBDC transactions (BIS, 2023). Trademark registrations demonstrate the SNB's commitment to CBDC. The SNB has filed trademark applications with the patent office for the names "Digital Franc," "Digital Swiss Franc," and "E-Franc." The SNB's projects, however, are restricted to what is known as wholesale CBDC, unlike other central banks (Rohner, 2022). It’s a challenging task to integrate a wholesale central bank digital currency (CBDC) into existing core banking systems. However, Phase II of Project Helvetia has demonstrated that such integration is feasible. According to Swiss legislation, it is permissible to issue a wholesale CBDC on a distributed ledger technology (DLT) platform that is owned and operated by a private enterprise (SNB, 2022). The reasons for developing CBDCs vary by country. For example, the People's Bank of China (PBOC) has been developing its Digital Currency Electronic Payment (DCEP) system to reduce reliance on the US dollar and internationalize the Chinese yuan. The PBOC aims to create a more convenient and secure payment system while maintaining control over its monetary policy (Peters, Green, & Yang, 2020). In contrast, the European Central Bank's (ECB) investigation into CBDCs is driven by a desire to keep up with the increasing digitization of payments and maintain public confidence in the euro but also offering consumers more choices in determining the payment method (ECB, 2022c). Before putting CBDCs into use, central banks all over the world are carefully weighing their potential advantages and disadvantages. In general, the investigation and development of CBDCs reflect a significant change in the financial environment. CBDCs are a growingly important field of research and development for central banks globally because of their potential to increase financial inclusion, strengthen payment systems, and maintain sovereignty over payments.

Figure 5: Central Bank Digital Currencies Status

3.5. Benefits associated with the Project of the Digital Euro The digital euro is the electronic form of central bank money and thus offers all the advantages of the current euro. Additionally, it stabilizes the European currency area in crisis situations where conventional means of payment cannot be used, such as during the current Corona pandemic. Paying with cash can spread viruses more quickly, increasing health risks for consumers due to smear infections. The digital euro can help minimize this risk (Lutz, Geering, & Lambertz, 2020). The digital euro would be a third type of money, in addition to the central banks paper money and the commercial banks "book money." This would make it the third type of currency that customers might use to make payments in our present monetary system (Nagel, 2022). Moreover, in light of the growing importance of international digital currencies, a digital euro could safeguard the currency sovereignty of the euro area against potential private competitors like Libra, and thereby make an important contribution to financial stability (Lutz et al., 2020).

3.5.1. Digitalisation In the digital era, there is a growing need for a secure, widely accepted, and efficient payment method for individuals and businesses. The introduction of the digital euro by the ECB offers a new alternative to existing digital currencies and payment systems, supporting the ongoing digitalization of the financial sector. Additionally, as digitalization progresses, there may emerge new private digital currencies specific to certain platforms. However, central bank-issued currencies would continue to play a crucial role and potentially gain even greater significance in this context (Nagel, 2022). The issuance of a digital euro to consumers also serves to protect European autonomy in key sectors like retail and represents a step forward in developing a European point-of-sale solution (Lutz et al., 2020). An additional advantage is the improved efficiency of payment transactions and cost reductions resulting from the anticipated decrease in cash holdings. Providing cash, despite its high demand across Europe, is becoming increasingly expensive, particularly in rural areas where the fixed costs of ATMs and bank branches outweigh those of digital payment solutions (Lutz et al., 2020). The ease of transferring funds between banks and across borders is also enhanced. Interfaces between different bank systems are no longer necessary as a simple update to the central bank's records suffices, resulting in faster and more cost-effective transactions (Darko, 2020). However, it is crucial to ensure easy access to legal tender for the entire population. The management of the digital euro can be either fully decentralized, with the ECB or commercial banks operating at the local level. The ECB aims to leverage this increased efficiency to reduce the overall cost and environmental impact of the European payment system. In doing so, the central bank seeks to take a pioneering role and encourage other providers to minimize their environmental footprint as well (Lutz et al., 2020). 3.5.2. Internationalization Like the ECB, many other foreign central banks have recognized the potential of digital currencies and are planning or have already introduced them. In addition, private players such as large technology companies are also working on digital payment solutions. With the introduction of the digital euro, the ECB can prevent currency substitution and the rise of exchange rate risks in the Eurozone economy, thereby ensuring Europe's financial, economic, and ultimately political sovereignty. This allows them to maintain the highest security standards and aims to prevent funds from migrating to other payment systems that are beyond the control of the ECB (ECB, 2020). Furthermore, issuing the digital euro can strengthen the international role of the European single currency and increase demand from foreign investors. Additionally, a digital euro could help reduce inefficiencies in existing cross-currency payment infrastructures, especially for remittances, by improving inter-currency compatibility between payment systems. These include fragmented data standards caused by outdated operating systems, as well as lack of interoperability resulting from different time zones and systems, making cross-border payments slower, more expensive, and less transparent (Lutz et al., 2020). 3.5.3. Resilience to External Influences In the event of natural disasters, it may not be possible to rely on private payment solutions. In such cases, the digital euro, together with cash, can serve as a potential emergency mechanism for retail payments and ensure liquidity. Pandemics such as the COVID-19 crisis can also affect consumer behavior, with cash being perceived as a possible source of virus transmission. This is why contactless payment options have become increasingly popular this year. To ensure the overall resilience of the payment system, the digital euro should be widely available and processed through robust channels that are separate from those of other payment service providers and can withstand extreme events (Lutz et al., 2020).

3.6. Risks associated with the Project of the Digital Euro The publication of the ECB's paper with the idea of the digital euro has not been received positively by all stakeholders. Many voices from different sectors have already expressed concerns about the introduction of a digital euro. Leading experts are of the opinion that the introduction of a digital central bank currency could lead to destabilization of the financial system and point to the increased risks of a bank run and associated credit crunches (Lutz et al., 2020): 3.6.1. Increased Risk of Bank Run In an interview with “Handelsblatt”, Burkhard Balz, a member of the board of the Deutsche Bundesbank, criticized the central bank's plans. According to his argument, the introduction of a digital euro would be accompanied by a "digital bank run". In such cases individuals can quickly convert their bank deposits into central bank money during financial crises (Nagel, 2022). This could potentially lead to the collapse of multiple banks if they face liquidity problems due to the sudden outflow of deposits. Unlike deposits at private banks, which are legally secured up to a value of €100,000 in the event of the bank's insolvency, a central bank cannot technically run out of money, according to former central bank chief Mario Draghi. Deposits at the central bank are therefore considered crisis-proof. For banks, such a bank run would have devastating consequences: A bank is legally obligated to return every customer's paid-in demand deposits at any time. In normal times, this is usually possible as not every customer demands the payout of their savings at the same time. However, if many customers demand the payout at the same time, the bank can quickly run into a liquidity bottleneck, as it usually does not have sufficient cash reserves. In this case, the bank would become insolvent, and there is also the risk of loss of confidence in the bank if it refuses to pay out customer funds. The trust of customers is the basis of the bank's business model, which can be destroyed by a single scandal (Lutz et al., 2020). 3.6.2. Risk of a Credit Crunch The consequences of such a withdrawal of customer deposits from commercial banks would be significant. Banks need to refinance the loans they grant, either through deposits or by borrowing from the central bank. If customers withdraw their deposits, there will be a shortage of funds to refinance the loans. Even if central banks can inject money into the banking system, commercial banks may not pass it on in the form of loans due to fears of having to hold the liquidity to pay out customer deposits. Banks will have to restrict their lending to the private sector, which can have real economic consequences. For example, companies may no longer be able to refinance themselves and may go bankrupt, leading to an inability to service supplier credits and triggering a downward spiral. As a result, an entire economy could plunge into recession (Lutz et al., 2020). Furthermore, the direct issuance of CBDCs by the central bank may create a competitive advantage and distort the playing field that is conducive to innovation (BIS, 2021a). This could lead to a concentration of financial power in the hands of the central bank, which could have unintended consequences for the overall financial system (Lutz et al., 2020). 3.6.3. Security risks and loss of privacy Many critics argue that the introduction of a digital form of currency, such as the digital euro, would result in a loss of privacy to a state institution. Central Bank Digital Currencies (CBDCs) have the potential to not only transform the monetary system but also impact the level of privacy in individual payments. Currently, cash, the only form of legal tender provided by central banks to individuals (European Commission, 2010), offers the highest level of anonymity (Kahn, McAndrews & Roberds, 2005). In contrast, new digital currencies and payment methods generate electronic records that can be traced and monitored to combat money laundering and illegal activities (Wandhöfer, 2017; Wadsworth, 2018). However, within the monetary system, data protection, privacy, and trust are crucial factors, and privacy has been recognized as a vital element in the development of CBDCs (Auer and Böhme, 2020). In addition to privacy concerns, there are a number of cybersecurity risks that must be addressed to ensure the integrity of the financial system. CBDCs are vulnerable to a range of cyber threats, which could result in the theft of funds or the compromise of sensitive financial data (Panetta, 2022). Furthermore, the anonymity and ease of use of CBDCs could make it more difficult for authorities to track and monitor suspicious transactions, potentially enabling criminals to exploit the system (ChatGPT, personal communication, 28th April 2023). Despite the pandemic accelerating digitalization, society must ultimately decide through trust, acceptance, and use whether the introduction of a digital euro will ultimately be beneficial or not. The monetary union is already in the midst of a transformation process, and the outcome remains uncertain (Lutz et al., 2020).

3.7. Consideration of Opportunities and Risks Globalization and digitalization have led to a constantly changing and dynamic landscape in the world of payment transactions. Technological innovations and changing needs have fueled competition, challenging traditional financial institutions, especially central banks. In this context, the introduction of a digital euro presents an opportunity not only to make the European currency competitive but also to strengthen the ECB's financial stability and keep welfare in focus by creating standards and political sovereignty that ensure resilience to external influences. However, to successfully introduce digital currencies, especially central bank currencies, the downsides must not be disregarded. Measures must be taken to prevent the economy from collapsing due to the dangers of bank runs or credit crunches. Privacy must also be guaranteed, especially in the interest of the users. Although the pandemic has acted as a catalyst for digitalization, society must ultimately decide for itself, through trust, acceptance, and use, whether the introduction of a digital currency is ultimately a curse or a blessing. The fact remains that the monetary union is already in the midst of a transformation process with an unclear outcome.

4. Literatur Review In this chapter, the aim is to gain a comprehensive understanding of the perspectives within the financial industry regarding the subjects addressed in the thesis. Relevant findings will be presented in detail, drawing from academic papers, case studies, and the theoretical framework discussed in the earlier sections. To facilitate this exploration, four carefully formulated questions have been devised to guide the investigation. The first question serves as the central focus of the thesis, establishing the groundwork for the research. The remaining three questions are closely intertwined with the topic and complement each other, providing a more holistic comprehension of the subject matter. Through addressing these questions, the objective is to illuminate significant aspects of the topic and contribute to the existing knowledge base in the field of finance.

4.1. Motivation behind CBDC What motivates central banks to develop or introduce their own digital currencies ? Kiff et al. (2020) delve deeper into the primary motivations and results of a Central Bank Digital Currency in their IMF working paper, "A survey of Research on Retail Central Bank Digital Currency," with a particular focus on offering the central banks a step-by-step how-to manual for implementing a Central Bank Digital Currency. Contrary to other studies, the so-called side effects on retail banks, for instance, are not covered in as much detail by the researchers because they claim that the motivation for a central bank digital currency range from addressing the issue of declining use of cash to looking for creative ways to expand financial inclusion (Kiff et al., 2020). However, the study highlighted the significant role played by third-party service providers, emphasizing the key decision of whether to outsource the management of the CBDC network to such providers and how to effectively manage any associated risks (Kiff et al., 2020). In their paper titled "Central Bank Digital Currencies: ”motives, economic implications and the research frontier," Auer et al. (2021) claim that central bank digital currencies are a concept whose time has come (Auer et al., 2021). The opportunity to improve payments generally by using a more modern form of the conventional Central Bank money, in this case fiat money, would be the primary justification for the creation of a Central Bank Digital Currency. If correctly created, a central bank digital currency has the potential to serve as the foundation of a brand-new, incredibly effective digital payment system. The research itself has two main points in its conclusions, the other being the already mentioned timeliness of a Central Bank Digital Currency and the fact that there is a real need for it because it would, at the very least theoretically, improve the efficiency of digital payments, data governance, and privacy standards in general (Auer et al., 2021). Payment security and domestic efficiency were reported to be the main drivers for adopting a digital currency in a study conducted by Barontini & Holden (2019). It is interesting to note that cross-border payment efficiency was given the least weight by retail CBDC, but financial inclusion was given less weight by wholesale CBDC (Barontini & Holden, 2019). Additionally, there were observable distinctions between developed and emerging market economies. For instance, a study by OMFIF and IBM revealed that the possibility for increased speed and cost-efficiency was the main driver for respondents to pursue a wholesale CBDC. In contrast, respondents thought that keeping payment systems competitive and enabling enhanced anti-money laundering enforcement were crucial factors in the implementation of a retail CBDC (OMFIF & IBM, 2019). Even more specific estimates were provided in a study published by the Copenhagen Business School and Sweden's KTH Royal Institute of Technology. The research paper by the Swedish Retail and Wholesale Council claims that cash usage will likely decline by the years 2025 to 2027. The article even made a specific prediction that by March 24, 2023, cash will no longer be an acceptable form of payment for businesses (Arvidsson, Hedman, & Segendorf, 2017). The financial sector, particularly the payments business, has quickly grown more complex due to the current trends favoring open banking and immediate payment options. Regulation typically lags behind rapid invention, and it would appear that this is still the case today. There is now a pressing need for a regulated, central bank-controlled type of digital currency because to the popularity of private, uncontrolled digital currencies like Ethereum, Bitcoin, and stable coins like Facebook's Diem (Engman, 2021). Ozili (2022b) examined about forty papers on Central Bank Digital Currencies (CBDCs) to see if there was any substantial agreement among academics in a literature analysis that was published in the Journal of Money Laundering Control in January 2022. The review's findings agreed with those of other articles in that it might improve financial inclusion, monetary policy, and the effectiveness of digital payments as the three primary reasons why central banks issued CBDCs. Peterson did, however, also draw attention to certain drawbacks, such as the cost of lending and the stability of the economy, and he underscored the significance of effectively constructing the CBDC. The review ended with a non-conclusive remark on whether CBDCs will yield the expected outcomes, leaving it up to the future to tell (Ozili, 2022b).

Critical Analysis The analysis of the provided CBDC studies about the motivation behind CBDC reveals important considerations. Firstly, the limited focus on potential side effects on retail banks raises concerns about the broader implications of CBDC implementation. Secondly, while CBDCs are expected to improve efficiency in digital payments, their real-world effectiveness and impact on financial systems remain uncertain. It is crucial to address potential risks and challenges associated with CBDCs, such as data governance and privacy concerns. Furthermore, the motivations for CBDC adoption vary, with some countries prioritizing payment security and domestic efficiency, while others emphasize financial inclusion or cross-border payment efficiency. This highlights the complexity of developing a universal CBDC framework that meets diverse needs. Moreover, specific predictions about the decline of cash usage and the timeline for its obsolescence require robust empirical evidence to be validated. The rapid evolution of the financial sector, including the rise of private digital currencies, adds further complexity to the CBDC landscape. Finally, many different factors need to be considered. Addressing potential risks, considering different motivations, as well as assessing the needs of the population and collecting empirical data are essential for informed decision-making and successful implementation of CBDCs.

4.2. Impact of CBDC on financial stability What is the impact of CBDC on the financial stability ? Several authors have investigated the effects of central bank digital currency (CBDC) on financial stability and bank runs using various frameworks. Shirai (2019) contends that CBDC could weaken financial stability through bank runs, but Brunnermeier and Niepelt (2019) argue that retail CBDC would reduce the risk of bank runs by giving central banks an informational advantage, enabling them to take action before runs happen. The incapacity of the central bank to end long-term projects early, according to Fernandez-Villaverde et al. (2020), may make it possible for commercial banks to experience bank runs while keeping the central bank safe. Skeie (2019) emphasizes a trade-off between pricing and financial stability resulting from the central bank's role as lender of last resort, whereas Bitter (2020) contends that CBDC may change the way liquidity is distributed in the financial system. The potential for CBDC to increase financial stability is highlighted by Kim and Kwon (2019) when the central bank transfers money back to banks as credit. All researchers contend that CBDC may affect financial stability in both positive and negative ways, depending on the analytical framework chosen. Many case studies shed light on this problem. For instance, the European Central Bank (ECB) studied how a CBDC may affect monetary policy and financial intermediation. According to the study, a CBDC may cause financial intermediation to be disrupted since it might cause deposits to move from commercial banks to the central bank. This might lead to a decline in credit availability and have a detrimental effect on financial stability (ECB Crypto-Assets Task Force, 2019). Similarly, the Bank of Japan (BOJ) conducted a study on the impact of a CBDC on financial intermediation and the payment system. The study found that a CBDC could affect financial intermediation by potentially reducing the demand for bank deposits and increasing the demand for the CBDC. This could lead to a shift in the balance sheets of financial institutions, potentially affecting their stability. The study also highlighted the potential risk of operational disruption to the payment system in the event of a cyber-attack (Bank of Japan, 2020). The International Monetary Fund (IMF) examined the potential effects of a CBDC on the financial stability of the Eastern Caribbean Currency Union (ECCU) in a different case study. According to the analysis, a CBDC might increase financial stability by lowering the possibility of bank runs and boosting the robustness of the payment system. The report did, however, also point out some dangers, including the threat of a rise in cyberattacks and the possibility for a CBDC to upset the monetary system if it were to take the place of the national currency (Zhang, 2020).

Critical Analysis The studies and case analyses reveal varying potential effects of CBDC on financial stability. While some suggest positive impacts such as risk mitigation and improved payment systems, others raise concerns about disruptions to intermediation, operational risks, and systemic challenges. It is crucial to critically evaluate these findings considering their limitations. Real-world implementation may yield different outcomes, and the specific design and behavior of market participants play a significant role. Operational risks and cybersecurity threats should be addressed, and systemic challenges must be carefully assessed. Thorough analysis, risk management, and weighing of costs and benefits are necessary to make informed decisions about CBDCs and ensure their potential benefits outweigh any adverse consequences.

4.3. Impact of CBDC on monetary policy What is the impact of CBDC on the monetary policy ? A growing amount of research has looked at how central bank digital currencies (CBDCs) might affect monetary policy. According to Bordo and Levin (2017), the implementation of CBDC could significantly affect how well central banks are able to manage the money supply and interest rates. They contend that the adoption of CBDC would change consumer preferences for commercial bank deposits, which might have an impact on central banks' ability to manage the money supply through open market operations. This could lead to a loss of control over monetary policy and jeopardize the ability of the central bank to accomplish its goals. While Boar et al. (2020) show that central banks will need to collaborate with other central banks to better understand the consequences of private digital tokens for central bank digital currency payments, central banks still want to introduce a central bank digital currency. Similar to this, Kahn, Rivadeneyra and Wong (2018) point out that the execution of monetary policy, particularly in terms of the transmission mechanism, could be affected by the introduction of CBDC. They contend that CBDC may have an impact on the demand for bank deposits, which may have an impact on banks' capacity to lend, thereby upsetting the monetary policy's credit channel. To effectively implement monetary policy, central banks may be forced to develop new tools as a result of this. According to Mancini-Griffoli et al. (2018), CBDC could improve the efficacy of monetary policy by giving central banks a more direct route to communicate policy to the entire economy. They contend that CBDC might be utilized to more effectively conduct monetary policy by enabling central banks to circumvent the banking industry and directly affect consumer and business spending decisions. Even though the majority of central banks are researching central bank digital currencies, only a tiny portion of central banks see releasing a central bank digital currency as a short- or medium-term aim, according to Barontini and Holden (2019). In their work Broadening Narrow Money: Monetary Policy with a Central Bank Digital Currency, Jack Meaning, Ben Dyson, James Barker, and Emily Clayton continue this line of inquiry. The same kind of risk related to interest-bearing and "digital bank runs" is underlined in their paper. According to Meaning et al. (2021), it may be possible to limit or prevent digital bank runs from retail banks while still preserving deposits, which would keep funding and collateral capacities in tact. These restrictions may take the form of fees or withdrawal caps. A central bank's ability to hold deposits, it was again suggested, may result in serious risk situations during financial crises. As central banks hold assets such as government bonds already, adding deposits to the central banks balance sheet in a time of crisis when generally the public seeks for less riskier options to hold their assets in could increase the risk level of the central banks’ balance sheet over the allowed limit. (Meaning et al., 2021). In addition to academic literature, there are several case studies that provide insights into the potential impact of CBDC on monetary policy. For example, the People's Bank of China (PBOC) has been conducting trials of its digital currency, the digital yuan, since 2020. According to a report by the Bank for International Settlements the PBOC's introduction of the digital yuan could lead to a reduction in the demand for cash and bank deposits, potentially affecting the implementation of monetary policy. The report notes that the PBOC may need to adjust its monetary policy framework and tools in response to the introduction of the digital yuan (ChatGPT, personal communication, 5th Mai 2023). Similarly, the Central Bank of The Bahamas launched its digital currency, the Sand Dollar, in 2020. A study by Soderberg et al. (2022) found that the Sand Dollar could enhance the effectiveness of monetary policy by improving the transmission mechanism and reducing the reliance on cash. The study notes that the Sand Dollar could help to overcome some of the limitations of traditional monetary policy tools in The Bahamas, such as the limited scope for open market operations due to the small size of the domestic bond market (Soderberg et al., 2022).

Critical Analysis The increasing interest in central bank digital currencies (CBDCs) and their impact on monetary policy requires a thorough examination. While some studies suggest potential disruptions and challenges, others highlight the potential to enhance policy effectiveness. The design, implementation, and interaction of CBDCs with market participants will ultimately determine their impact. To fully comprehend and harness the benefits of CBDCs in monetary policy, rigorous analysis, risk management strategies, and policy framework adaptations are necessary. Overall, a critical view emphasizes the need for careful evaluation and understanding of the potential disruptions, challenges, and risks associated with CBDCs.

4.4. Security risk and privacy challenges What are the security risk and privacy challenges associated with CBDC? A summary of the privacy consequences of the policy choices chosen when establishing a CBDC is provided by Rennie and Steele (2021). They assert that a range of central banks interests, including preventing criminal financial system abuse, geopolitical concerns, and private sector innovation, could ultimately pose a threat to privacy. Additionally, they assert that the current CBDC models provide privacy issues that could lead to losses such a loss of anonymity, freedom, individual autonomy, and regulatory authority. Grothoff and Moser (2021) assert that a CBDC that protects user privacy must assure legal compliance as well as adherence to anti-money laundering (AML) and countering the financing of terrorism (CFT) regulations. Additionally, they assert that a CBDC can only provide the transaction privacy feature of cash when it is implemented on token-based systems. Darbha and Arora (2020) explore what is technologically feasible for privacy in a central bank digital currency (CBDC) system. They make it clear that the main issue is what information should be kept private and from whom.

Critical Analysis The challenge in implementing CBDC is to balance the interests of central banks in preventing abuse of the financial system while protecting the privacy of users. It is critical to ensure that privacy is not protected at the expense of other objectives. Current CBDC models pose potential privacy concerns that could result in the loss of anonymity, freedom, and individual autonomy. It is therefore important to carefully assess the privacy implications of these losses and take appropriate protective measures. To safeguard user privacy, CBDCs must comply with applicable anti-money laundering and counter-terrorist financing laws and regulations. Developing adequate mechanisms to ensure compliance is of great importance. In addition, the technological feasibility of protecting privacy in CBDC systems requires thorough investigation. It is important to establish clear guidelines and find appropriate technological solutions to determine what information should be kept private and from whom. By considering these aspects, the benefits of CBDCs can be reaped while protecting the privacy of users.

4.5. CBDC adoption and development worldwide What is the current state of CBDC adoption and development worldwide ? In a study on CBDC adoption, Boar and Wehrli (2021) found that 14% of central banks were engaged in CBDC development and pilot projects, 60% of central banks were testing the technology, and 86% of central banks were actively considering the prospect of issuing a CBDC. Náñez Alonso et al. (2021) evaluate the situation of CBDCs in countries such the Bahamas, China, and Uruguay. They found that the development of CBDC in these countries is at varying stages. Ozili (2021) discovered that only seven African countries have explicitly indicated interest in central banking in a study on the adoption of CBDC by African countries. At the pilot test stage, four African countries had already embraced central banks' digital currencies. As of 2021, only three other African countries have a robust enough payment system infrastructure to support such a currency, and Nigeria is the only country in Africa with a central bank digital currency. Astonishingly, 78% of African countries had not expressed interest in central bank digital currency as of 2021, whereas the West African region had the highest percentage of such countries (Ozili, 2021).

4.6. Retail CBDC: Case Studies and Insights 4.6.1. The e-Peso Uruguay The Central Bank of Uruguay (BCU) introduced the e-peso in November 2017 as the nation's first operational test of a retail central bank digital currency (CBDC). Using digital banknotes that were printed and stored on a currency management platform run by the BCU, the pilot program aimed to enable the prompt completion of payments and settlements (Sarmiento, 2022). During the trial phase, the BCU gave 10,000 customers 20 million fiat pesos that had been converted to e-pesos using their mobile devices. The e-peso was usable by those with restricted internet access because participants did not have to stay connected to the internet (Shirai, 2019). In addition, the pilot included 15 companies, a state-owned telecommunications company, a few fintech companies, and payment service providers (PSPs), but no commercial banks (Shirai, 2019). The maximum amount of e-pesos that participants could add to their wallets was 200,000. Transactions between wallets were immediate and made possible through a peer-to-peer infrastructure via text messages or the e-peso application. Because the transactions were anonymous but traceable, it was possible to record every transaction and prevent double-spending and counterfeiting problems (Sarmiento, 2022). In April 2018, the pilot was successfully finished, and all e-pesos were cancelled. The BCU came to the conclusion that the e-peso promoted financial inclusion in the nation while lowering transaction costs and tax evasion (Shirai, 2019). 4.6.2. The Sand Dollar Bahamas Since its introduction in December 2019, the Sand dollar digital currency from the Central Bank of the Bahamas (CBOB) has been lauded as a success. To increase the effectiveness of the Bahamian domestic payments infrastructure and to advance financial inclusion, the Sand dollar, a token-based CBDC, was introduced. Through supervised financial institutions (SFIs) like commercial banks and payment service providers (PSPs), which are incorporated into the Sand dollar network via application programming interfaces (APIs), the Sand dollar is interchangeable with other types of money (CBDC WG, 2020). Deposits cannot be replaced by the Sand dollar because it does not pay interest and can only be swapped for cash. Users and Sand Dollar accounts with the CBOB are only distributed by the SFIs. Users do not require mobile data or internet connectivity to access the Sand Dollar network because it is designed to be robust and accessible. To further integrate the unbanked population, the CBOB wants to connect Sand Dollar wallets to bank accounts. The CBOB has provided funding for the Sand Dollar Experiment, which provides end users with a service that is essentially free (CBDC WG, 2020). The Exuma and Abaco islands were where the sand dollar was first introduced, but it is now sold all around the country, even in rural places. The Sand dollar has shown to be particularly helpful during the COVID-19 epidemic due to the diminished utility of cash, which needs physical contact and face-to-face transactions. The Sand Dollar has made contactless transactions possible, limiting the risk of the virus spreading (CBDC WG, 2020). A small transaction fee is anticipated to be levied when the Sand dollar user base grows to cover system upkeep. 4.6.3. The E-Yuan China With the assistance of four state-owned banks, the People's Bank of China (PBOC) has been testing its Digital Currency Electronic Payment (DCEP) in a number of locations, including Shenzhen, Suzhou, Chengdu, and Xunan. With approximately 80% of payments performed digitally in 2019 using Alipay and WeChat Pay, the DCEP is a cryptocurrency that was created in response to the Chinese population's preference for digital payments over cash (Peters, Green, & Yang, 2020). Yeung (2020) contends that the DCEP, which may be thought of as a digital, traceable cash that augments physical cash in M0, is essentially digital cash that is issued and backed by the central bank. Without requiring an internet or data connection, the DCEP can be transacted by mobile phones utilizing "touch and touch" technology, in which the transacting agents' mobile phones are touched to start the transaction. According to Lee, Yan and Wang (2021) the DCEP is anticipated to increase transaction security and efficiency, lower costs, and promote wider financial inclusion. The government will be able to trace and monitor money flows, which may help in the battle against tax fraud and money laundering (Gengxuan et al., 2021). However, issues have been expressed regarding the DCEP's possible influence on customer privacy, as well as how it would affect the current financial system and enhance power concentration (Peters, Green, & Yang, 2020). The DCEP's debut is considered an important step towards the yuan's internationalization and may pose a threat to the US dollar's hegemony in international trade and banking (Knoerich, 2021).

4.7. Analysis of the Case Studies and Evaluation of Implementation In conclusion, studies on retail CBDC, including those funded by the government and the central bank, are in a transitional phase. Central banks from all over the world have recognized the necessity for interoperable CBDCs (Boar & Wehrli, 2021), which may stimulate the development of more thorough and meaningful tests. The CBDC Working Group (2020) highlighted the value of cooperation and information sharing among central banks in determining the course of CBDC as a result.

The purpose of issuing CBDCs might range from lowering the use of cash to evading trade restrictions. These factors have prompted central banks to develop digital cash alternatives, promote payment system competition and efficiency, and prioritize client needs and preferences. It is critical to consider the CBDCs design, scope, application under the current legal framework, and the obligations of significant participants in the financial system during the design phase. To achieve usability and acceptability, CBDC must be created as a cash alternative with all the necessary features of currency woven into the design philosophy (CBDC WG, 2020). Central banks must be clear about their obligations as the retail CBDC system's sole operator and regulator during deployment. As they seek to build a solid and durable structure, this will enable business parties to collaborate rather than compete for control of the CBDC supply. The ideal organizational structure would be tier-based, with private agents like banks and Payment Service Providers competing for user attention and central banks in charge of minting. The CBDC system serves the public benefit and has a network of private agents, thus the majority of the setup and maintenance costs must be borne by central banks. According to Jiang (2020), it is critical to examine consumers' payment routines and prepare for potential conflicts between the CBDC and other payment options. This should prevent the CBDC from turning into a specialized payment option and position it favorably to help central banks accomplish their objectives. To ensure the stability of financial systems and the effectiveness of monetary policy, central banks need to thoroughly analyze the potential implications of features such as supply limits and interest rates in their central bank digital currency (CBDC) designs. While pilots around the world provide limited insights, it is crucial to consider alternative policy options in the rapidly evolving landscape of instantaneous payments facilitated by the internet and fintech innovations, even without implementing CBDCs. Ayuso and Conesa (2020) argue that these alternatives may prove equally effective at a significantly lower cost, particularly in advanced economies with widespread financial access. 5. Conclusion The implementation of Central Bank Digital Currencies (CBDCs) is receiving significant attention in numerous countries worldwide. As the use of physical cash declines and cryptocurrencies gain popularity, there is a growing recognition of the need for a reliable alternative to traditional fiat currency. This thesis has conducted an extensive literature review to delve into the theoretical foundations of CBDCs, with a particular focus on motivations, implications and the current global status of CBDC. By synthesizing key findings from a diverse range of academic articles, reports, and policy papers, this thesis provides a comprehensive overview of CBDC research. The exploration and development of CBDCs are driven by various factors, including the decreasing use of cash, the emergence of decentralized cryptocurrencies, the pursuit of financial inclusion, and the objective of improving payment systems and monetary policy execution. CBDCs, especially those utilizing blockchain technology, hold the promise of enabling immediate settlements and more efficient peer-to-peer and cross-border transactions, thereby reducing costs and improving the often burdensome remittance process. The implementation of CBDCs has the potential to reshape financial systems, economies, and individuals lives. However, it is imperative to adopt a balanced and well-regulated approach. Further research, collaboration, and policy formulation are necessary to effectively harness the benefits of CBDCs while mitigating associated challenges and risks. One concern for central banks is the risk of digital bank runs, wherein the ease of moving funds away from commercial banks without withdrawal limits may lead to liquidity issues during adverse shocks. Addressing security and privacy risks is also crucial, given the digital nature of CBDCs, which exposes them to cyber threats, hacking, and data breaches. Implementing robust security measures, striking the right balance between privacy and anti-money laundering regulations, and ensuring stringent data protection regulations are essential components in safeguarding CBDC transactions and user data. The current global status of CBDCs varies, with notable progress made in countries like China and Sweden, which have advanced pilot programs and testing. Meanwhile, other nations are in the early stages of exploration or conducting feasibility studies. Ongoing research, collaboration, and monitoring of global CBDC developments are crucial to inform their design, implementation, and regulation.

In conclusion, this thesis serves as a valuable resource for informed decision-making and policy formulation regarding CBDCs. It emphasizes the importance of continuous research and dialogue in shaping the future of digital currencies in our increasingly interconnected and digital world. Ongoing research, collaboration with regulatory agencies and industry stakeholders, and close monitoring of global CBDC developments are essential for harnessing the transformative potential of CBDCs in terms of financial systems, financial inclusion, payment efficiency, and security and privacy in the digital age.

5.1. Future Outlook The rise of Central Bank Digital Currencies (CBDCs) has garnered significant interest in recent years as countries worldwide seek to modernize their monetary systems and offer efficient payment solutions. This growing trend has led to the emergence of numerous CBDC projects globally, painting a positive future for this innovative form of digital currency. The success of CBDCs hinges on public trust and confidence. Central banks must prioritize the security, reliability, and user-friendliness of CBDCs, ensuring robust measures are in place to protect against potential cyber threats. Simultaneously, safeguarding user privacy is paramount. Public education and awareness campaigns will play a vital role in helping citizens understand the advantages and risks associated with CBDCs, fostering a solid foundation for widespread acceptance. Furthermore, the future of CBDCs will be influenced by the global regulatory landscape. As CBDCs gain traction, there may arise a need for international standards and regulations to ensure seamless interoperability and prevent potential conflicts. Moreover, the adoption of CBDCs could introduce new challenges in cross-border payments, necessitating coordination and cooperation among central banks to develop efficient solutions. While the outlook for CBDCs is promising, there will undoubtedly be hurdles to overcome. Central banks must strike a delicate balance between fostering innovation and maintaining stability, addressing concerns surrounding security, privacy, and the potential impact on the traditional banking system. However, with meticulous planning, collaboration, and a proactive approach to addressing challenges, CBDCs have the potential to deliver significant benefits to the financial system and society at large.

Contact

• Prof. Dr. Jörg Osterrieder
• Lorent Shabani