In the first half of 2022, the Bank of Japan will begin the second phase of a demonstration experiment for a Central Bank Digital Currency (CBDC), which would be a legal tender issued in the form of electronic data. BoJ is also now giving full-scale consideration to the introduction of a digital yen.
In mid-April, a senior BOJ official stressed the importance of studying the institutional aspects of CBDC through a demonstration experiment at a liaison conference of the government and the financial industry. "It is useful to consider what kind of design the system will be,” he said, “in making a decision as to whether or not to issue the currency."
The global movement toward the issuance of CBDC, which will improve the convenience of payments, is accelerating. Moreover, there is an intensifying battle for supremacy between China, which is trying to set the international standard by staking out the lead, and the United States, which is trying to regain its position.
Japan will likely need to respond in line with the US, but it will take more time to establish an international settlement framework and address concerns about the instability of the financial system.
What Is CBDC?
Central Bank Digital Currency (CBDC) is monetary value issued by the Central Bank, characterized by the fact that it can be deposited into smartphones and other devices and used for payment anywhere, just like cash.
For example, with electronic money, the place of use is limited to member stores, and stores need to wait for the payment from the settlement company. However, CBDC can be used anywhere, and the stores receiving the payment can make immediate use of it for purchases and other payments. Convenience is improved as CBDC reduces the cost of cash in circulation.
Bank of Japan's Experiment
In the first phase of the experiment, which lasted until March of this year, the BOJ verified the load on the system and other issues related to basic transactions, such as payments made by the BOJ to users through intermediary institutions and exchanges between users.
The second phase, which will run from April through March of next year, will examine the limits on transaction and holding amounts, linkage with private-sector settlement services, and settlement under conditions where communication and power supply are disrupted due to natural disasters and other causes.
Furthermore, the BOJ envisions the possibility of conducting a "pilot experiment" in which private businesses and consumers would participate, depending on the situation. Although the BOJ has no issuance plans at this time, it has not changed its stance about the importance of being prepared. The BOJ is now in the midst of a full-fledged study of the issue, in light of the accelerating trend toward CBDC’s introduction overseas.
When the possibility of the European Central Bank (ECB) issuing "digital euros" by 2026 was discussed in the House of Representatives Budget Committee in January 2022, BOJ Governor Haruhiko Kuroda indicated in his response that a decision on whether or not to issue digital yen could be made by around the same time.
Emerging economies such as the Bahamas and Cambodia have taken the lead in adopting CBDC for the purpose of widely distributing financial services. Among them, China's digital renminbi, which the Chinese government has been preparing while glancing sideways at the slow start in Japan, the US, and Europe, is gaining a stronger presence.
The Chinese government began research on digital currency in 2014 and expanded the scope of the project by launching a full-scale demonstration experiment targeting citizens in 2020. It made a big show of offering a prepaid card system for foreigners staying for a short period of time at the Winter Olympics in Beijing in February 2022. This aggressive stance seems to indicate China’s desire to expand its influence by setting international standards for the technology and institutional design and providing the technology to emerging economies.
Satoshi Osanai, a senior researcher at Daiwa Institute of Research Ltd, points out that the ban on dollar settlement against Russia and the exclusion of Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) due to the invasion of Ukraine has led to a growing sense of urgency in China. He notes that “this may accelerate the creation of an international settlement framework for CBDC."
There is concern in the US that the status of the dollar as a reserve currency could be threatened if China's initiative enables inexpensive and rapid international payments without going through SWIFT.
Battle for Control of Digital Currency Standards
In March, President Biden signed a presidential decree to consider the digital dollar, a shift from his previous cautious stance. According to a market participant, if the United States decides to introduce a digital dollar, “it could be assumed that Japan, the US, and Europe will join forces to develop an international settlement network.”
However, there are many issues that need to be addressed before full-scale introduction, such as privacy protection, stable operation of the system including cyberattack responses, and how the costs of introducing and operating the system should be borne. If huge amounts of funds are shifted from bank deposits to the convenient CBDC, the financial system, in which financial institutions use deposits as a source of funds to make loans, may be undermined, leading to economic stagnation. Striking a balance between the convenience of CBDC and the stabilization of the financial system will be an important theme.
Professor Masashi Nakajima of Reitaku University, who is familiar with CBDC, analyzes that “Central banks, including China’s central bank, are most concerned about the impact on the domestic financial system. So, they will first introduce CBDC for small-lot settlements.”
Nakajima believes that it will take about 10 years before an international settlement framework is in place.
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(Read the report in Japanese at this link.)
Author: Kiyoshi Takaku