Our last few posts have focused on CBDCs in general and their advantages.  We conclude this series with some additional thoughts on potential obstacles posed by their usage.

Potential Difficulties

Naturally, deploying CBDCs involves certain difficulties, especially during the transition phase. Therefore, all relevant authorities and government agencies must be attentive and responsive in order to effectively mitigate issues as they present themselves.

Among the potential difficulties we foresee, we expect the impact on the banking industry to be the most significant. As briefly described in prior witings, banks to some extent might experience a liquidity challenge affecting their available credit reserves, thus making credit more expensive through higher interest rates. There could be several paths to alleviate this and increase cash reserves:

• Generating new lines of business - The banking industry could undergo a major shakeup as new blockchain-based platforms are deployed, and many traditional (and highly profitable) services will no longer be provided by banks. It will challenge banks to redefine their role in the new economy and to adapt accordingly. While some banks probably see this as a threat, others could use this as an opportunity to grab substantial market share as the demand for new financial services grows. From the general public's perspective and even the central bank's, this spur in competition is positive, forcing banks to become more efficient overall.

• Central banks are in control of the deposit discount rate, and are therefore in control of the demand for CBDC and for banks' cash reserves. Therefore, the likeliest scenario is one where the central bank will set an interest rate (on CBDC reserves) to reach a new, improved and stable equilibrium. That equilibrium will see only a limited portion of banks' cash reserves flow to CBDC deposits, not most of it and certainly not all of it. As with other similar kinds of economic stabilization measures, it may take some time for the market to readjust, but the market will reach a new and better state, given that the central bank is trusted by the commercial banks

• The role of central banks is to balance several responsibilities in order to maintain a reliable, growing financial market. Providing the option of opening a CBDC account with the central bank makes any person or entity a de facto customer of the central bank. No one actually intends to have them deal directly with the general public, rather they would essentially outsource this service to commercial banks, generating a new line of business and new stream of revenues

• The new CBDC deposit accounts will not be credit facilities. Those will only be provided by commercial banks. Thus banks will focus on offering their customers active financial services rather than just money storage

There may be additional difficulties involved in the process of migrating to CBDC, however we will only discuss two more: user privacy and raising sufficient public awareness.

Firstly, privacy and anonymity, especially in the context of payment services, will always be a point of contention. On the one hand, many want full domain over their privacy by having the option to use fully anonymous means of payment. On the other hand, such features might be exploited by nefarious actors for illegal activity and tax evasion. As previously noted, CBDCs may provide different levels of user privacy, depending on the central bank's policy. The most simple solution would be leaving only the lowest value banknotes available, while limiting the allowed value per cash transaction. That would make the transition towards a true cashless economy smoother and quicker. In certain countries, it may even allow policy makers a defense against critics, as not all cash has been abolished.

Secondly, getting the public on board may present difficulties. Public awareness campaigns and proper education should mitigate this. We truly believe that any argument that certain parts of the population could not handle this transition and might be victims for potential fraud are patently absurd. Yes, there will be fraudsters and it will take longer for some to "master" the use of digital payments. However, this genuine concern is not reason enough to reject change outright. Had that been the case, there would have been no move to e-banking, internet or mobile devices. Can you imagine our world today without any of them?

Suggested Strategic Outline

In light of the above, and assuming that we have been able to persuade the reader that CBDCs are a powerful instrument that ought to be adopted by central banks, we suggest the following strategy, which calls for a centralized CBDC on a private blockchain protocol but which allows for development into a decentralized protocol - if the technology proves itself to be viable. Deployment would occur in three steps according to this strategy, spread over several years, but starting sooner rather than later. There is no point in indicating the length of each phase, which would be an open question, but we certainly expect a central bank to set reasonable targets on this roadmap and stick to that plan.

1. Phase 1 - Introducing CBDC Light, for digital payments only. This currency is the light version of the later full-featured centralized CBDC. The general public may open reserve accounts at the central bank, but they will not carry interest and are intended to be used as the central bank's certified digital wallets. The goal is to introduce the advantages of using digital payment services and reduce the use of cash to a minimum, leaving only the lowest value bills in circulation. This period will allow commercial banks to start getting used to the idea of having a CBDC, knowing that a full-featured CBDC is waiting just around the corner.

2. Phase 2 - Introducing a full-featured centralized CBDC. Once the public and commercial banks are accustomed to this lighter CBDC, the central bank upgrades it to a full-featured implementation in order to maximize its merits and utilize it as a full monetary instrument. This period involves potential disruptions to the economy, as discussed above. It is up to the central bank to manage the process carefully in order to drive the economy towards its new equilibrium, in which commercial banks are more efficient and generate new revenue streams. In parallel, the central bank during this time closely examines blockchain technology and cryptocurrency markets in order to determine when it would be suitable to deploy a decentralized CBDC

3. Phase 3 - Discussing decentralization. As noted earlier, we are still not convinced that CBDC decentralization is necessary or ever will be. Still, we urge central banks to think about it, even if just to push the envelope as a thought-experiment, so that as technology advances, they will be in a position to decide if implementation is the correct strategy for them. We are certain that with time, new technology would provide better solutions to problems that we now cannot see being resolved. Central banks should focus their efforts on understanding several key topics which are critical to a decentralized protocol:

4. What is the desired level of user privacy and anonymity?

5. Who are the participating nodes?

6. How does the White chain operate?

7. What are the KYC & AML procedures for opening an account on that chain?

Conclusion

In this series of posts, we have provided a brief overview of CBDCs and why they should be implemented sooner rather than later. Since CBDCs are such a powerful instrument, their implementation must be calculated and methodical in order to maximize their merits and minimize their demerits.

The roles and importance of major actors in our global economy are constantly questioned as we head towards a 'new economy'. Each and every one of them will have to adapt to technological innovation in order to maintain relevance and in their position of maintaining market stability. The same goes for central banks. Being the economy's equivalent of the "responsible adults" in the room, they must engage.

We support the recent trend of central banks experimenting and considering issuing a CBDC. In our view, central banks that are looking to lead rather than be led, cannot ignore the potential benefits of this opportunity nor the pitfalls of failing to follow what seems like an inevitable culmination of digital economic innovation over the last two decades.