The Future of Fintech, Economic Growth, and Monetary Policy:
Central Bank Digital Currency (CBDC)
Bhupinder Dulku
November 2018

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I. Introduction
Global technological advances, such as blockchain technology, and a decreased reliance on cash
has prompted countries and banks to start rethinking their approach to money and currency.
Countries such as Norway, Canada, and Sweden have started exploring the idea of a central bank
digital currency (CBDC). In order to fully understand the opportunity of CBDCs, it is necessary
to comment on the relationship between society and money, blockchain technology, and monetary
policy.
II. Money
Money is best defined as a unit of account, medium of exchange, or store of value (Olivier, 2017).
Currently money can be distinguished by four distinct categories: universally accessible,
electronic, central bank-issued, and/or peer-to-peer (see Figure 1)1
. As electronic devices and
digital networks have become pervasive, two new forms of currency have come to the forefront:
cryptocurrency & central bank digital currency (see Figure 2). The most important distinction
between these two is that one is central bank issued and as a result the liability of the government;
whereas the other is transacted peer-to-peer2
and not the liability of anyone.
2.1 Cryptocurrency vs. Central Bank Digital Currency (CBDC)
Cryptocurrency
In the simplest of terms, cryptocurrencies are “virtual currency / e-money3
designed to
work as a medium of exchange. It uses a network of peers, instead of a third-party financial
authority, to secure and verify transactions, and control the creation of new units” (Driscoll,
2013). Cryptocurrencies have proven to be extremely volatile in nature (see Figure 3) and
in some instances have been outright rejected as a form of payment. Immense energy (see
Figure 4) is also used in mining4
and confirming5
cryptocurrency transactions. Blockchain,
the underlying technology, upon which cryptocurrencies are built holds promise but this
application may only persist as a financial tool for criminal activity and anonymity due the
problems mentioned above.
Central Bank Digital Currency (CBDC)
Is a form of digital fiat currency. “Fiat currency is legal tender whose value is backed by
the government that issues it. For example, the US Dollar is a form of fiat money as is the
euro and other world currencies” (Ali, 2018).
1 Figures are located in the end of the document.
2 The exchange of information, data, or assets between parties without the involvement of a central authority. (Cointelegraph,
2018)
3 e-money is a store of value that has been converted from currency to an intermediary before either being transacted for goods
and services or converted back to the original currency or another currency. (MIT, 2018)
4 Miners take transactions, stamp them as legit and spread them in the network. After a transaction is confirmed by a miner, every
node has to add it to its database. It has become part of the blockchain. For this job, the miners get rewarded with a token of the
cryptocurrency. (Blockgeeks, 2017)
5 Confirmation is a critical concept in cryptocurrencies. You could say that cryptocurrencies are all about confirmation. As long
as a transaction is unconfirmed, it is pending and can be forged. When a transaction is confirmed, it is set in stone. It is no longer
forgeable, it cannot be reversed, it is part of an immutable record of historical transactions: of the blockchain. (Blockgeeks, 2017)

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As it currently stands central bank digital currencies already exist but only between
commercial banks and a country’s central bank. “This is why central banks are so efficient
and cost-effective at mediating interbank payments and lending transactions” (Roubini,
2018). Individuals, corporations, and non-financial institutions do enjoy the same access
and must rely on licensed commercial banks to process their transactions. By allowing any
individual to make transactions through the central bank, CBDCs would upend this
arrangement, alleviating the need for cash, traditional bank accounts, and potentially even
credit payment services. If “CBDCs were issued, they would immediately displace
cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized”
(Roubini, 2018).
The lack liability of any one authority, volatile price nature, and not a true store of value paves a
compelling narrative to endorse digital fiat currencies.
III. Technological Aspects, Required System, and Platform
With the advent of the digital era, it is important to understand how financial technology will play
a role in realizing CBDCs. Research, advisory, and information technology firm, Gartner,
highlights the hype cycle6
of emerging technologies. One such technology that has begun
showcasing immense applicability is blockchain / distributed ledger technology (DLT). The hype
cycle shows blockchain, in the banking and investment services industry, will reach its plateau of
productivity7
in the next 5-10 years (see Figure 5).
3.2 Distributed Ledger Technology (DLT): Blockchain
Distributed Ledger Technology is “a chain of time-stamped, cryptographically secured,
immutable blocks of consensus-validated digital data existing in multiple synchronized
networks spread across sites, institutions or geographies” (see Figure 6).
As the properties of distributed ledger technology (see Figure 7) are better understood and
commercialized over the next decade, it is important to emphasize the technological aspects
a CBDC system would need to have.
3.2.1 Technological Aspects
• Validation & Consensus: “the most fundamental problem any DLT must
solve is finding a mechanism for a distributed group of validators to reach
consensus on which transactions should be recorded and in which order on
the ledger” (Merkel, 2017). Unlike cryptocurrency, CBDCs will naturally
have a trusted party, the central bank. As a result, in this case, validators
would be known and authorized.
6 Gartner Hype Cycle: graphical representation for representing the maturity, adoption, and social application of specific
technologies. (Gartner, 2018)
7 Plateau of productivity is when “the real-world benefits of the technology are demonstrated and accepted. Tools and
methodologies are increasingly stable as they enter their second and third generation. The final height of the plateau varies
according to whether the technology is broadly applicable or benefits only a niche market.” (Gartner, 2018).

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• Encryption & Anonymity: This will need to range from complete to none.
Account-holder information will only be made available to law-
enforcement authorities and regulators if and when necessary. This will help
abolish concerns relating to money laundering, terrorism financing, and tax
evasion from privacy.
• Cyber-Security & Sustainability: This is the most compelling reason to why
a CBDC would need to use distributed ledger technology. “DLT would
offer a high level of operational resilience as there would be no single point
of failure” (Ali, 2013). In the event a validating party has been compromised
the consensus mechanism would ensure participants reject any phony
transactions. Financial technologies have a wide cyber-attack surface8
. DLT
safeguards against this attack surface with transactions having public
witness, making cyberattack difficult.
IV. Methodology and Objective Criteria to Introduce Digital Currencies
It is important for central banks and countries to determine exactly what criteria might motivate
them to issue a CBDC. In order to understand which criteria would be assessed we must first
understand what CBDC’s value to society is.
Money, as described above, can be defined as a medium of exchange, unit of account, or store
value. But there is something much more abstract that underpins and weaves these definitions
together and that is the idea of trust. Countries that experience low levels of economic trust are
positioned to benefit greater from the introduction of a CBDC.
2.2 CBDC Introduction Model (CIM)
A digital fiat currency would expand the money supply, M09
, and as a result it would lead
to an increase in the amount of money that people, and firms spend (GSU, Chapter 17,
Monetary Policy, 2017). This in turn would lead to an increase in GDP10
and an
environment where credit lenders would have more faith in transactions since they are
secure. Access to capital the bedrock to economic growth and is only possible when
environmental trust is high. As a result, trust in relation to a digital fiat currency can be
used as objective criteria in determining whether or not a central bank should introduce a
CBDC. Illustrated with the following model:
𝐼𝑛𝑡𝑟𝑜𝑑𝑐𝑢𝑡𝑖𝑜𝑛*+,* = 𝛼0 + 𝛽3(𝐶𝑜𝑟𝑟𝐼) + 𝛽7(𝑁𝑒𝑡𝐶) + 𝛽:(𝐶𝑟𝑅𝑖𝑠𝑘) + 𝛽>(𝑅𝐶𝑎𝑠ℎ ) + 𝜀B
8 The attack surface of a software environment is the sum of the different points where unauthorized user can try to enter data to
or extract data from an environment. (Tech Target, 2018)
9 Money Supply M0 is the most liquid measure of the money supply including coins and notes in circulation and other assets that
easily convertible into cash. Money Supply M0 and M1 are also known as narrow money (Trading Economics, 2018).
10 GDP = Money Supply x Velocity of Money (Trading Economics, 2018)

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Where:
at represents pre-existing level of societal trust
CorrI represents level of corruption in the country
NetC represents an internet connectivity index score
CrRisk represents country’s S&P500 credit default risk
RCash represents the country’s reliance on cash
ei represents the margin of error
2.2.1 Objective Criteria / Variables
Each variable is scored between 0 and 10 to create a potential overall aggregate
score of 40. The higher the score the greater the ROI on introducing a CBDC. The
lower the score the higher the level of disruption to the country’s economy.
(1) Corruption Score (CorrI): (data: Transparency Int’l Corruption Index)
closely associated with the overall level of economic development. The richer
the country, the less corrupt it tends to be (Figure 8).
(2) Internet Connectivity (NetC): (data: Huawei Global Connectivity Index)
Digital fiat currency hinges on strong internet connectivity and networks. This
is why CBDCs are more than ever a viable opportunity now.
(3) S&P500 Country Credit Rating Default Risk Score (CrRisk):
A combination of many variables, such as governance, structure, and growth.
Effectively evaluating the country’s overall default risk premium.
(4) Reliance on Cash (RCash): (data: World Atlas: Cashless Countries)
A low reliance on cash usually indicates strong banking institutions and an
economic ability to access capital from institutions.
2.2.2 Results
This model produces some interesting results (see Figure 9). Firstly, emerging
economies score higher illustrating a unique global growth opportunity. A stable
digital currency, such as a CBDC, would promote economic activity in these low
trust environments eventually making it easier to access capital for growth.
Secondly, developed nations exhibit a low reliance on cash. This indicates strong
banking and credit lending institutions. Raises the question: why would a central
bank introduce a CBDC if it would displace the financial sector? The answer is the
current fractional-banking reserve system is not without its flaws. With a CDBC
“central banks would be in a much better position to control credit bubbles, stop
bank runs11
, prevent maturity mismatches, and regulate risky credit/lending
decisions by private banks” (Roubini, 2018). Since disruption would be high a
public-private partnership is recommended in the introduction of a CBDC.
11 A bank run occurs when a large number of people withdraw their money from the bank (Investopedia, 2018).

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V. Financial Sector, Future Regulation, and Monetary Policy
5.1 Financial Sector
Banking institutions will need to find ways to innovate in order to mitigate potential
revenue loss from the introduction of a CBDC. Ways the banking sector could mitigate
potential revenue loss:
• Prepare for participation in CDBC System:
design services that could be offered within the CBDC system.
• Evolve Payment Cards’ Offer:
focus on features that will not be affected by a CDBC.
• Invest in domestic instant payments:
systems that will allow to offer payment solutions able to compete with CDBC
payment schematics.
• Expand Corporate Banking Services
fill revenue gaps that will arise in retail banking
5.2 Monetary Policy: True Price Stability
Central bank digital currencies can serve as a practically costless medium of exchanges, a
secure store of value, and stable unit of account. In order to achieve this CBDCs will need
to be interest bearing and the monetary policy target true price stability. “The interest-
bearing design would contribute to greater macroeconomic stability, because interest rate
adjustments would have the advantage of no longer being constrained by an effective lower
bound in response to sever adverse shocks. […] CBDCs will essentially eliminate the need
to maintain this inflation buffer, or to deploy alternative monetary policy tools such as
quantitative easing or credit subsidies” (Bank for International Settlements, 2018).
VI. Conclusion
In conclusion, the CDBC Introduction Model (CMI) helps determine which countries are set to
benefit the most from the creation of a CBDC. Ultimately, CBDCs based system would be a boon
for financial inclusion. Millions of unbanked people would have access to a near-free efficient
payment system through their cell phones. CDBCs are positioned to be an important catalyst in
promoting global economic growth, merits of blockchain technology, and financial sector
innovation.

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Figures
Figure 1: Taxonomy of Money
Source: https://www.bis.org/publ/qtrpdf/r_qt1709f.htm
Figure 2: New Forms of Currency
Source: https://www.bis.org/publ/qtrpdf/r_qt1709f.htm

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Figure 3: Value Volatility of Cryptocurrency: Bitcoin
Source: https://www.worldcoinindex.com/coin/bitcoin
Figure 4: How Blockchain Works
Source: https://blockgeeks.com/guides/what-is-cryptocurrency/

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Figure 5: Hype Cycle for Blockchain Business, 2018
Source: https://www.gartner.com/document/3884146?ref=exploremq
Figure 6: Distributed Ledger Technology (DLT)
Source: https://i2.wp.com/knowledgecrypto.com/

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Figure 7: Properties of Digital Ledger Technology (DLT)
Source: https://www.lpea.lu/2017/11/30/blockchain-unlocking-the-value-of-distributed-ledger-technology-in-private-equity/
Figure 8: Correlation of GDP and Corruption
Source: https://www.theatlantic.com/business/archive/2010/11/what-makes-countries-corrupt/66362/

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Figure 9: CMI Model Results
Countries considering central bank digital currencies (not an exhaustive list):
CMI CorrI NetC CrRisk RCash CMI Score
Venezuela* 7 6 9 8 30
Tunisia* 8 7 8 7 30
Senegal* 8 6 9 8 31
Marshall Islands* 6 6 7 8 27
Japan 2 8 2 2 14
Estonia 3 9 4 5 21
Germany 2 7 1 2 12
Switzerland 1 4 1 3 9
India* 9 8 8 9 34
Canada 2 4 2 2 10
Norway 1 6 1 2 10
Sweden 1 5 1 1 8
* = Developing Nation
Variables
(1) Corruption Score (CorrI):
closely associated with the overall level of economic development. The richer the country, the
less corrupt it tends to be (Figure 8).
(2) Internet Connectivity (NetC):
Digital fiat currency hinges on strong internet connectivity and networks. This is why CBDCs
are more than ever a viable opportunity now.
(3) S&P500 Country Credit Rating Default Risk Score (CrRisk):
A combination of many variables, such as governance, structure, and growth. Effectively
evaluating the country’s overall default risk premium.
(4) Reliance on Cash (RCash):
A low reliance on cash usually indicates strong banking institutions and an economic ability
to access capital from institutions.

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