Central bank digital currencies (CBDC) development and interest are growing rapidly worldwide but regulatory issues remain a challenge, especially for cross-border CBDC transactions.
But German IT company Giesecke+Devrient (G+D) – winner of Best Technology Award in the Hong Kong Monetary Authority’s Global Fast Track CBDC 2022 competition during the city’s FinTech Week in November – is upbeat about overcoming such challenges.
G+D’s project, Filia, is a retail CBDC solution described as a kind of cash equipped with smart features. Forkast spoke to the company’s Chief Evangelist Lars Hupel about how retail CBDCs could change lives.
The Q&A has been edited for clarity and brevity.
Ningwei Qin: Filia has been winning commercial pitching competitions in Singapore, Hong Kong, and Indonesia & BIS. What is your secret?
Lars Hupel: The secret is to have a good product. One of our unique selling points is the offline capability on a variety of devices – smart cards, wearable devices, and smartphones – that our product has. All of those can be used to transact with each other in a peer-to-peer fashion. This is what sets us apart from a lot of other providers.
Qin: Digital payments typically require an internet connection – like most experiences in mainland China. Can you explain, in a simpler way, how Filia can do payments offline?
Hupel: We have a token-based core protocol. A payment is essentially handing over one token to another person. If that person is online, they can either take the token or invalidate it with the central bank or the issuing authority.
This payment check can be deferred if you have a dual-offline payment – both payer and receiver offline. You store an auditable trail in a pseudonym, and the terminal can use it later once it regains online connectivity to validate the payment. Checks may happen at a different stage depending on whether you’re online or offline.
What we’ve read in the press and in research is that one of the main points is financial inclusion because there are a lot of underbanked people in mainland China.
Qin: So what benefits can retail CBDC bring to ordinary people? You mentioned CBDC and financial inclusion.
Hupel: Various reasons can contribute to lower financial inclusion. In some countries, there is high distrust in the banking system where people prefer cash for privacy reasons. And there are rural areas with just no bank branch available. And [there are] coastal residents who have little money but pay high fees to the bank.
We need a holistic approach to tackle that. Offline-capable payments address many of those issues. So in the token-based offline model, you can issue smartcards or some devices that do not require a banking bank account. I could go to an agent and give that agent cash, and that will convert it to CBDC and put it on my card.
Resilience is another topic. Many of these [online] electronic payment schemes will experience problems when there’s a network or power outage. That will also protect against or help in a natural disaster or a power outage.
Qin: Since we already have cash, why do we need retail CBDC?
Hupel: Cash also has problems. For many merchants, handling cash is quite expensive, and it can also be risky when transporting cash. If you have economies with a large informal sector with street vendors and wet markets, there are challenges to managing that cash.
You cannot use cash to pay online, but CBDC can. We’re not saying that retail CBDC should replace cash; we always say it complements cash.
Qin: What factors can affect a country or a city to adopt CBDC?
Hupel: I can disclose something about our project in Ghana. We had conversations with commercial banks and fintechs there. The private-sector [company] that we spoke with was eager to integrate with all the CBDC solutions to exchange mobile money for CBDC and build new products. We saw not so much a focus on risks but focus on the opportunities. It was nice to see that they had the idea that ‘we can use CBDC to reduce friction in our payments.’
Still, the pilot project is the perfect way to try it out. No central bank worldwide wants to launch a completely new thing the next day because it could risk the economy. So they typically go for restricted pilots first.
Qin: Will Hong Kong launch a retail CBDC?
Hupel: We are in a conversation with the Hong Kong Monetary Authority, so we’re happy to discuss the challenges and opportunities they see, especially because they also recently published this white paper on the e-HKD.
They made it very clear [in the white paper] that they don’t have a decision yet. Many of those more technologically advanced economies might try to evaluate safety.
So I say they [Hong Kong] might launch, but it might take a little while.
See related article: Hong Kong seeks use case to sell public on retail CBDC
Qin: How does the success in the commercial pitch competitions translate into real-world business opportunities with these countries and cities?
Hupel: I have no simple answer to that because there were various different points of interest in all the pictures we have done. If we look at emerging economies, they’re very interested in offline payments. In Brazil, they looked forward to the online payment aspect.
But if you look at countries in Southeast Asia, there is already a pretty big e-payments market, and there’s already lots of competition there. So the things we want to achieve are very different there.
So we look at partnering the private sector to build new and innovative solutions on top of the CBDC. We think of CBDC there as a common language substrate upon which the private sector can then build, and the central bank guarantees it. They make sure that the system is resilient and safe. But the central bank is not interested in disintermediation to take business away from the commercial players.
We’re focusing on partnerships and conversations with the private sector, so that they can form new business models like micro-lending. With CBDC, you can establish a credit history for people who were only using cash or programmable payments.
The success factor is that all of the central banks agree that, for CBDC to be successful, you need user adoption – this drives us there. Offline payments, for example, for informal merchants or for resilience, and making sure that it’s affordable and universally accessible. So being able to produce devices for reuse, existing devices where people can transact with.
Every time we go into a pilot project or enter discussions with the country, we start with the use cases first. We look at their market and say, well, you may already have mobile money in your country. How can CBDC incorporate mobile money? Or maybe you have a lot of credit card payments, where can we add value to that?
Qin: What will be the highlights of CBDC development in 2023?
Hupel: One of the biggest challenges in technology is performance. If you do a limited pilot in the country, you have a limited number of uses and machines, and you may get into the hundreds of transactions per second.
But if you want to scale up and base much of your economy on the CBDC system, it needs to be really robust and performant. There are various backend differences; some adopt decentralized ledger technology (DLT), and others use hybrid models.
From a technology perspective, what will be exciting is how those solutions can be scaled up and how we can end up with five or even six-figure transactions throughput per second.
Qin: What do you think about cross-border CBDC payments? What are the challenges of cross-border CBDC?
Hupel: In some African countries, when immigrants send money from abroad to their families in the country, the currency pairs traded may not be so liquid and you have to go through multiple intermediate banks, which incurs a lot of fees. The process is also very long, and there are many regulatory frictions in the middle.
The instant settlement cooperation of multiple central banks in a CBDC network is one angle to reduce this friction.
Payments through CBDC are settled immediately. But another problem will come, that is the issue of regulatory screening. So a cross-border payment via CBDC may come under greater scrutiny than a domestic payment.
In that respect, as a community, we still need to figure out better standards on how that can be addressed in a cross-border fashion.
Once again, regulatory challenges are still challenging.
See related article: mBridge participants to end domestic payments of foreign CBDCs