On 27 April 2022, the Hong Kong Monetary Authority (“HKMA”) published a discussion paper “e-HKD: A policy and design perspective” (the “Paper”), inviting views on key policy and design issues for introducing a retail central bank digital currency (“CBDC”), known as e-HKD. This article summarises the key points of the Paper.
What is CBDC?
CBDC is money issued or backed by the central bank that is both electronic and accessible by the public (i.e. the electronic version of coins and notes). It has the potential to have functions (e.g. cryptography) depending on design and technical feasibility. It is distinguished from crypto-assets as it is issued and backed by the central bank – as such, its market price is less volatile.
Benefits of retail CBDC
(1) Improving the availability and usability of central bank money
Generally, retail CBDC would increase the availability and usability of central bank money- enabling it to be used in ways beyond physical cash. It will also promote financial inclusion- with retail CBDC, those without a clearing account with the central bank and those in underbanked communities will be able to use central bank money.
Notwithstanding the above, in Hong Kong, physical cash in circulation remains sizeable and the unbanked population in small. Thus, the aforementioned benefits may not be very compelling in Hong Kong.
(2) Positioning for the challenges of new forms of money
Given the rising prominence of stablecoins (read our article on HKMA’s discussion paper here), there is a possibility that the role of the domestic currency as the single unit of account would be undermined. Furthermore, if stablecoins become widely used in Hong Kong, the control of central banks over local monetary conditions may be undermined as well. That said, while the widespread use of stablecoins in Hong Kong is remote, the HKMA is of the view that Hong Kong should gear itself for future challenges. e-HKD could help the HKMA support the continued use of the Hong Kong dollar and reduce the risk of alternative units of account dominating.
(3) Supporting innovation and meeting future payment needs in a digital economy
Retail CBDC could offer and enable greater innovation in payments and payment-related digital services. A programmable retail CBDC could enable innovative applications in the digital economy (e.g. smart contracts to facilitate automated payment), it could also facilitate the provision of fiscal subsidies to the public.
That said, the potential benefits would come with risks and challenges- for example, dependency on external data sources for smart contracts could cause vulnerabilities in the integrity of the system if such sources are compromised.
(4) Improving resilience and efficiency of the payment system
While additional payment methods with alternative design features can help support the operational resilience of payment systems, this benefit is less relevant to Hong Kong as local electronic payment systems are highly resilient and efficient, with disruptions being very rare.
(5) Reinforcing the transmission of monetary policy
In theory, remunerated retail CBDC could reinforce the transmission of monetary policy to the real economy. Retail CBDC could also relax the effective lower bound on policy rates and allow them to become more negative. These benefits are not very relevant in Hong Kong as:
- remunerated e-HKD would differ from unremunerated physical cash, raising public communication challenges about the equivalence of e-HKD with physical cash;
- to strengthen monetary policy transmission, remunerated e-HKD must be in widespread circulation in order to influence bank interest rates, but doing so would lead to a greater disintermediation of banks; and
- in the scenario where a negative interest rate policy is warranted, the continued existence of physical cash would mean that the public could still hoard cash, which would undermine the effectiveness of direct monetary policy transmission through remunerated e-HKD.
Potential challenges of retail CBDC
- Implications for bank funding and its consequences
Potential holders of e-HKD may need to switch funds out of their deposit accounts for retail CBDC, which would affect the balance sheets of commercial banks and lead to disintermediation of banks. Further, as e-HKD would be part of the Monetary Base, the designated distribution banks would be required to submit USD to the HKMA for the right to make e-HKD available to the public amid the fall in banks’ retail deposits. If the substitution from deposits to e-HKD is significant, this may lead to disintermediation of banks.
- Increasing cyber security and software risks
The retail CBDC system could be an attractive target of cyber attackers. The e-HKD system would face risks such as distributed denial-of-service attacks. Apart from the risks arising from the payment system itself, there are also cyber risks associated with the adoption of smart contracts.
- Increasing economic vulnerability to power/network outages
Reliance on electricity and data network systems would mean that economic activities would be disrupted during power/network outages, albeit the low possibility of such events.
Design considerations of e-HKD
- Issuance mechanism of e-HKD
- Banks submitting USD in exchange for e-HKD (Coins approach);
- Banks submitting USD in exchange for Certificate of Indebtedness (CIs) (Banknote approach); or
- Banks converting existing Aggregate Balance (AB) into e-HKD (AB approach).
- Interoperability with large-value and retail payment systems
The design of e-HKD should avoid creating a closed-loop payment system which impedes payments made between e-HKD users and users of other payment systems.
- Privacy and data protection
- A key consideration is whether e-HKD should be token-based or account-based.
- The e-HKD system should at all times comply with the Personal Data (Privacy) Ordinance and relevant codes of practice, guidelines and best practices issued by the Office of the Privacy Commissioner for Personal Data from time to time.
- Legal considerations
- The legal mandate and legal tender status of e-HKD would be expected to align with that of existing Hong Kong currency in the form of currency notes and banknotes issued under the Legal Tender Notes Issue Ordinance, and coins issued under the Coinage Ordinance.
- There is a need for anti-money laundering/counter-financing of terrorism controls.
- It would seem logical that ownership should pass upon “delivery” – and the point of delivery (in the absence of physical possession) may fall to be determined by reference to the “ledger” technology used to record the transfer of e-HKD.
- Consideration should be given to any benefits of adopting criminal law protections (a “digital equivalent” of current anti-counterfeiting provisions) to protect and bolster confidence in the e-HKD.
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