With the Hong Kong Monetary Authority (HKMA) working to lay the foundations for the potential implementation of a central bank digital currency (CBDC), 16 firms, including HSBC, will conduct a series of pilots in an effort to deep-dive into proposed use cases under the HKMA’s e-HKD Pilot Programme. The programme allows HKMA to collaborate with the industry to examine innovative use cases and maximize Hong Kong’s readiness for a potential e-HKD. 

HSBC plans to conduct two pilots in the coming months. One is a hypothetical e-HKD payment ecosystem at The Hong Kong University of Science and Technology (HKUST), leveraging the university’s research and its campus environment. HSBC will invite hundreds of participants to perform real-time transactions to prove various potential social and economic benefits, such as reduced fraud, improved rewards mechanism, and a more efficient payment rail. 

The second is an initial tokenized deposit capability through collaboration with Visa and Hang Seng, studying the viability, key design considerations and interoperability of commercial bank-backed deposit tokens as an additional mean of issuing digital currencies.

Since the announcement, there has been notable interest in the subject with numerous questions raised. This article tries to address some of the most frequently asked ones.

What is a Central Bank Digital Currency (CBDC)?

A CBDC is a digitized form of banknotes and coins, also referred to as fiat money, issued by the central bank of a market and accessible by the public. It can, and often does, use Distributed Ledger Technology (DLT) – blockchain is one such example – but other types of technology can also be used. Its value is equivalent to existing currency, as it is it issued by and a direct liability of the central bank. 

How are CBDCs different from other digital currencies, including cryptocurrencies?

There are multiple types of digital currencies, each with unique characteristics. It is worth noting that there isn’t yet a single standard model of a CBDC implementation, which can vary from market to market.

CBDCs and cryptocurrencies are different, although they can use the same underlying DLT technologies. Cryptocurrencies are privately issued and often decentralized, while CBDCs are fully regulated by a central authority and backed by the central bank. CBDCs are formal market currency, intended to be used for payments and be managed by the existing financial system. Cryptocurrencies have a range of use cases, including payments and/or other utilities. They have also been the focus of speculative investment by their users, which is why the value of a cryptocurrency can fluctuate, often significantly, depending on market forces.  

On the other hand, the value of a CBDC is equivalent to existing currency value.

Another form of digital currency are stablecoins, which are a specific type of private, stabilized cryptocurrency often pegged to another currency or financial instrument with the goal of maintaining a 1:1 value with the applicable currency. Stablecoins are a liability of a private entity issuing them (e.g. Circle for USDC) and remain subject to risks associated with the backing assets that maintain the stablecoin value.

How are CBDCs different from digital forms of payment, such as digital wallets, credit cards, FPS etc.?

Financial institutions and payment providers supplement physical money with a model that records balances and transactions digitally, for example through bank accounts or digital wallets like PayMe or Octopus. 

A CBDC would be different because a CBDC would be a liability of a central bank, whereas digital money is a liability of a commercial bank (e.g. HSBC) or an institution providing digital payment services (e.g. Octopus). 

In addition, CBDCs can potentially offer several unique features, primarily leveraging the new technologies that underpin digital currencies:

• Programmable money: digital currencies can be programmable to be purpose-bound and/or time-bound, or to be used or transferred under specific terms and conditions. This capability can be applied to a variety of scenarios, such as preventing fraud or improving the impact of government subsidy distribution. 
• More efficient payment rail: CBDCs could provide faster finality of payments, with more capability to support automation on chain rather than batch jobs, remove some intermediary services involved in servicing electronic payments. 
• Offline payments: An offline CBDC offers users benefits such as enhanced resilience and better accessibility features. It enables transactions without the internet while still allowing online purchases when internet connectivity is available.
• Financial inclusion: CBDCs have the potential to bank unbanked populations and boost financial inclusion.

Would the widespread adoption of CBDCs be an evolution or a revolution for how we think of currency? 

Broadly speaking, it will be an evolution of how we think of money, as central banks are taking a very prudent approach towards CBDCs. Among their considerations, financial stability in the system is paramount. Fundamentally, CBDCs would be used as the safest form of payment, just like today’s currency is. However, it may be a significant change in the way public money is issued and managed, as it uses fundamentally different technology with unique features (e.g. programmability) that today’s currency does not have.

How can a CBDC empower small businesses compared to today’s solutions?

Among the biggest beneficiaries could be SMEs, the engine for economic growth in much of the world. The burden of today’s long settlement times often falls disproportionately on smaller enterprises, squeezing cash flow and blunting their competitiveness. If well designed, CBDCs payment approaches could help ease some of these pressures. 

Firstly, the underlying technology can allow for instant settlement and a more efficient payment rail. This may also result in lower fees paid by small businesses to e-payment solutions available today, thus making it a preferred choice for accepting payments. 

Secondly, the programmable features of CBDCs mean merchants may have the ability to issue coupons in real-time and monitor the use of those coupons in real-time, but also to reduce fraud. We will be testing these hypotheses in the HKUST ecosystem.

How are CBDCs addressing privacy concerns?

Central Banks are looking to strike a balance between offering adequate levels of data privacy to users and providing authorities with the information necessary to conduct, for example, anti-money laundering or know-your-customer checks. What matters are governance structures, and trust that data is not being mishandled or misused. 

Bojan Obradovic, Chief Digital Officer Hong Kong at HSBC