The Future of Payments? To CBDC or Not to CBDC. That is the question
Let me state one thing, before we start … a digital currency is not a cryptocurrency — it is the equivalent of fiat currency, but in a digital form. Before reading the rest of this article, you need to understand this concept. It is not a stablecoin or tethered, either. Basically, it all relies on the trust that central banks have built up in their fiat currency over the centuries and translates this to digital wallets (rather than paper-based approaches).
With a stable coin, we have a cryptocurrency where (it is hoped) there are enough reserves to pay everyone back, whereas a Central Bank promises to pay the bearer for the fiat currency (and hopefully has the reserves to pay for this). All that happens with a CBDC is that, rather than transferring paper money (either physically or electronically), we now have it in a digital form, and public key encryption confirms the transaction. In the following, Alice transfers funds to Bob, and signs the transaction with her private key, and then this will be verified with her public key. The Central Bank and Alice’s bank will store her public key. In the end, the Central Bank will approve or not, the transaction:
The move to the Digital Pound?
So, I was at the Bank of England today to discuss the potential move towards a digital fiat currency for the UK pound:
The catchy name of digital fiat currency is a CBDC (Central Bank Digital Currency), and it isn’t a cryptocurrency and it isn’t a stable coin. Essentially, it’s paper money that’s available in a digital form. This currency is then issued by the central bank rather than by a commercial bank.
Overall, we have two modes: a retail mode (where citizens and businesses can use it to make transactions), and a wholesale mode (where financial institutions can use it for their reserves). In most cases, in retail mode, the central bank issues the digital fiat currency and manages it centrally. With this, Alice will have a digital wallet with her bank (known as a Payment Interface Provider), and which then interfaces to an API layer in the Central Bank, and which will authorise the transaction or not:
In many cases, a CBDC will not utilise distributed ledger technology (DLT), although several models incorporating these technologies exist, such as OpenCBDC [1]:
For many, the greatest worry about CBDCs is that a government can track the transactions of their citizens and businesses. The approach of OpenCBDC is to use a UHS (Unspent funds Hash Set), and which is a Zero Knowledge Proof (ZKP) to show that a customer has enough digital fiat currency to pay for something:
But, without these ZKPs, the central bank will be able to monitor the transactions made by citizens (and possibly block them). The many reasons for this are typically related to protecting against fraud and where the banks must run AML (Anti-money laundering) and KYC (Know Your Customer). In a CBDC, without privacy-aware methods, we can move the checking from the banks to the central bank.
Within a more privacy-aware infrastructure, the banks would create Zero Knowledge Proofs for the transaction, and where the Central Bank then approves it or not:
The CBDC in China
One of the most interesting implementations of a CBDC is in China, and which deploys E-CNY — the digital Yuan. It is also known as the Renminbi (RMB) and means “People’s Currency” in Mandarin [2]. Overall, it is issued by the People’s Bank of China (PBoC) — the Central Bank of China. In order to keep control of their currency, the Chinese government banned cryptocurrency exchanges in 2017 and transactions in 2021. Around 2020, the PBoC created a digital currency (e-CNY) and which is pegged against the Yuan.
One of the key pilots involved the city of Suzhou and where public sector employees received their salaries using the digital currency. As a starting point, in January 2021, the PBoC gave RBM 200 (US$30) away to 100,000 people (and selected through a lottery system), and asked them to spend it. Those who won the lottery were also given their winnings in e-CNY, and could spend this in thousands of shops. Another key feature of the trail was the use of offline payments, where e-CNY could be transferred simply by bringing smartphones close to each other, or by scanning QR codes.
Overall, there was no need for an Internet connection, and thus, an offline payment system was tested. This trial used digital wallets provided by Huawei Technologies Company and Vivo Communication Technology Company. The test involved integration with the four largest state banks in China (Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial and Commercial Bank of China) and the largest telecom companies in China (China Telecom, China Mobile and China Unicom). Overall, there was no need for users to have an account with the major banks.
Currently, it is only available in 29 pilot areas, and cannot be accessed outside these regions (and where the GPS location of the smartphone is monitored). The roll-out of e-CNY has managed to achieve around two million wallets created, with another 700,000 merchants accepting it. In the 2022 Winter Olympics in Beijing, it was actually one of the three accepted currencies for payments.
China is actually one of the most digitally payment-aware countries in the world, and where 93% of all payments are digital. It is likely that cash transactions in China will fall to around 3% of the total transacted by 2027. For citizen engagement, e-CNY has generally struggled to gain adoption and mainly because Alipay and WeChat are so popular. The actual fee paid by the merchant on Alipay and WeChat is only around 0.55%, while credit cards can charge up to 3.5% of the transaction value. One significant development is that deposits for Alipay and WeChat have shifted away from commercial banks and into the central bank. Perhaps this is due to the deposits being more resilient against bank runs.
Offline payments, banking the unbanked
One of the core objectives of the advancement of the e-CNY is to help the “rural poor” — and the unbanked — with more opportunities to transact digitally. Overall, it is thought that there might be around 700 million Chinese citizens who do not have a smartphone or have Internet access. For this, a e-CNY hard card wallet was developed, and which allowed for payments without the need for a smartphone or an Internet connection [here]:
In this first set of trials, a small screen at the top right-hand corner of the card showed the amount of e-CNY left.
In the likely model for the digital pound, there is an interaction between the central bank and the transacting parties (Bob and Alice). In some circumstances, there could be no Internet connection, and thus, there needs to be an offline transaction. This type of transaction will likely require a secret enclave to be set up on a hardware payment device so that the transaction cannot be tampered with.
Banking infrastructure
There is a two-tiered architecture with the PBoC issuing currency to large commercial banks, and then they distribute this to the smaller banks. Customers of the banks can then create a digital wallet and make peer-to-peer payments (typically using a merchant-created QR code). By 2023, there were around 10 million merchants accepting e-CNY, but the adoption has been fairly low, and where, in 2023, it only accounted for around 0.16% of all the money in circulation. For the first four years of the digital currency, there were around $1 trillion in transactions and with less than a fifth of the population using it at all. If we compare this to Alipay and WeChat, they account for around $70 billion in transaction value in a single year.
To speed up the adoption of e-CNY, the PBoC does not charge fees for settling transactions and customers are not charged a fee (institutions, though, can be charged). The PBoC is also now investigating whether the digital currency will pay interest (as no interest is charged at the current time). So, as the digital currency does not gather interest, there are very few incentives for customers to keep funds in their wallets.
Cross-border payments and smart contracts
One core use case for the e-CNY seems to be for cross-border business-to-business transactions and bank settlements, and which is supported by the Project M-Bridge for wholesale CBDCs to interface with other central banks. This has the advantage of avoiding fiat currency conversions, and especially avoiding US dollar conversions.
Programmabllity
Most current models must have the full state transition of a transaction to be in-place for a transaction to go ahead (to avoid double spending). Within contract implementations, there may be intermediate states that allow for the digital pound to exist in an intermediate state awaiting an event. For example, Bob might commit to paying Alice for a new car, but she will not accept shipping the car until Bob commits the funds. Once she ships the car, the funds will then stay pending until Bob confirms its receipt. This smart contract associated with the transaction would thus need to store the state of the intermediary state, and not release the funds to Alice until there is a digital proof of receipt from Bob (Figure 6).
Privacy, what privacy?
For privacy, there is a citizen identifier included in the Central Bank infrastructure, and where banks require a SIM-linked identifier. While a distributed ledger (DLT) was initially experimented with, the central bank now runs a centralised ledger. The source code, too, for the centralised ledger is also private and is not available for review. It is also likely that the Central Bank knows how much digital currency is in each wallet and could even transfer funds between them. The overall approach seems to be for “anonymity for small-value and traceability for high-value transactions”.
At the current time, the data revealed for a P2P transaction is:
and for a retail transaction:
An MIT paper [here] outlines a method of using a digital certificate to identify valid customers. This certificate could be used for each of the transactions, and which would anonymise the customer. Parts of this certificate could then be proven to the PIP whenever a transaction is made. This might relate to “I am a client of this bank” or “I am over 21 years old”.
We can also have exceptional circumstances where a true identity is required. With this, it is possible to set up escrow IDs, and where Alice could encrypt to the public key of an auditor. On an investigation, it would be possible to trace back to the audit, and who would then reveal the identity of Alice. The cybersecurity of this would be the storage of these public key identities in a centralised database, and thus risk data leaks on the connections between auditors and their customers.
Denial of service attacks
In a model where Bob and Alice own their private keys, there are no fees for a payment. This means there is no cost to support payment transactions, which means that it could be susceptible to a Denial of Service attack against the infrastructure, as it will not cost anything to flood the system with valid and invalid transactions. Likely mitigations here are rate-limiting, and the enforcement of a cool-off period before money can be spent on another transaction. Along with this, there could be proof-of-work transactions (such as computing a hash value of a given complexity for each transaction), or fees charged for a given volume of transactions.
Quantum resistance
Existing public key encryption methods — such as ECC and RSA — are at risk against quantum computers. The infrastructure that we create must be resilient to a medium-term attack against transactions. Currently, NIST has defined that Dilithium, FALCON and SPHINCS+ are the preferred solutions for digital signatures, and should replace RSA and ECDSA signatures. For key exchange, Kyber is recommended as a replacement for ECDH. It is likely that any digital currency will support these methods, alongside existing public key methods — but will migrate in time to the post-quantum robust methods.
Conclusions
So, will there be a digital pound? Well, we will have to wait and see. Perhaps Visa and Mastercard are charging way too much for merchant fees, and the rise of a digital pound may be one way to reduce these. One thing that is for sure is that the future of payments is not cash — it is digital!
Key takeaways from the trials and roll-out in China:
- China are really pushing their CBDC (e-CNY), but citizens still love Alipay and WeChat (and which are charging merchants much less than Visa and Mastercard for transactions).
- China is much more of a cashless society than the UK, and much more digitally payment aware (with QR code payments being common).
- Interesting trials in off-line payments for the “unbanked” and non-Internet-connected.
- China wants to keep control of its currency (and has banned cryptocurrency), and which is possibly one of the main use cases for a CBDC for the digital pound for the Bank of England (along with stimulating innovation).
- The wholesale market, banking reserves, and interbank transfers (not involving the dollar) are possible core use cases at the current time. China perhaps want to increase its dominance in these areas.
The downsides are:
- Likely to use a centralised ledger, and not a distributed one.
- Loss of privacy, and where the Central Bank could possibly see the wallets, unlike Zero Knowledge Proofs (ZKPs) which can be applied to the transactions on the central ledger.
- No interest is paid on digital wallets.
- No fees charged for citizen transactions — banks will say, “What’s in it for us?”.
- Programmability of digital currencies with smart contracts still seems quite a way off.
- There are many concerns around the cybersecurity aspects of the API integration and the openness of the central ledger.
To improve privacy:
- Use an anonymisation layer to convert citizen and transaction details into a Zero-Knowledge Proof.
- Use homomorphic encryption to check and match person details.
- Use escrow ID for citizens and/or digital certificates to prove the rights to transact.
References
[1] Lovejoy, J., Fields, C., Virza, M., Frederick, T., Urness, D., Karwaski, K., … & Narula, N. (2022). A high performance payment processing system designed for central bank digital currencies. Cryptology ePrint Archive.
[2] Chin, G. T. (2025). China’s ‘digital renminbi’(e-CNY) as financial inclusion: the global frontier of central bank digital currency. Global Public Policy and Governance, 5(1), 63–81.
