Central bank digital currencies (CBDCs) are on the rise. Numerous countries, such as China and Sweden, are already working on specific CBDC prototypes. A special form of a CBDC is a synthetic CBDC (sCBDC). In the case of an sCBDC, often also called a hybrid “CBDC”, the CBDC system is not managed directly by the central bank, but a large number of operational tasks are outsourced to institutions in the private sector, such as e-money institutions. In the case of an sCBDC, the money issued is 100 percent covered by central bank reserves.
In this guest post, Jonas Groß and Anna Maria Bracio explain such an sCBDC system and compare it with a “classic” CBDC system
An sCBDC is a form of digital central bank money that is structured in a public-private partnership. E-money providers get access to central bank money – in the form of central bank reserves – and secure the corresponding e-money 100 percent with central bank money.
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But first things first: What is e-money anyway? The Bundesbank defines e-money as
any monetary value stored electronically, including magnetically, in the form of a claim against the issuer, which is issued against payment of a sum of money in order to carry out payment transactions within the meaning of § 675f para. 1 sentence 1 BGB, and also from other natural or legal persons are accepted as the issuer.
E-money is often stored either on prepaid cards or mobile phones. If a mobile phone is used to store e-money, the user pays the money that he wants to convert into e-money – typically via an app – to the e-money issuer. The user then receives e-money units credited to his mobile phone via the app.
How is e-money issued?
In order to be able to legally offer e-money services, the European Central Bank (ECB) and BaFin must first grant the e-money institute (EMI) permission to issue e-money. Compared to other financial services, e-money usually proves to be convenient, as e-money institutions typically have more experience in the field of user-centered design and the integration of e-money applications into social media (Adrian, 2019). In addition, transaction costs are usually relatively low and trust in e-money institutions is higher in some countries than in banks (Adrian, 2019).
Figure 1 illustrates the process of issuing e-money. The e-money issuer and the end customer act as the main actors. The end customer intends to hold a certain amount of money in euros as e-money units. The EMI creates digital e-money and exchanges giro money (bank deposits) at a ratio of 1: 1 into e-money units.
It should be noted here that EMIs are not allowed to grant loans with corresponding interest rates. EMIs primarily generate income from fees charged for converting units into e-money. They keep the end customers‘ money mainly in the form of bank deposits in one or more collective accounts (Adrian, Mancini-Griffoli, 2019). In this way, there is a certain counterparty risk: The EMI’s bank deposits, which consist of the individual contributions of the end users, can fail if the partner banks run into corresponding payment difficulties. In addition, there is also a risk of failure of the EMI itself (Adrian, Mancini-Griffoli, 2019).In order to increase the trust and security of the end users, the e-money institution can set up a trust fund into which it pays the end users‘ euro units. In this case, the trustee holds and manages the deposited money.