Central Bank Digital Currencies: Needs, Challenges and Implementation Analysis

1. Introduction

The COVID-19 pandemic has accelerated the shift toward digital payments, with contactless payment growth reaching nearly 70% in Serbia during the first year of the pandemic. Cash usage in Europe has declined by one-third between 2014 and 2021, with Norway reporting only 3% of total payments in cash. This rapid digital transformation has compelled central banks worldwide to explore Central Bank Digital Currencies (CBDCs) to maintain monetary sovereignty and financial stability.

2. Incentives for CBDC Development

2.1 Monetary Sovereignty Preservation

Private sector initiatives like Bitcoin (created 2008-2009) and other cryptocurrencies threaten central banks' monopoly on money creation. The emergence of stablecoins and private digital currencies could fundamentally reconstruct the monetary system, challenging the existing financial order that delineates between central bank-issued money (outside money) and privately created money.

2.2 Technological Disruption Response

Central banks must adapt to technological changes affecting economic activity and public behavior. The growing public interest in digital assets, combined with declining cash usage, creates both pressure and opportunity for central banks to innovate while maintaining control over monetary policy transmission mechanisms.

3. Design Challenges and Dilemmas

3.1 Architecture Models

CBDC design involves critical choices between retail (general public access) and wholesale (interbank) models, as well as decisions regarding distributed ledger technology (DLT) implementation versus centralized systems. The trade-off between privacy and regulatory compliance presents significant design challenges.

3.2 Financial Stability Risks

The introduction of CBDCs potentially opens risks for existing financial institutions, particularly commercial banks that may face deposit disintermediation. During financial stress, the ease of converting bank deposits to risk-free CBDCs could accelerate bank runs, requiring careful design of holding limits and conversion mechanisms.

4. Implementation Framework

4.1 Technical Specifications

CBDC systems require robust technical infrastructure capable of handling high transaction volumes while ensuring security and resilience. The monetary policy transmission through CBDCs can be modeled using modified Taylor rule frameworks:

$i_t = r_t^* + \pi_t + \alpha_\pi(\pi_t - \pi_t^*) + \alpha_y(y_t - y_t^*)$

Where $i_t$ represents the policy rate, $r_t^*$ the natural rate of interest, $\pi_t$ inflation, and output gap $(y_t - y_t^*)$.

4.2 Operational Models

The two-tier operational model, where central banks issue CBDCs but commercial banks handle customer-facing services, appears most viable. This approach preserves the role of existing financial intermediaries while leveraging their distribution networks and customer relationships.

function validateCB DCTransaction(transaction) {
  // Verify digital signature
  if (!verifySignature(transaction.signature, transaction.publicKey)) {
    return {valid: false, error: "Invalid signature"};
  }
  
  // Check balance sufficiency
  let senderBalance = getBalance(transaction.sender);
  if (senderBalance < transaction.amount) {
    return {valid: false, error: "Insufficient balance"};
  }
  
  // Validate against holding limits
  if (exceedsHoldingLimit(transaction.receiver, transaction.amount)) {
    return {valid: false, error: "Holding limit exceeded"};
  }
  
  // Anti-money laundering checks
  if (amlRiskDetected(transaction)) {
    return {valid: false, error: "AML risk detected"};
  }
  
  return {valid: true, transactionId: generateId()};
}

5. Critical Analysis and Future Outlook

6. References

1. Bank for International Settlements. (2023). Annual Economic Report 2023: CBDC Developments. BIS Publications.
2. European Central Bank. (2022). Digital Euro: Design and Policy Considerations. ECB Working Paper Series.
3. Lukic, V., Popovic, S., & Jankovic, I. (2023). The Need and Challenges of Central Bank Digital Currencies Introduction. Proceedings of the Faculty of Economics in East Sarajevo.
4. People's Bank of China. (2023). Digital Yuan Pilot: Progress Report. PBoC Official Documentation.
5. Federal Reserve Board. (2022). Money and Payments: The U.S. Dollar in the Age of Digital Transformation. FRB Discussion Paper.