What we can learn about wCBDCs from Costco

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TL;DR Wholesale CBDCs are meant to make the payments system run faster under the hood

When you go to Costco, you’re making the decision to buy from a wholesale market instead of your usual retail corner store (well, technically a warehouse store). The appeal of Costco is that the products you find there are low cost and you can buy in large quantities.

If you think of money as a product, CBDC is an additional type of money that you can only use if you’re a central bank account holder. While it is still at the testing phase, early indications are that it would come in two types – retail and wholesale. Each has a different user base with their own preferences and requirements. Retail CBDCs, like retail grocery stores, would have a larger user base which could include corporates and individuals. Wholesale CBDCs (wCBDC) are a little different. They’re intended to improve the payments infrastructure, which means they have a predefined user base of institutions involved in payments like banks, clearing institutions and other payment service providers.

So where’s the tie-in to a bulk goods store?

You can think of wCBDCs as the financial system’s equivalent of Costco. They are similar in three ways. First, users have to have an account to use them. In the same way as Costco requires a membership account to enter, wCBDCs will require that you are an account holder at the central bank. Second, both deal only in large transaction sizes. Finally, the draw of both wCBDC and Costco are their low operational costs and processing efficiency

These three features give us some surprising insight into why wCBDC are going to affect our day-to-day lives. Let’s go into more detail

You need to be an account holder

To shop at Costco you have a member account. The store doesn’t really care how you pay for your items – credit card, cash, nickels, anything is fine. But before you even walk in the door, someone will confirm that you are an account holder with Costco. This is because only members are allowed to shop there.

This design decision sets Costco apart from retail grocery stores. At your local grocery, no one is particularly interested in checking your identity. Instead, they are concerned more with verifying that you’re not trying to pass a fake $100 bill or using a stolen credit card. Since they don’t have information about you, they gather information on the token of payment you present.

These two different models of operation have specific terminology – Costco uses an account model, and every other grocery store uses a token model. This also turns out to be one of the fundamental CBDC design decisions. Central banks need to decide if they will issue CBDCs using an account model like Costco – where you verify the identity of the payer before the transfer happens; or a token mode like the regular grocery store – where they don’t care who you are, but verify the validity of the object you use to pay.

For wCBDCs, most central banks are leaning towards using an account model. In other words, if you want to use a CBDC, you need to be an account-holder at the central bank. This makes it relatively faster to deploy since there are already a set population of institutions that are allowed to have an account there.

 There are going to be some large transactions

The second feature that sets Costco apart from your corner grocery is the size of your receipt when you leave. You might dip into the corner store for a $1.10 can of black beans, but on your average Costco trip, you leave with a $140 bill.

In the same way, wholesale central bank transactions are considerably larger than something you’d execute using your checking account. Your average Zelle payment is about $258, while the average value per transfer on Fedwire was $4.6 million. Because wCBDCs are intended to be used for wholesale transactions – which refers to transactions which the banks conduct with each other – we can expect that the amounts will be very large, in contrast to a retail CBDC in which consumers are doing smaller day-to-day transactions.

The characteristic of large transaction sizes mean that wCBDC will have a significant impact on the domestic payments system simply as a result of deployment. If large transactions can be settled with finality, this would improve the overall resilience of the domestic payments system. Consider how the volatility of bitcoin makes people reluctant to use it for payments, if that type of volatility were present in the payments infrastructure, the economy would grind to a halt.

Beyond system resilience, efficiency is a third important feature of wCBDCs that corresponds directly with our Costco experience.

Simplified logistics creates efficiency

Costco curates a positive customer experience by designing a more efficient supply chain. Compared to a retail grocery store, there are fewer items, no frills, and the goods are jammed into the aisles in the pallets they were shipped on. By reducing the number of touch-points in the supply chain, Costco creates a smoother overall experience. You never see these efforts, but you benefit from them.

In the same way that you don’t have visibility into the supply chain challenges that Costco faces getting products into its stores, you’re probably not aware of how settlement happens in the financial system. Often it requires complex counter-party workflows. wCBDCs are intended to create efficiencies in the settlement infrastructure that supports payments. This could include faster settlement of interbank transfers, cross-border transfers with lower fees and lower foreign exchange risk, and a more robust unit of exchange that allows for the programming of policy. More efficient settlements means that there will be more liquidity in the system overall, which can free up payments service providers to offer new services and products to consumers.

The main impact on you: a more convenient and secure payments system

Every time you make a payment with a credit card or Venmo, you’re interacting with the national payments infrastructure. This can be shockingly slow. This is why after you return that wool coat you bought online, it takes a week or more for you to see the refund on your credit card.

The lag is caused by the settlement process that happens behind the scenes. Financial institutions (like banks and your credit card company) settle up with each other via their accounts at the central bank. The current exchange process uses electronic central bank money and a set of steps that make it slow, expensive and introduces some risk. wCBDC would attenuate the risks while accelerating the settlement. Better overall payments system efficiency would make all of our lives a lot easier, while allowing unique new forms of conditionality of payments.

What this changes in your life

 wCBDC is under development today. It won’t directly impact your activities. But it has some important features that will smooth your experience with payments today.

  • Faster (or event instant) settlement at the infrastructure level means lower costs for you when you make a payment
  • Everyone likes more choice. wCBDC for financial institutions will diversify the number of money products available in the monetary system