As many central banks undertake initiatives to implement digital currencies and new payments systems, many are looking to include offline functionality as a key feature. According to a survey conducted by the Bank for International Settlements Innovation Hub Nordic Centre, 98% of central banks consider offline payments for retail CBDC either vital or advantageous.
It seems that offline payments will be very complex to implement. According to OMFIF’s 2023 Future of payments survey, 69% of respondents view offline payments as a challenge to implement, with 41% viewing it as the most challenging feature. Implementing offline payments could possibly compound the already difficult process of setting up the infrastructure for a central bank digital currency. Central banks will need to ensure that the technical, operational and security architecture can support payments both online and offline. This will be especially difficult due to the differing requirements for offline and online systems.
How much more complex and costly will it be to implement offline payments functionality to address existing issues, such as financial exclusion or a lack of developed communications infrastructure?
Offline payments could deliver many benefits
The benefits of implementing offline payments are clear – enhancing payments system resilience, financial inclusion and cash resemblance. Central banks will prioritise these benefits differently, depending on whether they come from emerging or developed markets.
Offline functionality might also be a crucial tool for achieving digital financial inclusion by guaranteeing universal access to the unbanked, those from remote areas or from areas without adequate infrastructure. This issue is especially salient for central banks from emerging markets, where 34.5% of respondents from the BIS Innovation Hub survey deem offline functionality vital, while this share is only 14.5% of respondents from developed markets.
Issues regarding resilience may also be more pressing for emerging markets, but still can still apply to developed markets. Offline payments could ensure the public’s access to basic payments in the event of a widespread system failure. Users could continue to transact if a temporary network failure or power outage occurs. For crisis situations, such as conflict or natural disasters, offline functionality may also function as a civil contingency measure where users may still be able to make payments despite loss of infrastructure.
Enhanced privacy via offline functionality can also be built into the CBDC. Some central banks may also aim for cash resemblance, which could include preserving the experience of using cash. However, offline functionality is not the sole means of achieving privacy. Transacting offline could possibly guarantee users the same level of privacy as cash, but this would depend on privacy models, such as how much user information is stored on the online ledger or how much access to information central authorities might have.
The European Commission has outlined its intentions for offline functionality in the digital euro, aiming for most of the benefits just discussed. It aims for offline payments to ‘provide a superior level of privacy’, ensure the CBDC continues to function in case of limited connectivity and promote digital financial inclusion by accommodating people with disabilities, the unbanked or those who are not digitally or financially literate.
But obstacles need to be overcome first
Introducing a new CBDC or payments system, even one with offline functionality, may not naturally lead to the benefits outlined. There are a range of technical, operational and security considerations that central banks will need to incorporate into their offline payments design.
Addressing low financial and digital literacy would require education for end users to be able to successfully transact CBDCs, alongside strong user experience design to avoid confusion. Depending on the CBDC’s offline functionality model, there might be separate balances and ledgers for offline and online transactions. Good UX design will be important to clearly present the information to users and prevent double-spending.
A financially inclusive payments system should be accessible across generations and abilities, function ubiquitously on different devices and be available to people without bank accounts, reliable telecoms infrastructure or mobile phones. Thoughtful user design will play a key role in meeting these requirements. Some hardware-based solutions to these considerations could include access outside of smartphones, through smartcards, smart tags, tokens or fobs.
The CBDC’s ability to uphold security while offline may also be an additional challenge. Risks include double-spending and fraudulent charges. To mitigate these risks, central banks may need to work out the appropriate offline limits to balances and transaction value and how to enforce them – through the wallet or the point-of-sale terminal. Furthermore, central banks will need to ensure that both online and offline transactions remain anti-money laundering- and know-your-customer-compliant. Hardware-based solutions are one way to address these considerations. The devices can be pre-loaded up to a certain value, while identity checks and onboarding can be done online or at basic levels for low-value transactions.
However, the CBDC’s ability to maintain privacy, uphold security, be financially inclusive and function in times of need will be a challenge and important for building and maintaining trust. Users are less likely to adopt new technology if they feel that their privacy is not protected. User privacy will need to be incorporated into the value transfer protocol design while meeting AML and KYC requirements. The appropriate level for the country’s context may need to be decided at the start of the design phase and appropriate policy should support these decisions.
Is offline CBDC the best solution?
Central banks will have to weigh their options: would it be more work to improve the infrastructure, build a new system and educate consumers to implement a CBDC with offline functionality, or would it be less daunting to address the infrastructure, financial inclusion or contingency needs through other methods?
There are solutions for disaster recovery, financial inclusion and privacy in payments that do not involve addressing the security questions needed to deliver offline payments. Disaster recovery protocols for internet networks and payments systems are already in place and could be strengthened by further investment. Basic bank accounts with lower requirements for ID proofs have been effective in promoting financial inclusion, and privacy can be a feature of online or offline payments.
The Central Bank of Kenya’s m-pesa is a key example. Instead of building something new from the ground up, the system built on the existing infrastructure around trading pre-paid mobile phone airtime via agents. Since its launch in 2007, the service has proliferated to include a range of other services, including offering microcredit and remittance services.
There is no simple solution. Whichever route central banks choose will depend on their available resources and their assessment of the risks they face. However, the complexity of building offline payments should not put central banks off from this undertaking. The list of benefits for offline payments encompass the needs of both developed and emerging market economies. With continued collaboration with the private sector, offline payments functionality could be the stepping stone for further innovation.
Katerina Liu is Research Analyst at OMFIF.
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