South Korea Explores the Introduction of a Digital Won

In August, South Korea’s central bank took an initial step toward the introduction of a central bank digital currency (CBDC). While not committing to the ultimate deployment of a CBDC, the Bank of Korea (BOK) initiated a pilot project with private sector partners to determine the feasibility of a retail CBDC.

With the rise in usage of digital and contactless payment systems during the pandemic and efforts by the private sector to develop digital currencies, central banks are increasingly looking at the feasibility of a CBDC. More than 80 central banks are conducting studies related to CBDCs, which are a digital version of fiat currency issued by a central bank that can be used to purchase goods or make payments.

A small number of central banks have taken additional steps, including the BOK. The Bahamas and four Caribbean nations have formally launched digital currencies. The BOK is among the 14 central banks undertaking a pilot program to test the feasibility of a CBDC, although some of these pilots are further along than others. The People’s Bank of China, for instance, has begun distributing its CBDC through local lotteries in preparation for a nationwide launch. Most central bankers expect these numbers to grow and at least one of the G-7 central banks to issue a CBDC in the next three to five years, according to a survey by UBS.

As central banks consider moving toward CBDCs, trends in South Korea make it a promising candidate for early adoption of a digital Korean won. Over the last decade, cash payments have declined from 66 percent of transactions in 2010 to an estimated 34 percent last year, while polling indicates that 77 percent of South Koreans have a preference for digital transactions.

In addition to South Korea’s increasing adoption of digital payments, the public, especially those in their 30s, have embraced cryptocurrency. South Korea is estimated to account for 10 percent of the world’s cryptocurrency transactions, while 90 percent of trading is in altcoins, or coins other than Bitcoin.

To test the feasibility of a CBDC, the BOK’s pilot is being conducted in cooperation with tech firms from the private sector. The central bank’s primary private sector partner is Kakao, whose blockchain unit Ground X has been contracted to develop the blockchain for the pilot based on its Katlyn ledger. While Ground X’s Katlyn ledger is a public blockchain based on Ethereum, the pilot will utilize a private Katlyn ledger in a virtual environment.

The pilot will be divided into two phases. The initial phase is scheduled to run through the end of the year and will examine the feasibility of issuing, redeeming, and distributing a digital Korean won. The second phase will run through June of next year and test the system for transfers abroad, offline payments, and the purchase of digital assets.

Determining the functionality of using a CBDC on smartphones for payments and remittances will also be part of the pilot. Samsung Electronics will utilize its Galaxy line of smartphones to determine whether payments can be made via smartphones without internet accessibility, a key feature if a digital Korean won is to compete with existing payment systems, as well as whether funds can be transferred between two individuals’ phones or to a bank account.

Initially, the most significant difference South Korean consumers and businesses might notice from the formal introduction of a CBDC is the speed of transactions. Transactions through the existing banking system can often take days to clear. A CBDC would increase speed and move toward real-time transactions.

The Katlyn ledger’s consensus algorithm, the process by which the parties on a blockchain reach an agreement on transactions, will initially be capable of handling 3,000 transactions per second (TPS). That is expected to scale up to 10,000 TPS, which would allow for 864 million transactions in a single day. That should be more than sufficient to handle the estimated 10.33 million daily mobile transactions in South Korea, as well as expand the estimated 6 billion annual real-time transactions.   

Businesses and consumers would also likely benefit from interoperability with other CBDC blockchains. Interoperability would reduce payment time and costs with overseas partners for businesses, while also benefiting consumers by easing direct overseas purchases. Direct overseas purchases, which have become increasingly popular, have risen from $1.5 billion in 2015 to $3.5 billion last year and were up an additional 44 percent in the first quarter of this year.

By utilizing an Ethereum-based blockchain, businesses will also benefit from the ability to develop smart contracts. The second phase of the pilot project is expected to utilize Solidity for drafting smart contracts, which would enable businesses to develop self-executing contracts that would provide payment once the conditions in the contract are fulfilled.

While the introduction of a digital Korean won would likely result in more efficient transactions for consumers and businesses, it also underscores questions about the future of private banks and privacy. Some models for CBDCs envision individuals having digital wallets directly with central banks. While this model raises questions about the future of deposits at private banks and how lower levels of deposits might impact the cost of loans, it also raises concerns about privacy as the central bank would have access to all of a consumer’s transactions.

Instead of embracing a CBDC model where individuals have digital wallets directly with the central bank, the BOK will directly issue digital currency to banks, who will then distribute the new digital Korean won to individuals. This model maintains the traditional role of private financial institutions in the financial system and addresses concerns about privacy by leaving transaction data in private hands.

If the pilot project is successful, the BOK will likely need the National Assembly to pass legislation adjusting the central bank’s charter before introducing a digital Korean won. Prior to commencing the pilot project, the BOK commissioned a study of the legal issues related to the BOK issuing a digital won and concluded that while the Bank of Korea Act gives the BOK the sole authority to issue currency, that authority, however, is limited to the issuance of banknotes and coins.

With the development of cryptocurrency and the pandemic pushing the established financial system to innovate, the BOK’s CBDC pilot has the potential to place South Korea at the forefront of a shift in modern finance. However, the project’s benefits extend beyond the BOK’s own ability to determine the feasibility of a digital Korean won as the private South Korean firms involved in the project will also gain valuable experience that will position them to be service providers to other central banks looking to introduce digital currencies.