South Korea CBDC Project: Why It Was Paused

The Bank of Korea’s central bank digital currency (CBDC) initiative, a notable effort in the global push toward digital finance, has recently hit a significant roadblock. While the initial pilot, known as Project Hangang, successfully completed its first phase, the central bank has decided to suspend further development and postpone the second round of testing.

This decision stems from a confluence of factors, primarily strong resistance from participating commercial banks and a shifting regulatory focus toward private-sector stablecoins. The pause highlights the complex challenges central banks face in balancing technological innovation with the interests of existing financial institutions and the broader market. Understanding this situation provides crucial insights for other nations exploring their own digital currency strategies.

Why Did South Korea’s CBDC Project Encounter Resistance?

South Korea’s CBDC project faced significant pushback from commercial banks primarily due to financial burdens and an unclear business model. The pilot required banks to invest substantial capital in new infrastructure, with reports indicating a collective cost of around 35 billion won (approximately $26 million) for the initial phase alone. This investment was made without a clear path to commercialization or profitability, leaving banks to question the long-term viability and purpose of the project. The Bank of Korea attempted to mitigate these concerns by offering to subsidize half the costs for the next phase, but this was not enough to sway the banks, who saw a more immediate and commercially promising opportunity in the burgeoning stablecoin market.

The friction between the central bank and commercial institutions underscores a critical issue: the potential for a CBDC to disintermediate traditional banking services. While the Bank of Korea’s model involved “tokenized deposits”—a system where a CBDC would function as a settlement asset between banks, and retail payments would be made using tokens issued by commercial banks—the fear of reduced revenue and a diminished role in the financial ecosystem remained.

The banks’ collective decision to focus on developing their own won-based stablecoin consortium demonstrates their preference for a private-sector solution that aligns more closely with their business interests and offers a clearer path to profitability. This pivot from a state-led digital currency to a bank-led stablecoin consortium suggests that for South Korea’s financial institutions, the private option is a more attractive and viable route.

The political and regulatory landscape also played a pivotal role. The new government, led by President Lee Jae-myung, has openly supported the development of won-based stablecoins and has introduced legislation to facilitate their issuance by a broader range of companies. This shift in official policy created ambiguity around the roles of CBDCs, stablecoins, and tokenized deposits, leading the central bank itself to acknowledge the need to “wait and see” how the situation develops. This regulatory uncertainty further complicated the central bank’s position and gave commercial banks the momentum they needed to pursue their stablecoin alternative.

What Are the Key Differences Between CBDCs and Stablecoins?

Central bank digital currencies (CBDCs) and stablecoins are both forms of digital money, but they differ fundamentally in their issuer, backing, and purpose.

A CBDC is a digital form of a country’s fiat currency, issued and regulated by the central bank. It is a direct liability of the central bank, similar to physical cash, and is intended to function as a public good to support the existing monetary system. In contrast, stablecoins are privately issued digital assets, typically pegged to a fiat currency like the Korean won or the US dollar. While they aim to maintain a stable value, they are backed by reserve assets managed by a private entity, which can be vulnerable to risks such as lack of transparency or insufficient reserves, as seen in past stablecoin failures.

A key advantage of a CBDC is its role in providing a risk-free digital payment option, as its value is guaranteed by the state. This can be crucial for financial stability in a crisis. However, stablecoins, especially those backed by commercial banks, can offer more flexibility and potentially a clearer profit motive for private institutions. The Korean banks’ shift toward a won-based stablecoin reflects their belief that this model allows them to maintain control and derive commercial value from digital payments, something a central bank-led CBDC might not offer. This competitive dynamic, where private alternatives are seen as more commercially viable, is a significant challenge for central banks worldwide.

How Will This Decision Impact South Korea’s Digital Finance Future?

The Bank of Korea’s decision to pause its CBDC project does not signify a retreat from digital innovation but rather a pivot toward a new, more collaborative approach. The central bank has since renamed its “Digital Currency Research Lab” to the “Digital Currency Team,” signaling a move from theoretical research to practical application. It has also established a new Virtual Asset Committee to address the legislative and regulatory needs of the stablecoin market. This shift suggests that the central bank is not abandoning digital currency altogether but is instead repositioning itself to oversee and regulate the private stablecoin market.

The implications of this move are twofold. First, it acknowledges the growing momentum and commercial viability of private-sector stablecoins. The government and participating banks see a clear path to leveraging stablecoins for digital payments, cross-border transactions, and other innovative applications. This could position South Korea as a leader in creating a regulated, bank-led stablecoin ecosystem.

Second, it highlights a potential new paradigm for central banks, where their role shifts from being a direct issuer of a retail digital currency to a supervisor and regulator of private digital assets. This “wait and see” approach allows the central bank to observe how the market and new legislation develop before making a definitive move, ensuring that any future digital currency initiative is aligned with the needs of both the public and the private sectors.

The ongoing discussions about how CBDCs and stablecoins can coexist are critical. Some argue that CBDCs could serve as the foundation for interbank settlement, while stablecoins handle retail payments, creating a tiered system. This model could preserve the stability and trust of a central bank-issued currency while allowing for the innovation and commercial benefits of private digital money.

The South Korean experience provides a real-world case study on this topic, demonstrating that the future of digital currency may be a hybrid model where public and private assets work together, rather than a single, state-mandated solution. Ultimately, the suspension of the CBDC pilot is not a failure but a strategic realignment in response to market realities and a new political direction.

FAQs

Q: What was the purpose of South Korea’s Project Hangang? A: Project Hangang was a pilot program by the Bank of Korea to test the feasibility and functionality of a central bank digital currency (CBDC) in real-world transactions. It involved 100,000 participants using “tokenized deposits” for payments at various merchants.

Q: Why are banks in South Korea against the CBDC? A: Banks were concerned about the high costs of participating in the pilot and the lack of a clear commercial model for the CBDC. They saw a more profitable and commercially viable opportunity in issuing their own stablecoins.

Q: How is the government supporting stablecoins? A: The South Korean government has a new, pro-crypto administration that has introduced legislation to allow a wider range of companies, including non-banks, to issue won-based stablecoins, shifting the focus from a state-led CBDC to private-sector innovation.

Q: Will South Korea ever launch a CBDC? A: The Bank of Korea has not canceled the project but has paused it to “wait and see” how the regulatory landscape for stablecoins develops. The central bank’s new focus is on overseeing the stablecoin market, but a CBDC could still be considered in the future as a complementary tool.

Q: What is the main difference in risk between a CBDC and a stablecoin? A: A CBDC, being a direct liability of the central bank, is considered a risk-free asset. Stablecoins, however, carry risks related to the issuer’s reserve management and transparency, as their value is only as stable as their backing assets.

Key Takeaways

• The suspension of South Korea’s CBDC pilot was driven by commercial bank resistance and a new political focus on private-sector stablecoins.
  
• The high costs for banks and the absence of a clear business model made the state-led CBDC less appealing than a private, bank-led stablecoin consortium.
  
• This shift highlights the critical challenge of aligning incentives between central banks and commercial institutions in the development of digital currency.
  
• The Bank of Korea is now repositioning itself as a regulator and supervisor of a private stablecoin market rather than a direct issuer of a retail CBDC.
• The South Korean case study suggests that the future of digital currency may involve a hybrid model where public and private digital assets coexist under a new regulatory framework.