Central Banking Digital Currencies: Are CBDCs the Future of Money?

Because of their increasingly unstable nature, it’s hard to picture a future where Bitcoin et al could be seriously considered as a means of purchasing goods or services. Sellers aren’t going to be happy if they accept Bitcoin in a sale only for the price to plummet immediately after its complete and inversely, a buyer won’t be impressed if the value of their money increases dramatically after they’ve used it to pay for something.

This is where CBDCs come in - offering the benefits of cryptocurrencies, without the financial risk.

CBDCs: what are they, how they are driving digital innovation and extending financial inclusion globally, and what to prepare for in future?

CBDCs are digital currencies issued as digital tokens in much the same way as cryptocurrencies. However, the main difference between the two is that CBDCs are issued by a central bank and are pegged to the value of a country's fiat currency. 

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CBDCs are attempting to address the issues associated with cryptocurrency by pegging their value to a unit of underlying asset, often issued on faster blockchains, and backing the coins wholly or partially with state-issued tender.

Through stable fiat backed digital currencies, it is hoped that more people will be able to gain access to financial services than ever before. Between 2020 and 2021, the percentage of people with no bank account in the APAC region alone rose from 24% to 29%, demonstrating the need for the kind of simpler and more accessible financial services CBDCs hope to provide. 

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What opportunities and risk factors do CBDCs present to the industry and how will they shape the future of the finance? 

It’s incredibly early in the CBDC development cycle to make any solid predictions regarding the direction of travel for these currencies. For example, it’s unclear at this stage whether central banks will focus their efforts of retail or wholesale use cases and emphasize domestic or cross-border applications.

However, CBDCs have the potential to bring increased efficiency to any financial system which employs them. Because payments using these digital tokens occur in real-time, are gross and final, the settlement risk within the financial system is reduced and the need for interbank settlement and reconciliation is eliminated.

There is also immense potential when it comes to cross-border payments. Currently expensive and subject to time-zone related delays and the Herstatt risk, cross-border payments with digital currency rely on the transfer of CBDCs being contingent on the real-time transfer of the other asset.

On the other side of the [digital] coin, there are the ongoing concerns regarding blockchain technology and its impact on the environment. The processing power needed to create Bitcoin is more than that required by some small countries, so we will have to see if central banks can make the technology more efficient in this regard. 

How can the private and public sector collaborate to bring CBDCs to life?

A fitting example of how the private and public sectors can come together to develop CBDC technology and work to maximize the opportunities and minimize the risks associated with the currency, is Project Dunbar.

Being led by the BIS Innovation Hub in partnership with the Reserve Bank of Australia, Central Bank of Malaysia, Monetary Authority of Singapore, and South African Reserve Bank, Project Dunbar is seeking to use multi-CBDCs to enable international settlements.

By bringing together the collective knowledge of central banks, commercial banks, and technology partners from earlier research and development work on digital currencies, Project Dunbar has developed two prototypes which could enable international payments using digital currencies issued by multiple central banks.

“A single cross-border payment could pass through multiple correspondent banks, using the foreign currencies held with them,” reports BIS. “Each leg of the overall transaction takes time and effort to process, with fees levied that add up quickly and are passed on to customers, resulting in slow and costly cross-border payments. A multi-currency common settlement platform would enable transacting parties to pay each other in different currencies directly, without the need for intermediaries such as correspondent banks.”

The prototypes developed thus far are a first key step along the road to simplified and cheaper cross-border payments using CBDCs. While there are still many challenges to overcome, the Project Dunbar initiative elegantly demonstrates the progress which can be made by bringing together private and public sector organizations united by a single vision.

To read on about how CBDCs and extreme finance pose a risk in financial inclusion