Central bank money, which is comprised of cash and reserves, is often considered the safest form of money with no risk of default. Households, businesses, and corporates can only access central bank money in physical form as cash-- and with cash usage as a means of payment decreasing globally and cryptocurrencies growing at an unprecedented rate, many central banks have confirmed that while they have no intention of ending the cash cycle, they are now seriously considering launching a digital version of cash, Central Bank Digital Currencies (CBDCs), which would give consumers and businesses a greater choice of payment options while ensuring that the public can continue to benefit from the resilience and security that central bank money provides.
CBDCs could also offer societal benefits like greater financial inclusion, since the unbanked would be able to access and transfer funds without the need for a private bank account and could enhance financial stability as it would allow consumers to have access to a safe asset should there be a black swan event.
So far, cryptocurrencies have generally garnered a negative sentiment among the Central Banking community, with some central banks seeing cryptocurrency as a threat to their monetary sovereignty and many countries arguing that it is a speculative, volatile asset that fundamentally pulls away investments and innovation from the real economy into a bubbled economy, exposing both consumers and investors to risks of loss. They also contend that bitcoin is not scalable and has a high environmental impact due to miners’ energy use for computing power.
But CBDCs would differ from cryptocurrencies in several ways: a CBDC would be issued by a state and, like cash, would have an official legal tender status. If it were to be introduced by the Federal Reserve, for example, it would be denominated in dollars, just like banknotes, so $10 of CBDC would always be worth the same as a $10 note. It would also be a highly secure digital instrument: like paper currency, each unit would be uniquely identifiable to prevent illegal activity, but unlike physical cash, it would also provide traceability, with a digital record demonstrating that funds have been exchanged between two parties.
The financial innovation that CBDCs would bring to the payments landscape can’t be underestimated: Banks, like all businesses, compete by becoming more innovative, and central bank digital currencies would enable new market entrants to introduce new payment products such as the programmability of money, digital wallets, the ability to make micro-payments followed by greater access to data and services to consumers while leading incumbents to upgrade their existing products and services and offer new CBDC services to their client base, which in turn would lead to greater financial deepening. They could also reduce existing payment friction and deficiencies, such as costs (operational, transaction and liquidity), transaction payment times, high levels of rejections, and a lack of payment transparency, particularly with cross-border applications.
We are likely to see different countries implement CBDC with different applications and use cases, due to the different objectives of central banks. For example, the aim of the Bahamian Sand Dollar is to promote digital payments and increase payments efficiency compared to cash. In the Bahamas, financial inclusion is a key aspect that is tackled by allowing individuals to set up a wallet without identification by introducing holding limits (the holding limit is 500 Sand dollars). In addition, in Nigeria, eNaira looks at fostering cross-border trade, improving financial inclusion and enabling the government to spread aid and welfare payments. Each CBDC will be different and whether it leads to greater financial innovation in each nation will depend on the scale of deployment and desired objectives.
Advancing the future of money
CBDC is also likely to have a positive impact on GDP by increasing the utility of money, addressing deficiencies in payments such as costs (transactional and operational), speed, settlement and liquidity risks as well as new use cases. For example, according to our own research, CBDC will allow central banks to come out with new instruments of monetary policy, potentially allowing central banks to implement negative interest rates, addressing the zero lower bound (or the even lower, effective bound) on interest rates and other options to enrich the central banks’ monetary policy toolkit which could substantially improve their ability to stabilise the business cycle.
Launching a CBDC could also lead to an increase in cross-border trade by broadening the use of a nation’s currency and making it more interchangeable, and other benefits that will come from having interoperable CBDCs, including reduced payment rejections, greater payment transparency, and instant cross-border real-time payments, which will reduce costs. Governments and central banks could also benefit from better data on economic activity which will add to the monetary policy toolkit, enforcing AML / CFT requirements as well as the facilitation of new technology, authentication, data management and risk management.
Digitalization on its way
Africa is becoming a mobile payments innovation powerhouse, and several African countries are looking at central bank digital currencies as a way of equipping the unbanked, including Egypt, where more than 50% of the country’s 100 million population is unbanked. India, where almost 200 million people are unbanked today, is also looking at CBDC as a solution for greater financial inclusion and greater access to financial services across the countries. There have also been significant developments in China, which has focused on innovating its infrastructure and payment systems to drive cashless transactions as well as helping to serve the unbanked. For example, AliPay introduced a popular mobile e-wallet back in 2008, which is now dominating the smart and mobile payments market in China. WeChat has also been innovating with a new all in one service that combines a social media app with grocery shopping, bill payments, money transfer, and other services and has inspired similar innovative ideas and solutions in other countries in South East Asian region in particular.
There is also an opportunity with CBDC to introduce improved machine-to-machine payments and automated payments between machines via digital wallets, without any human interactions. At FIS, we are keeping abreast of all the innovation and global developments around central bank digital currencies, and our technology capabilities have allowed us to be the pioneers in discussions with central banks, regulators, and policy makers.