Ashish Bhatnagar, Head of Cards & Payments at Cognizant
As the use of physical cash has declined, and new cryptocurrencies and digital payments systems have flourished, central banks have been looking for ways to maintain control over their financial systems. One of the leading ideas has been for central banks to offer their own digital currency (CBDC). The appeal of this new system has grown quickly over the years, with 114 countries around the world now either exploring the idea, or even launching their own CBDC. That’s up from just 35 countries in mid-2020.
However, there is a big difference between creating a new cryptocurrency and building a system that can support a country’s financial network. For instance, central banks need to be sure it is created in a way that provides good user experience, while still protecting individuals’ privacy. This requires strong cooperation between public and private sector organisations. If central banks are successful in achieving this though, it could provide huge opportunities for both retail and wholesale payments.
What are the ingredients of a successful CBDC?
It is no surprise that many central banks lack the digital skills needed to create their own digital currency, with employees traditionally focused on economics rather than technology. Which is why many of the trials around the globe have seen them partnering with commercial banks and private wallet-providers who have been able to attract technological talent with higher wages. For example, in India the ICICI Bank and Kotak Mahindra Bank have been helping retailers process CBDC payments. By creating partnerships like this, central banks can create a system which easy and convenient to use for consumers. Part of this will also be ensuring that transactions can still be processed when customers are offline. Allowing payments to happen in geographically remote or sparsely populated areas with limited connectivity will help increase adoption and ensure the system can still work even if there are occasional outages.
While convenience is important, it is also vital that any new system puts user privacy front of mind as well. Consumers now expect a strong level of privacy and may also be concerned about sharing more personal information with a central bank. For instance, a consultation on digital currencies by the European Central Bank found 41% of replies centred on issues around privacy. Yet there will also be a need to balance privacy needs against policies aimed at combatting money laundering and other financial crimes. One method of overcoming this problem is cryptography, which could allow banks to validate transactions without needing to see the unencrypted data. This means privacy is protected while still allowing authorities to take action against potential criminals.
Finally, data has shown that people change their spending habits based on which instrument they are using. For example, consumers spend more when using a credit card compared to cash. Any new system therefore needs to be designed so that it doesn’t exploit these behavioural weaknesses. Instead, central banks and their partners should develop ways of educating individuals on good financial practices, or install limits such as with contactless payments, to ensure people are not putting themselves in a bad financial position.
Why do we need CBDCs?
While experimentation with CBDCs has increased over the years, there have also been questions from some financial institutions as to the benefits of them. For example, some commentators state that banks can achieve their aims of controlling their country’s financial system within the current models they have. However, there are still several benefits which could come from creating a CBDC which help it stand out from the traditional system.
For instance, retailers can improve payment efficiency through programmability and smart contracts. This would enable them to bring forth new innovations and services for their users. Likewise, creating systems that are compatible with other CBDC developments allows cross-boarder payments to happen with greater speed and reduced cost than before, saving firms money and time when ordering new stock.
A new CBDC network could also make payment systems more competitive. Currently, only certain financial institutions have access to central bank funds. However, a digital currency would allow fintech providers access to central banks directly, instead of via traditional banks. This would benefit both retailers and consumers alike, as competition helps drive transaction costs down and increase the speed that payments are processed.
Finally, for the few CBDCs that have trials underway, central banks have offered incentives to entice users onto the platform. For example, the Sand Dollar(https://www.sanddollar.bs/about) used in the Bahamas has no transaction fees and doesn’t currently charge interest, offering a bonus to consumers and businesses looking to save money.
CBDCs are just around the corner, get ready
While it might feel like CBDC platforms are a while away from becoming truly mainstream, we are not as far away as some might think. As such, if central banks don’t want to get left behind and miss out on the early benefits these platforms can bring, they need to start examining their offerings now, and identify the partners which can provide the necessary skills and expertise needed to make it a reality.
