Over the past year, we have witnessed various announcements from central banks across the globe – from China and Sweden to Singapore and South Africa – stating the issuance of Central Bank Digital Currencies (CBDC).
The main catalyst for the increasing interest in CBDC is the blockchain technology. The distributed ledger architecture of blockchain technology provides transaction transparency and traceability, thereby paving the path for a more efficient financial ecosystem.
A blockchain-based CBDC is a type of cryptocurrency that holds massive potential in terms of faster, cheaper and more secure transactions. Furthermore, cryptocurrencies offer a higher level of automation and a lower level of risk.
Despite this great promise, cryptocurrencies are struggling for mainstream adoption because of their volatile nature. They are deemed unsuitable for use as a store of value. A solution to this problem is stablecoins. A stablecoin is a cryptocurrency that is either pegged to a fiat currency or that maintains a stable value by some other means. The first stablecoin, Tether, which was developed in 2017, focused on resolving the payment problem for blockchain-based payments. Today, we are witnessing the second generation of stablecoins projects, including Facebook’s Libra, Binance Coin, Terra, USD coin, JP Morgan’s JPM Coin, China’s DC/EP project, and Gemini dollar.
While many enterprises are still considering partnering with a reliable stablecoin development company to build their stablecoins and there is no empirical evidence of the impact that these currencies have on the economy, it is believed that CBDC can offer significant benefits to central banks and the financial system.
Digital assets are poised to disrupt the capital market, offering accelerated and transparent transactions, automated lifecycle management, and increased efficiency. CBDC could chart a path for a viable and more efficient blockchain-based payment system that could offer benefits like immediate settlement of transactions, thereby enabling digital assets to reach their potential.
Additionally, CBDC could also bring cost savings to the financial system. By replacing the middlemen and offering increased automation, blockchain-based transactions could be more cost-efficient, secure, and less complex.
An international equivalent for tokenized national currencies could mitigate risks in foreign exchange transactions by enabling a payment-versus-payment settlement approach. This could not only benefit the governments but also millions of businesses and individuals.
The existing cross-border payment process is slow and expensive; a typical international payment has to transit through various correspondent banks and it is beset by huge transaction and reconciliation costs and long waiting time. Individuals, especially migrant workers, have to bear an additional cost of the network of physical outlets at the sending and receiving ends.
A world with CBDC-driven origin currency and destination currency could forge the path for a seamless money transfer system that is automated and uses cryptographic techniques to enable interoperability between systems and distributed ledgers. The proliferation of mobile phones in developing countries can mitigate the need for physical distribution channels, further alleviating the costs.
The existing process of interbank transaction settlement by using central bank money is carried out on a Real-Time Gross Settlement (RTGS) system. It has the benefit of settling payments on an individual order basis between counterparties, rather than grouping multiple payments. The drawback of this system is that it relies on batch processing overnight and requires collateral to cover the outstanding positions. Thus, this system does not completely eliminate settlement risk. Furthermore, many RTGS systems today rely on old technologies and have operational risks.
CBDC, for interbank payments, holds the potential to enable real-time payments between counterparties with zero settlement risk and reduced operational risk. In addition, CBDC-based systems are anticipated to be more secure and efficient than the existing systems.
Although real-time money transfer can be carried out quickly and cost-efficiently, all businesses and consumers do not have access to real-time, low-cost remittance. Many financial institutions charge their consumers for real-time transactions. Additionally, many developing countries, especially in South East Asia, offer free intra bank payments but charge for interbank money transfer.
Central bank-sponsored digital currencies, which can be quickly and easily transferred between users, can forge the path for new regulators to set new market standards, thereby enabling retail financial institutions to augment their value proposition to SMEs and consumers. This can comprise extended operational time – maybe round-the-clock, more transparent system, and higher interoperability between platforms.
Many countries today are assessing the potential of central bank digital currencies. Being an early mover in the CBDC market could offer noteworthy benefits to a currency. It is opined that central banks should work together to agree on CBDC standards to interoperate across borders.
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