Key benefits of a CBDC
Creating a centralised, digital currency can provide many benefits that impact citizens, companies, and governments alike. Some of the most important will likely be economic stability, better payments and financial inclusion.
We estimate implementing a well-designed CBDC takes at least 3-5 years, including the discovery, research, and pilot phases, but the sooner a government begins the scoping process, the sooner they can get in front of an inevitable global economic, social, and technological shift.
Economic stability
CBDCs support a central bank’s ongoing role in issuing currency and maintaining economic stability. They can improve the competitiveness of a local currency as a means of payment in dollarised economies such as Venezuela or Lebanon. Central banks should consider CBDCs as a more direct and efficient means of executing policy.
Better payments promote stability
More secure, less costly peer-to-peer and interbank payments may promote stability. As will the fact that central banks can monitor economic data in real time and gain greater visibility on the flow of money, building resilience against shocks such as inflation, recession, or the impact of events like a global pandemic.
Changing citizen behaviours
Today, citizens and consumers primarily hold money in banks, as the most convenient way of making payments is by using debit/credit cards. With the adoption of a CBDC it is conceivable that citizens may start to hold more cash in their wallets and use digital cash as their primary payment method. This may reduce current account balances at commercial banks, forcing banks to review their exposure to risky investments and instilling market discipline.
The need for trust
Public trust is also critical for stability. Governments that commit to protecting citizens’ privacy, reducing crime, and ensuring transparency in the banking system will more easily gain such confidence.
Policy benefits
CBDCs allow for tighter control over monetary and fiscal policy. Interest rate changes, or distributing financial aid by way of fiscal payments like during Covid, can be instant. Currently, policy decisions can take time to come into effect and impact citizens.
A more direct control over policy can lead to fraud reduction, opportunities for innovation, improved public interest in policy decisions, and cost reductions in policy implementation and execution. And if cash is not readily available, CBDCs can also provide a delivery mechanism for negative interest rates. Digital currencies can address the zero-lower bound on conventional monetary policy, using cashback payments on expenditures paid in CBDC.
A CBDC would also allow governments to receive instant feedback on the impact of policy changes across agencies in real-time and make adjustments accordingly.
Financial inclusion
CBDCs extend the benefits of physical cash to modern digital payments. They do so by offering an inclusive and scalable gateway for the unbanked and underbanked to access electronic payments as well as a wide variety of products and services.
Cash is more financially inclusive than a digital bank account, which not everyone has the financial literacy, means, nor the accepted proofs of identity and address, to open.
Commercial bank branches may be far away, and services can have limited working hours, whereas retail CBDCs offer 24/7 payments anytime, anywhere, including via mobile devices, smart cards, and apps. This is especially transformative in emerging economies for remote, marginalised communities.
In many countries the costs exceed the value of a small transaction and digital cash can facilitate casual micropayments which can benefit poorer citizens. Instant transactions and check depositing can also be a benefit for those who cannot afford delays when being paid.
Better payments
Cheaper and faster settlement
Settlement with digital currencies can be significantly cheaper and faster than today’s legacy payment systems. This applies to wholesale CBDCs, that offer faster interbank settlements, as well as to retail CBDCs, for peer-to-peer payments between citizens or merchants at the point of sale. A digital peer-to-peer cash system can also facilitate payments between connected devices, such as IoT.
Ledger scalability
Leading ledger technology demonstrates the ability to handle over 50,000 transactions per second, for stable fees as low as a fraction of a cent. This compares to VISA’s average of around 5,000 transactions10 per second. CBDCs are cheaper than using credit card payment providers such as VISA or Mastercard, while also reducing the likelihood – and therefore the financial burden – of errors, crime, and reconciliation due to the tamper-proof transaction record. Operating on a single immutable and distributed ledger is more efficient than across multiple, mutable ledgers.
An open transaction processing market model can also unlock competition, encouraging even lower prices and innovation.
Instant payments
CBDCs can offer instantaneous peer-to-peer local and global payments, reducing network hops and cutting cross-border payments down from days, as with legacy systems, to mere milliseconds. Network hops may also introduce additional KYC protocols at every cross-border exchange, which CBDCs can simplify by embedding identity management.
Public blockchain technology can validate and settle transactions even offline or where the user has an unreliable connection, a functionality that is not currently possible with legacy systems. Offline payments should be a key requirement for central banks to ensure digital cash remains as inclusive and accessible as physical cash is today and provide resilience to the wider payment landscape.
Security
CBDCs are more secure than legacy systems, both in the system design and in the technology. One of the critical benefits is that CBDCs enable digital payments with less fraud risk, and less systemic and counterparty risks. Nothing is perfectly secure, though levels of economic security can be achieved by making the costs of an attack exceed any potential benefits.
This is just not a matter of adding tools like cryptography but also in the design, authentication method, rules, and regulations that the network can enforce, as well as the reliance on third parties. Resilience and security are achieved using an economic model that incentivises good behaviour.
Digital currencies that are based on a public distributed ledger provide critical security improvements because they eliminate central points of failure. Even if the majority of nodes on a blockchain network fail or attempt to cheat, the system will continue to operate.
Making tax easier
Transparent government
CBDCs can increase transparency and public accountability.
They allow openness, innovation, and competition. Legacy infrastructure is often fragmented, with interoperable but closed-loop systems that citizens rarely see or understand the links between; taxation, public services, payments, bank deposits etc. CBDCs can help resolve this.
From a technology standpoint, an immutable record or one that is public encourages even more transparency. This can help build people’s confidence in a central bank or government, and provides a mechanism to instil market discipline across the sector. The protection of personal data is also a vital part of public trust.
A transparent and traceable CBDC may help external investors have a greater sense of trust in the movement of money across a country, encouraging greater investment.
Preventing crime
Powerful tool for AML
CBDCs can be a powerful anti-money laundering (AML) solution, providing tools and mechanisms that reduce the risk of financial crime and lower the barrier to justice. This is heavily dependent on programme design, but at a minimum, having a permanent, immutable payments record disincentivises dishonest behaviour, fraud, or theft. Pseudonymous privacy can mean appropriate authorities, like law enforcement or tax offices, can be given tiered access to certain identifiable information with the digital ledger where authorised.
Real-time prevention
Connected to appropriate identity, registry, and other services, CBDCs can even prevent financial risks in real-time via automatic monitoring, automatic audit, and event-driven taxation. These services can also improve economic stability. Public networks that feature advanced digital signatures to authorise transactions can easily incorporate existing standards around AML and customer due diligence.
For wholesale CBDCs, incorporating digital identity solutions with AML/KYC data alongside the transaction provides flexibility in the way service providers can adhere to upcoming regulations, such as the Travel Rule.
Safeguarding citizens
Pseudonymous not anonymous
CBDCs offer a similar level of privacy to cash, while remaining discoverable within the constraints of the legal framework. A fully anonymous CBDC is not recommended, but pseudonymity is important to maintain the financial privacy of citizens when using CBDCs. Users should also be able to see who has read access to their fields and metadata.
Token-based benefits for privacy
Token-based CBDCs, based on a public network, can further ensure privacy by allowing personal data to be stored at the edges of the network (rather than on the ledger itself). By allowing only relevant parties to have access, data from pseudonymous users remain private.
Reduced third-party risk
Privacy is a key issue, as evidenced by legislation such as the EU’s GDPR and China’s PIPL. Currently, citizens rarely know who holds what data in a payments system – and often personally identifiable information is stored by third parties in databases that are at risk from hackers.
Instead of people filling out detailed forms (sharing personal information) with every merchant or business, CBDCs can offer a system where merchants simply validate that a customer’s encrypted data has been verified by a trusted know your customer (KYC) authority. In other words, it removes the need to share unnecessary personal data.
Cross-border remittances
Removing friction
CBDCs can remove friction with cross-border payments that may bridge different regulatory frameworks, market dynamics, data practices, and infrastructures – in accordance with the FSB’s stage 3 roadmap.
This will depend on interoperability, or the ability for national CBDCs to be easily connected; a benefit that commercial banks using a wholesale CBDC will appreciate. The central banks of China and the United Arab Emirates are already exploring such a concept with the Multiple CBDC (m-CBDC) bridge project. Project Dunbar, between the central banks of Singapore, Australia, Malaysia and South Africa, is another such prototype.
For citizens, instant micropayments provided by certain ledger technologies can improve the way remittances are sent and received, reducing the reliance on transfer services such as Western Union or OMT.
How would a typical cross-border transfer work in practice?
1. Sender notifies exchange provider that they wish to transfer to their family member abroad. The exchange provider confirms the rate and prepares a purchase order and billing.
2. Exchange provider submits transaction to be settled on the CBDC 1 ledger in the sender’s country.
3. Exchange provider, who holds both CBDC 1 and CBDC 2 currency, makes an internal conversion.
4. Exchange notifies recipient bank of the transaction in CBDC 2 currency.
5. Recipient bank submits transaction to be settled on CBDC 2 ledger.
At nChain, we are working with central banks to research and design a truly more resilient, trusted and inclusive modern economy, securing the livelihoods and prosperity of citizens for generations to come.
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CBDC Playbook
This 40-page comprehensive guide will help you understand how CBDC programs can be designed and implemented, and some of the key questions that need to be addressed to help ensure a successful CBDC implementation.
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The nChain CBDC Tech Masterclass Series aims to provide both foundational principles, expert opinion and lively discussion around the technical considerations of CBDC and creating a more resilient payments system for all.