Cash in digital form

One day soon, we’re going to get used to a new acronym: CBDC. It stands for “central bank digital currency” – and CBDCs could become the future of money and payments. Most of the world’s major central banks are either actively developing CBDCs or at least researching them.

China’s central bank is expected to announce a pilot central bank-issued digital currency in 2020. In India, meanwhile, a government economic panel has recommended that the Reserve Bank of India should adopt a digital currency. The South African, European, Canadian and Japanese central banks are all also exploring this concept.

Why are CBDCs being developed? Simply put, because they promise to serve a demand in payments that is currently not being met. Today, only one form of financial exchange meets the requirements of all users under almost all circumstances, and that is cash. That might seem like an odd thing to state when many of us are becoming increasingly habituated to paying by card or smart device.

Old money, new money

Far from being a relic though, cash still works most often for most people. “Banknotes are flexible and reliable, and make a good means of payment that can be used by anyone. The only problem is that they don’t work digitally,” says Raoul Herborg, Business Lead Digital Currencies, G+D.

Cryptocurrencies, based on powerful cryptography in which the payment process is decentralized and therefore made secure, are one recent approach to making digital money widely available, but are far from proven. Pioneers such as Bitcoin and Ethereum, the most famous cryptocurrencies, are wildly volatile, carry high transaction fees, and so lack the basic trust that is a prerequisite for any payment system.

In China, the rise of private commerce payment platforms, such as Alipay, offer hugely popular and fast-growing digital payment options that work well. Facebook’s proposed Libra stablecoin is another comparable but so far unproven solution. Anxious not to see the payment ecosystem operate entirely in the private sector by players who may become too big to fail, however, central banks are looking at how they can help ensure safe, secure and trustworthy means of digital payment. 

The power of central bank digital currencies

Central bank digital currencies promise a new legal tender with no interoperability issues, and offer direct peer-to-peer transactions.

CBDCs would have the same value as the physical currencies they represent but could be used in a variety of ways, including with smart cards, smartphones and so on, all guaranteed by government. “CBDCs would give all citizens access to a secure and stable means of payment without transaction fees,” says Herborg.

From the end-user perspective, a CBDC would free anyone to pay anyone else direct in all payment scenarios, as everyone would be obliged to accept it in the same way they would for cash. It would not even require a bank account, and transaction costs would be far lower than existing phone-based solutions. 

CBDCs raise the prospect of cheap, easy payments, for example, from smart card to smart card or device, without a middleman – such as the merchant card providers. Imagine two people using a small device, transferring funds between two smart payment cards in a field in the middle of nowhere without any intermediary.

How will CBDCs work? The exact technological components are still being explored and may or may not use decentralized ledger or blockchain solutions. They should also offer less energy-intensive solutions than Bitcoin.

G+D is working on these issues, and is busily consulting and developing pilots with a range of banks, adds Herborg. “Our concept is designed to be as close to cash as possible, to provide outstanding security and high availability with no single point of failure, and allow you to balance privacy versus transparency.”

Better than Bitcoin

The capabilities of CBDCs are also flexible. They can be made fully private, enabling consumers making transactions to shield their sensitive data. However, safeguards can also be built in against money laundering, fraud, tax evasion or other financial crime, allowing payments to be tracked in certain circumstances, for example, by applying for a court order.

While CBDCs won’t arrive tomorrow, it seems likely they will be in use this decade, perhaps in as little as five years. “G+D is supporting central banks on this journey,” says Herborg. “It is about trust and very high security. The risks need to be evaluated – not just the technology ones but also their impact on the existing financial system.”

CBDC’s impact in payments, banking, central banking, and even the balance of economic power will be profound. For example, if China becomes the first major economy to use a digital currency, it will put pressure on other countries to set up their own.

The epicenter of global economic power could shift, suggests a report from Deutsche Bank.¹ “If companies doing business in China are forced to adopt a digital yuan, it will erode the dollar’s primacy in the global financial market.”

Perhaps the most far-reaching impact of CBDCs on people, and on the potential to spread wealth and grow global GDP, is their ability to vastly expand financial inclusion. The potential to extend payment services to the hundreds of millions of the world’s unbanked who have been hard to reach, and who have no or limited access to digital payments, is compelling, says Herborg.

“Our vision is enabling payments for everyone, everywhere, young and old, in cities and in remote rural areas, people with the latest technology and those without.”

Published: 10/05/2020