CBDC Promise Lies In Being More Than Currency Alternative
The advantage of digital currency over any other form of currency is its intelligence. It's a leap in paradigm from currency being just storage and transfer of value to intelligent money.
If a central bank issues digital currency, it has inherent value, along with the fact that it can be programmed to be smart, intelligent, and capable of decision-making.
Almost every central bank in the world is planning a Central Bank Digital Currency (CBDC) — this will fulfill the potential that decentralized finance once promised.
The Atlantic Council has prepared a CBDC tracker here. It gives the details of CBDCs rolled out by different banks. For instance, 19 of the G20 countries are preparing to launch a CBDC.
More than a currency replacement
Currently, CBDCs are only seen as a digital replacement of existing national currency or a response to cryptocurrency. I have for a long time argued that the CBDC has a role beyond this and that countries must develop not just a currency but a ‘smarter’ way of commerce.
The end use of the CBDC cannot be limited only to the role that currency has played in the past, as it will be used to program smart contracts and increase trust in commerce. Ensuring trust by creating deliverable contracts of goods and payments facilitates transactions and, in turn, economic growth.
Two unknown entities transact with each other when they know the promised goods will be delivered and payment made. Building this trust boosts trade and commerce — this is the role that CBDC will play.
In today’s global trade, the delivery of goods and payment are managed by a series of international banks, a multitude of contracts, inspection agencies and checks. CBDCs, when programmed to be part of smart contracts, will reduce these layers of paper contracts and checks. In turn, this lowers the cost of trade or transactions, both local and international.
This cost reduction is not nominal. According to a Corpay study, the foreign exchange conversion cost could be as high as 4 %, and there are many hidden charges that remitters and even receivers have to pay. This makes many trade transactions unviable.
CBDC-based smart contracts
The promise of lower cost and reducing the global bank hegemony in transactions that decentralized finance offered with crypto assets can now be realized legitimately with CBDCs. Thanks to the rapid expansion of cryptocurrency and the existential threat they posed to central banks and currency, CBDCs are being rolled out.
Till now, currency itself did not carry any intelligence of its own — it was a piece of paper, metal, or leather, but a digital currency can carry data. This data element can impart intelligence to make sure where and how CBDCs can be used and even what can be purchased with them. Even the way the digital ledger is kept for storing this currency can be used to create smart contracts. This is the true digitization of the economy because, fundamentally, the currency unit will have its own intelligence.
To give you a comprehensive example with some assumptions, it is now possible to structure a payment between a large company and a small vendor. This ensures parity of payment. However, the most significant pain point for all MSMEs dealing with large companies is that they are not paid on time. Moreover, for any small or micro vendor to extract payment from a large company is almost impossible.
I know this for a fact because, as an independent consultant, it's almost impossible to get large companies to pay you on time. Their financial teams are not equipped to handle small vendors, so the smaller or medium-sized vendor gets squeezed. If smart contracts were based on CBDCs, money would automatically get debited from these companies' accounts on the delivery or completion of a contract and credited into the small vendor account. It would make several MSMEs viable. If the CBDC is in the central bank blockchain-based ledger, it will not even go through the traditional banking layers or high-cost system.
Creating digital trust
These smart contracts can reduce the cost of transactions and increase trust in domestic and international commerce. If vendors know that they will get paid in every interaction, it will ensure that they can transact with strangers even across multiple borders.
Currency's primary role in developed societies was to build trust in a monetary system so that commerce could be enabled. This can be taken to the next level now with smart CBDCs enabling quicker and better commercial transactions.
When CBDCs are applied to global digital commerce, it will have a ramification for wholesale and global banking. This is an area that even the most well-funded fintech has not been able to breach. And this is because, while fintechs may pride themselves on innovation, their area of operations has been limited to state borders. Yet, it is where CBDCs can unleash innovation at a global scale if it is built with multicounty exchange in mind.
Bridging islands of innovation
This is what the Bank of International Settlements (BIS) should insist on with CBDCs. They should not remain as islands of innovation in their own countries.
BIS has been trying to standardize some of the operational aspects of CBDCs. An example of wholesale CBDC involving different currencies is the BIS innovation hub project involving the central banks of China, Hong Kong, United Arab Emirates, and Thailand collaborating on the Multiple Central Bank Digital Currency (mCBDC) Bridge Project. This project aims to develop an international settlement platform through which central banks can utilize CBDC for transactions by financial institutions.
The mCBDC project will enable cross-border payments that can be done in real-time between the four jurisdictions 24/7, with the foreign exchange leg settled in real-time.
Yatish Rajawat is the founder of Centre Innovation in Public Policy, a think tank based in Delhi. His area of research includes everything digital affecting policy, people, and the biosphere. Feedback or contact at [email protected].
Image credit: iStockphoto/simpson33
