Since 2021, many governments have been ramping up their central bank digital currency (CBDC) efforts.
Moving from deliberation to the experimentation phase, central banks are actively building capacity to deliver next-generation payment systems backed by their governments. With growing competition from global digital assets, a CBDC is a central bank’s vehicle to re-establish its role in a country’s monetary system.
Lipsa Das is a freelance crypto writer and strategist based in India. This op-ed is part of CoinDesk's Crypto 2023 series.
A quick overview of CBDC global adoption rates
According to the Atlantic Council think tank, over 100 countries are actively exploring CBDCs in the research and development phase. Eleven countries have launched their CBDC programs, including Jamaica, Nigeria and the Bahamas. Many countries are in the pilot phase, such as China, India and Thailand.
Notably, China has had the most success with its digital yuan, with transactions surpassing $14 billion, although overall volumes have slowed significantly from a record 154% growth in transaction volume in 2020 to just 14% since the end of 2021.
Finally, some countries, including Ecuador and Denmark have explored the possibility of launching CBDCs but have since paused their efforts.
The newest entrant to the CBDC race: India
India’s pilot launch of its e-rupee has sparked global interest. As the largest democracy in the world with a massive crypto user base, India is the perfect testing ground to implement a large-scale CBDC campaign.
Its direct competitor, UPI – India’s current digital payments system – has onboarded over 376 banks and currently processes monthly transactions of over 119 lakh crore ($1.4 trillion), a solid foundation to build digital currency infrastructure.
Future of CBDCs: Predictions and areas of improvement
CBDC adoption woes
Despite the widespread enthusiasm among governments and central banks, the adoption of existing digital currency projects has been lukewarm. There are several barriers to adoption working against CBDCs.
As the International Monetary Fund (IMF) states in its paper on instant payments, from a consumer point of view, there is little difference between instant payment systems and CBDCs since both are fast, backed by the central government and free of charge.
Thus, CBDCs need to provide tangible benefits for users to switch from an already working system. For instance, India’s e-rupee plans to target those who don’t have bank accounts, in contrast to UPI, which enables bank-to-bank transfers. Further, UPI doesn’t permit cross-border transactions, but CBDCs can potentially tackle this issue once a global standard is established.
We will also see widescale incentivization and marketing campaigns to boost CBDC adoption. These could range from free money and tax benefits to foreign transaction fee waivers and public sector salaries paid with CBDCs.
However, in countries with more restrictive financial laws, incentivization might look very different, sometimes infringing on basic human rights. For instance, Nigeria plans to ban ATM cash withdrawals over $225 a week, with exceeding amounts attracting a 5% processing fee. This is a clear attempt to boost Nigeria’s cashless policy and the lackluster adoption of its CBDC, eNaira – which has an adoption rate of just about 0.5% of the country’s population.
Countries that follow China’s example (where cryptocurrencies are banned) could potentially pose considerable restrictions on cryptocurrencies and stablecoins to boost CBDC adoptions.
A continued focus on CBDC technology
Designing a financial system for an entire country is a massive undertaking. Unsurprisingly, there have been multiple technical roadblocks along the way as governments roll out their centralized digital currencies.
One banker told Reuters earlier this month that India’s e-rupee is, at the moment, “more inefficient” than traditional banking. Bulk trade settlement, paperwork reduction and other systems must be introduced to entice banks to keep using e-rupee. Additionally, CBDC trade volumes need to exceed volumes on other payment methods, otherwise it leads to more paperwork for the bank.
Similarly, Nigerian users have found it hard to use eNaira, despite the fact that it is legal tender in the country.
“I've been able to create a wallet [on the eNaira app] and all, but I can't fund it yet as it’s throwing an ‘account not found error.’ The entire experience has been quite frustrating, as the whole thing seems very half-baked,” Yusuf, a programmer and crypto enthusiast in Nigeria, told CoinDesk.
Based on the Google reviews for the eNaira app, this sentiment seems to be uniform across most Nigerian Android users. Nigeria’s plans to encourage a cashless policy when many users can’t even verify their accounts would likely result in a ton of backlash. For CBDCs to stand a fair chance against other payment systems, ironing out these technical details is crucial.
Co-existence of CBDCs, stablecoins and other payment methods
While some may believe CBDCs to be the future of money, the transition to CBDCs will be slow and, most likely, partial. And that’s if CBDCs are even successful.
For instance, according to a Bank for International Settlements (BIS) report, CBDCs could find a use case in facilitating cross-border payments, improving banks' limited operating hours and long transaction chains. Merchants and wholesalers can directly benefit from faster settlement times and less paperwork.
CBDCs also show promise for settling bulk high-value transactions for wholesalers and entities. Sen. Cynthia Lummis (R–Wyo.), who has played a significant role in crypto regulation in the U.S., believes that CBDCs should be restricted to wholesale users, central banks and other government entities.
Last month, the U.S. began its 12-week pilot program of the digital dollar with a group of major banks and the Federal Reserve Bank of New York.
“I believe that the direct-to-consumer product will actually be stablecoins,” Lummis said in an interview with tech news site Protocol.
Other payment methods such as credit cards and cash will likely co-exist with CBDCs for the foreseeable future, with each catering to a different audience. In advanced economies, where we already see a cash decline, CBDCs could accelerate the process and reduce the need for ATMs. User adoption will be the final judge.
Addressing control over money flow and privacy concerns
One of the primary arguments against CBDCs revolves around data privacy and government control over individual financial assets. These concerns aren’t unfounded: Iran’s threat to freeze bank accounts of women who don’t wear hijabs and Nigeria’s cash withdrawal limits scratch the surface of what kind of control governments could potentially exert with mandated use of CBDCs, such as the removal of e-wallets as punishment.
What happens in the case of a war? Can trade restrictions and financial sanctions extend to government restriction of money between countries with the click of a button?
Democracies such as the U.S. want to distance themselves from the potentially privacy-breaching nature of CBDCs. “[In China], the digital yuan is direct-to-consumer. It's also a means of surveillance. We don't want a CBDC that is dollar-denominated that could be used as a means of surveillance,” said Lummis.
Privacy technologies used to combat CBDC’s privacy issues are expected to become popular among democratic countries that emphasize human rights. India has indicated that it will be looking into integrating its CBDC with privacy-based technologies. How effective these technologies will be and the extent to which they will be implemented by the government remains to be seen.
Further, experts such as Bitget’s Gracy Chen have called for the possibility of CBDCs having multiple permissioned nodes so that a central bank is not the sole authority in a major payments system.
CBDCs across borders
Most countries experimenting with CBDCs are doing so independently. This drives a new problem: Different CBDCs use drastically varied design standards and technologies that are typically incompatible with one another.
Thus, there’s a very real possibility of ending up with the same fragmented, siloed financial ecosystem again, with CBDCs adding to the problem and not solving it.
We’ve already seen this happen with the current cryptocurrency ecosystem. Different blockchains such as Ethereum, Solana and Avalanche have their own ecosystems, which are largely incompatible with one another, except through common points such as bridges or centralized exchanges.
This issue could become even more complicated with CBDCs, which live on private ledgers controlled by governments who usually aren’t very eager to share information with each other.
Some form of standardization is needed to enable smooth, fast, cross-border transactions. SWIFT’s solution of globally interlinking CBDCs is a start, but more collaboration and testing across operational CBDCs is needed.
Banks and fintech providers will have a role to play
CBDCs might weaken the power of the existing financial system – especially banks. According to a BIS report, we risk systemic bank runs if many people rush to convert their money into CBDCs abruptly. However, that doesn’t mean banks and fintech providers don’t have a role to play in the adoption of CBDCs.
Many central banks across the globe are exploring a hybrid model for CBDCs, where the central bank distributes CBDCs to a regulated entity such as a bank or fintech institution. While CBDCs would be regulated and managed by the central bank, intermediary entities would handle the basic checks for know-your-customer (KYC), anti-money laundering and overall transactions.
To achieve this, banks must significantly overhaul their structures and teams. They will need to assess how their existing structures can be upgraded, revamped and integrated with CBDC technology, and bank staff will need to be trained in the basics of distributed ledger technology. If a bank is responsible for laying the groundwork for a CBDC, it will also need to hire more technical staff.
Further, CBDC onboarding will likely be contracted out to private players, particularly if the country’s banking infrastructure isn’t strong. For instance, Jamaica has partnered with technology provider eCurrency to onboard the country’s financial institutions.
To CBDC or not to CDBC
While still in the development phase, one thing is for certain: There is no one-size fits all approach to CBDCs. China’s success with CBDCs as an authoritarian country compared to Nigeria and the Caribbean’s extremely low adoption rates paint very different pictures.
To truly drive adoption, CBDCs need to evolve and customize strategies based on their customer’s needs and priorities – whether it be privacy, payment system efficiency or cross-border payments.
Most CBDC models are still new, with tepid success in terms of adoption and ease of use. Retail consumers, especially those happy with the existing payment solutions, will be the hardest sector to convince. As eNaira user Owolabi Abdullah told CoinDesk, “Our CBDC doesn’t solve anything. It’s additional stress – I could just have a regular crypto wallet.”
Plus, giving governments more control over their financial assets just doesn’t sit well with most people, unless there’s something in it for them.
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