August 17, 2023 By Ayman Abi Karam 4 min read

The financial world has been revolutionized by blockchain technology, which has enabled peer-to-peer transactions without the need for intermediaries. The introduction of Central Bank Digital Currency (CBDC) has added a new dimension to blockchain technology that transforms the future of payments for businesses and individuals.

Some time ago, banks and governments started shifting their attention towards using digital assets in their operations and economies. The executive order from the President of the United States, “Responsible Development of Digital Assets,” is one example of the public acknowledgment for the need for prudent development of such assets. Banks and governments are actively seeking CBDC because it is a more secure alternative to crypto.

Digital currency and blockchain lead to greater integrity and efficiency

CBDC is a digital form of fiat—money that is issued by central banks. It is designed to be a digital representation of the country’s physical currency. Unlike cryptocurrencies like Bitcoin or Ethereum, CBDC is backed by the government and is legal tender. The aim of CBDC is to improve the efficiency of payments and reduce the cost of printing, storing and transporting physical cash.

CBDC operates on a secure, transparent blockchain network, and it uses blockchain technology to create an immutable record of all transactions. This means that all transactions are recorded on a decentralized ledger, making it impossible to modify or tamper with the data.

On the other hand, blockchain uses a distributed ledger technology (DLT) that allows for the secure and transparent recording of transactions. It consists of a decentralized network of computers, each of which maintains a copy of the ledger. Whenever a new transaction is added to the ledger, the network of computers uses complex cryptographic algorithms to verify and add it to the existing chain of transactions in a way that ensures the integrity of the ledger.

Blockchain technology is characterized by its transparency, security and immutability. Transactions recorded on the blockchain are visible to all participants in the network, making it a highly transparent system. This technology has numerous potential applications in the financial services industry, supply chain management, voting systems and more. It is seen as a promising technology for increasing transparency, reducing fraud and enabling secure peer-to-peer transactions without the need for intermediaries.

CBDC and the secure, inclusive future of payments

CBDC has the potential to transform the future of payments. It can be used to create programmable money that can be spent only on specific things. For example, a government could issue a stimulus package that can only be spent on certain goods and services. This would ensure that the money is spent in the intended manner and would reduce the risk of fraud.

Also, CBDC can improve financial inclusion. According to the World Bank, around 1.7 billion people do not have access to basic financial services. CBDC can solve this problem by providing a digital currency that anyone with a smartphone can use, without the need for a bank account.

When a CBDC holder uses their phone as a medium for transactions, it becomes crucial to establish a strong link between their digital identity and the device they are using. This link is essential to ensure that the right party is involved in the transaction, mitigating the risk of fraud and promoting trust in the digital financial ecosystem. That said, CBDC and the digital identity can work together to improve financial inclusion. Here are some points to consider:

  • Reliable identification: Digital identity provides a means to reliably identify individuals participating in financial transactions. By linking a person’s unique digital identity to their CBDC wallet, the central bank can authenticate their identity and establish trust in the digital payment system.
  • Access to financial services: Many individuals, particularly those in underserved or remote areas, lack access to traditional banking services. By enabling CBDC transactions on mobile phones, individuals can participate in the formal financial system without the need for a physical bank account. This extends financial services to unbanked or underbanked populations, fostering financial inclusion.
  • Secure transactions: By securing digital identity and authenticating the device, CBDC transactions become more secure. It ensures that only authorized individuals can access and use the CBDC wallet on their phones, reducing the risk of identity theft and fraud. This security builds trust in the system, encouraging individuals to adopt CBDC and engage in digital financial transactions.
  • Inclusive digital ecosystem: When CBDC is coupled with digital identity, it can enable interoperability across various digital financial services. It allows individuals to connect their CBDC wallet with other digital platforms, such as e-commerce, digital lending or insurance services. This integration creates an inclusive digital ecosystem, empowering individuals to access a range of financial services conveniently and securely.

Moreover, CBDC can reduce the risk of money laundering and terrorist financing. Blockchain technology can be used to create an immutable record of all transactions, making it easier to track the movement of money and identify suspicious activity.

CBDC represents a significant opportunity for the financial industry

CBDC is a relatively new development in the world of finance, and its emergence has created several opportunities in the market:

  • Improved payment systems: CBDC can improve payment systems by providing a secure, fast and low-cost payment method. It can potentially replace cash (which is more expensive to produce and manage) with a digital currency that can be easily transferred between parties.
  • Increased efficiency: CBDC reduces the need for intermediaries in the payment process, which lowers transaction costs and increases speed.
  • Enhanced monetary policy: CBDC can provide central banks with better control over monetary policy by allowing for more direct control over money supply and velocity, and by granting them visibility over payment flows. Central banks can evaluate performance with real-time economic behavior instead of relying on lagging indicators to assess the health of the economy.
  • New business models: The introduction of CBDC can create new business models (such as digital wallets and omnichannel payment solutions) that can provide value to consumers and businesses.

CBDC could be the future of payments, and it will be interesting to see how the market evolves as more central banks begin to explore and adopt this technology. It has the potential to revolutionize the financial world by providing a digital currency that is more efficient, secure and transparent.

Contact the IBM Payments Center to learn more
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