Even in developed nations, it’s significantly cheaper to mail cash than to send money digitally. But the benefits of a formal financial institution aren’t available for 2.5 billion people in the world who are unbanked, not only because of poverty, but also due to costs, travel distance and paper work involved.

These people, who often live in developing economies where the transfer cost of remittances is often the highest, stand to benefit the most from financial institutions issuing central bank digital currencies secured by blockchain technology.

Blockchain for financial services

What is a central bank digital currency?

The core concept behind digital currencies has been around since 1983 when David Chaum introduced the idea of digital cash. Digital mediums of exchange are extremely prevalent in the world and have a broad range that goes from virtual currencies like Fortnite’s V-Bucks to cryptocurrencies such as Bitcoin. These currencies can often be used in the real world to exchange for physical goods and services, just like paper banknotes, but are often restricted to specific communities as is often the case with electronic money. The record of the funds available to a consumer is stored on an electronic device for use over a computer network and is often limited to specific networks like Visa, Mastercard and others.

But what if every single person in a country had a digital, immutable financial record that was with them at all times? A record that they could debit and credit between parties in seconds without being limited to a network provider and any party on the blockchain network, regardless of geography, could instantly transfer funds.

A central bank digital currency (CBDC) is a digital extension of a central bank’s medium of exchange able to permanently settle transactions between parties. The central bank is able to remove credit risk and ensure stability by guaranteeing the value of the CBDC, exactly like paper money. And any person tied to any central bank on the network can instantaneously transfer value between any other person tied to any other central bank on the network. The defining value of blockchain for business is the ability to collaborate between networks and that is one of the defining blockchain use cases.

What are the benefits of a central bank digital currency?

As noted by the October 2018 OMFIF report titled Central bank digital currencies, “The main motivations for pursuing a wholesale CBDC, according to survey respondents, lie in the potential to improve speed and cost efficiency. It may also help to overcome the limitations of existing systems, especially in system security and resilience. A wholesale CBDC can reduce operational risks and running costs due to productivity gains as more financial assets become tokenized and recorded on distributed ledgers.”

What are the risks of a central bank digital currency?

One of the key risks raised in Monetary Policy and Digital Currrencies: Much Ado about Nothing? by the Banque de France’s Christian Pfister, Deputy Director General, Directorate General Statistics, and reinforced in the paper Fintech and the Future of Retail Banking by Jan Smets, Governor, National Bank of Belgium, around central bank-issued digital assets is the worry that a CBDC would facilitate bank runs, or large numbers of customers withdrawing their money in an emergency where they’re concerned about the future of a financial institution. This primary concern is addressed, however, in the Bank of England’s staff working paper, Central bank digital currencies – design principles and balance sheet implications with their third core principle for a CBDC. By not obligating banks to convert their deposits into CBDC on demand, they’re able to protect the aggregate banking system.

What does the future hold for central bank digital currency?

As noted in the IBM Institute for Business Value study, Charting the evolution of programmable money, “Despite the intense opposition from some commercial banks, central banks’ interest in digital currencies hasn’t wanted; in fact, it is still emerging. Understanding that they may need to regulate some cryptocurrencies, central banks have been quietly but actively evaluating their merits and experimenting with their own version, called central bank digital currencies. In 2019, the Bank for International Settlements published a survey on central banks and CBDCs showing that while 85 percent of central banks say they are unlikely to issue a CBDC within the next three years, about a quarter of the central banks said they already have the authority to issue a CBDC or will soon have it. And a full 70 percent acknowledge they are studying the issue.”

Because of the benefits afforded by a central bank digital currency, policymakers at central banks estimate that at least one consumer-ready CBDC will launch within the next five years, according to a new study from IBM and OMFIF, an independent think tank. The study, which drew on survey data from 23 small and large central banks, determined that the first central bank digital currency will be in a small nation and employ a narrow use case, for example facilitating remittances or promoting financial inclusion in regions where physical banks are few and far between.

But while there will likely always be a role for private banking — central banks surveyed by OMFIF almost unanimously said CBDCs would be implemented through public-private partnerships — once the first CBDC is launched, more will likely follow.

Read the full report on retail CBDC — the next payments frontier