In the coming years, banks will have many options with distributed ledger technology, cryptocurrency, and central bank digital currencies. Rajashekara Viveswara Maiya is the VP & Global Head for Business Consulting at Finacle. She shares the potential benefits that these technologies can offer businesses as fintech moves on to the next stage of its evolution.
The IMF launched a paper about the experiences of six countries that have experimented with Central Bank Digital Currencies (CBDCs). This new wave in fintech development has caught the attention of central banks around the world. Is this the next major disruption in the global financial system's structure?
Discussions on central bank digital currencies always touch on two related subjects, distributed ledger technology (DLT), and cryptocurrency. Financial institutions should consider the potential impact of CBDC on their businesses as they weigh the implications. Let's look into each of these transformative technologies in greater detail.
1. DLT: Faster and Safer. Also, It’s Cheaper
Cybersecurity risks are increasing due to the rapid adoption of digital bank transactions. DLT is less susceptible to attacks because it is a highly secure technology by design and nature. DLT is fast, efficient, and scalable. The new technology has been tested on a large scale by well-respected companies, such as IBM in Hyperledger's case. Distributed ledgers are cheaper than traditional infrastructure for building new technologies. The total cost of ownership of infrastructure built on a distributed ledger technology platform foundation is lower than any other technology.
Many transactions that were previously physically handled by banks were digitalized. Banks are now able to onboard customers online and approve and disburse loans digitally. They can even close accounts digitally. This eliminates the need to deal with paper documents. DLT elevates it by including smart contracts. These contracts are much more secure than traditional paper contracts, as they can't be altered or falsified. Another advantage to using smart contracts is the elimination of dubious practices such as duplicate financing of invoices. The digitized bills are validated via a distributed network before being paid.
2. Cryptocurrency: What’s the Tech Under the Coin?
For several reasons, regulatory bodies remain skeptical of cryptocurrencies. They are not controlled by any sovereign bank or government agency and they are not backed by securities or precious metal reserves. They also do not provide any visibility into the ownership and end-use of funds. Fraudsters have repeatedly hit them, prompting central banks to raise public awareness about the dangers of speculating with these currencies.
While authorities are hesitant to give it legal recognition they closely monitor the developments around cryptocurrency. Cryptography is a key technology that can help financial institutions protect their relationships with corporate customers and prevent fraudulent transactions.
3. CBDC: Better Money
A CBDC is a digital currency that represents a country's fiat currency. It is not a new concept. Preloaded currency cards and e-wallets are all built on the same idea. However, DLT and cryptocurrency have provided so many digital currency options that nearly all central banks are now interested in them. The survey of central banks by the Bank for International Settlements revealed that 86 percent were looking into the potential of CBDCs. 60 percent were trying it out and 14 percent were creating pilot programs. The Sand Dollar, the Bahamas' CBDC, was put into circulation over a year ago. China is rapidly moving forward with the e-CNY. It has more than 100,000,000 users and transactions that amount to billions. Nigeria, India, and the United States are all at different stages of exploration.
CBDCs are attractive to financial institutions because they can be used in any of the traditional bank transaction formats, such as a person-to-person transfer or a transaction between an individual and a merchant or between individuals. A central bank-issued digital money simply replaces physical money in each case. This offers several benefits:
- CBDCs reduce the large cost of printing and maintaining currency notes at a national level. Individual banks can save money by not having to replace soiled notes or supply ATMs with crisp new notes.
- A CBDC is an organization that can solve counterfeit money problems in countries. It improves security via cryptography and allows regulators to have almost total control over the money in circulation.
- Governments and banks can combine their CBDCs to combat the shadow economy within their respective countries. This will improve transparency, and tax collection, and reduce unaccounted cash transactions.
- It is possible to use digital currency to increase financial inclusion. Highly underbanked areas, like Africa and South Asia, don't have the financial resources to build extensive banking infrastructure. They have access to high-speed internet and mobile connectivity that they can use to offer digital banking services using QR codes, UIDID, and, now, CBDCs.
- CBDCs can be used to reduce the large fees currently levied for international remittances. Banks should investigate the possibility of creating infrastructure for cross-border digital payments using digital currency.
- In extreme cases, digital currencies can come to quick service. cash, the digital currency of the Eastern Caribbean, is accepted in St. Vincent and Grenadines for public use. It will help the country recover from the April 2021 volcanic eruption.
A Powerful Trinity
DLT offers security, speed, efficiency, and security in transactions. The cryptography technology that underlies cryptocurrency can also reduce fraud, counterfeiting, and other malpractices. CBDC has potential benefits such as financial inclusion, cost savings, and mitigation of issues like fake money and shadow economies. The possibility of combining these three is even more exciting. This could lead to valuable use cases. Imagine a central bank using DLT to issue a CBDC created using cryptography. This would allow them to reap all of their benefits simultaneously.