Central Bank Digital Currency (CBDC) – few considerations for Central Banks

Central Bank Digital Currency (CBDC) is a new form of Digital Money which we introduced in our first CBDC post. CBDC Projects are a complex and costly endeavor and hence before delving into CBDC Projects, Central Banks should evaluate the Business Case in terms of CBDC benefits and risks. These evaluations should not be done in silos. Socio-economic conditions, technology maturity of financial services sector and central bank priorities differ, and hence country-specific due diligence is required while planning the CBDC projects.

Introduction of CBDC can have multi-dimensional benefits for consumers as well as governments. Some of the low-hanging fruits can be maintaining Payments System Sovereignty and Monetary Policy controls vis-à-vis private cryptocurrencies, reducing subsidy leakages, improving Tax compliance. In some scenarios, even Synthetic CBDCs issued by Commercial Banks/PSPs (Stablecoins backed by Central Bank reserves) can be a faster and easier way of achieving such policy goals. Hence both CBDC and Synthetic CBDC (Stablecoin models) are worth considering.

In our view, Central Banks should consider what other synchronous technology and policy changes are required along with CBDC implementation. E.g., if CBDC platform needs to be integrated with a national ID platform or a Fiat Currency Settlement system, the integration and interoperability requirements should be closely considered. Similarly, for achieving key benefits of tokenization, smart contract, Delivery vs Payment (DvP) and various Decentralized Finance (DeFi) use cases should be part of broader architecture vision from early stages of the program.

Managing the Risks:

CBDC Projects face multiple risks which should be closely managed. They include Business Model disruption risks, Technology Risks, and Policy related risks. These risks if not identified and managed in timely fashion, have potential to jeopardize the whole economy. E.g., if the CBDC platform cannot scale with the growth in payments transactions and face huge latency in completing payment transactions, customers and businesses face significant challenges. Similarly, if the platform is not resilient consumers will have trust issues around the platform.

CBDC is expected to have huge transformational impact on business models of Commercial Banks. Such disintermediation risks need to be managed with account and transaction limits as well as arranging new avenues of fund raising for commercial banks. There can be unintended consequences of the innovation built on top of CBDC platforms. A badly written smart contract can mess up government or consumer’s financial life at scale and such discrepancies may be very difficult (and late) to identify. Hence any such code changes or configurable features should go through extensive testing and regular audit process.

Developing the CBDC Roadmap:

After assessing high level policy priorities and program dependencies a time-boxed roadmap should be developed. To achieve incremental value-realization in a risk-mitigating way, high value-low risk capabilities should be built first (‘low hanging fruits’) followed by more complex/high risk capabilities.

CBDC system needs to be designed to be interoperable with existing payment systems and financial platforms to enable easy flow of funds between various parts of the financial system. This will enable rapid and broader adoption of CDBC based payments. Central banks can enable interoperability by ensuring adoption of established messaging standards (such as ISO 20022), data standards (such as BIC, IBAN, SWIFT), technical standards (such as REST API) and cyber security standards (related to Cloud security, network security and application security). Interoperability of CBDC system across countries will foster rapid adoption of cross-border payments using CBDC.

Next Steps for the Central Banks:

Central Banks need to focus on following next steps to kick start and accelerate their CBDC initiatives:

  • Define the key objectives and expected benefits of CBDC initiative
  • Compare the various design choices and firm up the CBDC features to enable the launch of CBDC. Some of the design choices deal with areas such as CBDC minting (based on DLT or not), CBDC distribution (Two Tiered or fully managed by Central Bank), CBDC issuance method (Token based or Account based), Anonymity (Pseudonymous or fully identifiable) etc.
  • Launch initial Proof of Concept and execute subsequent iterations to explore various options with respect to technology, architecture, and policy decisions. Clearly define and articulate the evaluation framework and techniques to provide clarity on the approach to all the participants in the CBDC pilot launch and in subsequent iterations. This will provide impetus to Commercial Banks / FI, NBFCs, PSPs, Corporates, government agencies and Consumers to embrace CBDC journey without any hesitation.
  • Conduct periodic discussions with ecosystem stakeholders to receive feedback and fine tune the approach as the Central bank goes about accelerating the adoption of CBDC for a wide variety of use cases.

Moonshot projects – targeting high inefficiencies through centralization:

Even though tokenization started as a decentralized model, true value is achieved when all stakeholders are in same chain and hence through centralization. Governments and Central Banks across the globe should target Projects which can address key market inefficiencies through tokenized models in common chains. Some of the potential opportunities are:

  • Healthcare Payments – In general healthcare payments are extremely inefficient – CBDC, DVP and programmable money features can significantly improve the situation
  • Cross border payments – Multiple CBDC Bridge(mCBDC) and Regulated Liability Network (RLN) models can significantly improve the cost and speed of cross-border payments

We believe CBDC and related technologies will truly transform the Finance world as we know today, and we are excited to be part of the journey!

Author Details

Abhisek Bhowmik

Abhisek is a Principal in Infosys Consulting. He specializes in Banking, Payments, Digital Currencies(CBDC) and Financial Risk Management and has advised several top banks and payments companies in the world. In his blog, Abhisek will share his insights on next generation technology trends, Domain Products and Fintechs.

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