The Rise of Blockchain-Based CBDCs: What it Means for the Future of Payments?

Undoubtedly, Central Bank Digital Currencies (CBDCs) have captured the attention of mainstream media, policymakers, regulators, and bankers. According to the Bank for International Settlements, approximately 85% of central banks worldwide are exploring or testing pilot projects related to enterprise blockchain development-based CBDCs. The question is, what is causing all this excitement, and what are the key points to consider?

Although CBDCs are a complex topic and their narrative is still evolving, this blog offers a comprehensive overview of their crucial characteristics and the potential scenarios that could arise in the coming years.

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CBDCs and tokenized money

Throughout history, the concept of money has undergone several transformations, evolving from everyday objects to precious metals and from the gold standard to fiat currency in 1971, in response to technological advancements and social changes.

While digital money has been around for a few decades, experts suggest that we are on the verge of digital money 2.0 — a new era of token-based digital money that differs from the account-based electronic money that has predominated in recent years. Tokenization, often utilizing blockchain technology, serves as the foundation for cryptocurrencies, stablecoins, and many proposed central bank digital currencies (CBDCs). The emergence of tokenized money can be traced back to the introduction of Bitcoin in 2008, which became the first widely accepted, decentralized, peer-to-peer cryptocurrency built on distributed ledger technology known as the blockchain.

Global Adoption of Blockchain-based CBDCs

Central banks worldwide are actively investigating the potential of blockchain-based CBDCs. Among them, the People’s Bank of China (PBOC) is at the forefront of CBDC adoption, having conducted several successful pilots and trials of its digital yuan. Additionally, the PBOC has partnered with other central banks, such as the Bank of Japan and the European Central Bank, to explore the potential of cross-border payments facilitated by blockchain-based CBDCs.

In Europe, the European Central Bank is exploring the possibilities of a digital euro, which could supplement physical cash and offer an alternative payment solution. Likewise, the Bank of England is examining the potential of a digital pound, which could mitigate the risks associated with cash and promote greater financial inclusion.

Challenges of Blockchain-Based CBDCs

One of the primary obstacles facing blockchain-based CBDCs is concerns about

• privacy.

While enterprise blockchain development technology provides heightened security, it is also transparent, resulting in all transactions being visible on the blockchain. This creates worries about privacy, as individuals may not desire their financial transactions to be publicly accessible.

• Another challenge is regulatory hurdles.

Blockchain-based CBDCs are a relatively new technology, and there is still considerable uncertainty surrounding how they should be regulated.

Solution

To address these concerns, central banks will need to collaborate with regulators to establish well-defined guidelines for utilizing CBDCs.

• Finally, there are challenges related to adoption.

While blockchain-based CBDCs hold the potential to improve payment efficiency and security, their success will hinge on widespread adoption.

Solution

To accomplish this, significant investment in infrastructure and education will be necessary to help people understand how to utilize CBDCs.

The Roadmap Ahead

When considering any new technological advancement, it is essential to thoroughly assess both the benefits and drawbacks and examine both intended and unintended consequences. Nevertheless, it is apparent that policymakers are now focusing on the potential advantages of CBDCs. Although the narrative surrounding CBDCs is still unfolding, several key characteristics are already notable. For instance:

The future of money is expected to incorporate a combination of centralized, decentralized, account-based, and token-based systems, with various types of currencies co-existing, such as CBDCs, stablecoins, and cryptocurrencies, alongside traditional digital and physical currencies.

While most countries are presently exploring wholesale CBDCs as a first step, there is an increasing interest in safe and efficient retail CBDCs, although related risks will need to be thoroughly examined. As ongoing research and testing continue, it is anticipated that retail CBDCs will be introduced in the future.

As central bank digital currencies (CBDCs) gain more mainstream attention, there is also an opportunity for greater cooperation and consultation between the private sector and central banks. This could entail central banks establishing regulatory sandboxes and innovation hubs, allowing tech companies, fintech firms, and other financial institutions to experiment with various CBDC options.

Implications for Financial Institutions

Central bank digital currencies (CBDCs) are a topic of discussion at the macro-economic level, but their impact is expected to eventually trickle down to businesses and consumers. Financial institutions like banks must consider how they can prepare for this new technology and its potential implications.

CBDCs have the potential to revolutionize the way individuals and businesses store money and conduct transactions, which may significantly alter how customers interact with financial institutions. Here are some key factors that traditional banking services should consider:

• Deposit and Loans:

With the introduction of retail CBDC and digital wallets, non-bank financial institutions may be able to host the CBDC wallet, potentially posing a risk to banking deposit accounts. This competition for banking deposit accounts may lead to lower deposit balances, which could affect asset liability management if reserves fall below the required levels needed for lending activities.

• Payments:

The emergence of blockchain-based CBDCs may impact the ability of financial institutions to collect fees from traditional payment services such as wire transfers and check issuances. With the potential introduction of central bank-issued digital wallets, consumers may have the option to conduct instant and low-cost electronic payments without relying on traditional banks. This could lead to increased competition in the payments space, and financial institutions may need to re-evaluate their business models and fee structures to remain competitive.

A Guide for Financial Institutions: Adapting to the Future

As the global economy increasingly moves towards CBDCs, financial institutions need to be aware of the potential for significant changes. To gain a competitive advantage, institutions that offer digital asset services should develop a strategy that includes stablecoins, tokens, and institutional custody services that align with CBDC requirements.

• Develop a Digital Asset Strategy

To assess their readiness to support CBDCs, financial institutions should evaluate whether their existing programs and systems can handle the expansion of traditional custody services to include digital assets. They should also prepare their staff with the necessary skill set to adapt and implement changes quickly.

• Develop the appropriate skillset

By considering potential threats from CBDCs, financial institutions can identify areas of opportunity and pivot towards new products and services that leverage the transformative nature of digital assets. Those who lead in developing these strategies will be better positioned to define the impact of CBDCs on the bank’s value proposition.

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