Are you ready for CBDCs?

Central Bank Digital Currencies (CBDCs) arguably represent the greatest threat to banks’ current business models since the 1600s. By changing the way in which value is exchanged, these nascent digital currencies have the potential to disrupt the banking model itself. However, for many in the industry CBDCs continue to be something of an enigma. It isn’t always clear what CBDCs are, how they work, or what threat they actually pose to current money flows.

So what do you need to know about CBDCs? How much progress is happening in this space? And what sort of practical use cases could we see in the future?

CBDCs: the story so far

Amidst the rising price of bitcoin and surging interest in cryptocurrencies, central banks have been keen to develop something they can manage and regulate themselves. At the same time, there is a growing focus on countering the proliferation of unregulated digital tokens and currencies – such as Diem, the digital coin backed by Facebook – by providing digital equivalents. And another driver is the need to improve the efficiency of payments in support of cross-border trade.

These factors have given rise to the concept of Central Bank Digital Currencies (CBDCs) – a broad term used to describe a digital form of currency issued by the relevant country or region’s monetary authority. Broadly speaking, CBDCs come in two distinct flavours: retail CBDCs, which are targeted towards consumers, and wholesale CBDCs, which are targeted towards banks. Another point of distinction can be drawn between account-based and token-based models. With a token-based CBDC, the payee verifies the transaction by confirming the validity of a token, whereas an account-based CBDC transaction is verified by confirming the account holder’s identity.

At this stage, central banks around the world are at varying stages of launching and issuing digital currency:

• Sand Dollar is a digital version of the Bahamian Dollar and was first issued by Central Bank of the Bahamas in October 2020.
• The People’s Bank of China (PBOC) is currently piloting e-yuan in several cities.
• The Reserve Bank of India may begin trials for a digital rupee later this year.
• Sweden’s Riksbank is exploring the possibility of issuing e-krona.
• In the UK, the Bank of England and HM Treasury have set up a CBDC taskforce to coordinate the exploration of a potential CBDC.
• Banque de France launched an experimental programme in March 2020 and carried out a CBDC experiment with SEBA Bank in June 2021.

Also of note are collaborative efforts such as Project Ubin, an initiative led by the Monetary Authority of Singapore (MAS) to explore the use of blockchain technology for the clearing and settlement of payments and securities. Meanwhile, Project Dunbar is an initiative by the Bank of International Settlements to test the use of CBDCs for international settlements, with involvement from the central banks of Malaysia, Singapore, South Africa and Australia.

A further significant development is J.P. Morgan’s blockchain Onyx, which has been used for pilot CBDC transactions by Banque de France and MAS.

CBDCs: identifying the use cases

So what are the opportunities arising from digital currencies? –In particular, we have identified three use cases in which we see the potential to leverage CBDCs:

1. Institutional banking For transactions between banks to manage liquidity or exchange settlements, as well as client transactions on stock exchanges, CBDCs could present an alternative to the use of CHAPS, RTGS or SWIFT payments.
2. Trade finance Over 200 banks are currently using our trade platform. While they can use SWIFT to carry out trade transactions, complex processing is needed to address both sides of the transaction. The use of CBDCs and smart contracts could represent an opportunity to simplify and automate this processing with immediate settlement of trade transactions.
3. Commercial lending  Likewise, over 200 banks use Loan IQ, the world’s leading solution for servicing commercial loans. Another area of interest is the potential use of CBDCs to support the tokenisation and secondary trade of assets on Loan IQ.

To find out more about how CBDCs will shape the future of finance join us on 20 September for our webinar; “Making the world of finance open and connected with digital currencies”