What is CBDC & How Does It Improve Payments?

Work towards developing a central bank digital currency is underway in many regions of the world. As countries explore the potential benefits of national digital currencies, the European Central Bank in close partnership with private sector partners has speeded up its efforts toward building a more secure, and effective pan-European digital payment solution in the form of a European CBDC i.e., the digital euro.

What is CBDC?

Central Bank Digital Currency or CBDC is the digital form of a country or region’s fiat currency. This digital money is issued and regulated by the central bank or monetary authority of the country. There will be 2 types of CBDC: retail CBDC and wholesale CBDC. A retail CBDC can be used for peer-to-peer payments as well as for paying for goods and services. The wholesale CBDC is meant to settle trade between financial institutions.

Some of the main objectives in the creation and issuance of the CBDC are:

• Preserve the sovereignty of public money.
• Strengthen the public’s trust in national currency or public money.
• Boost the performance, stability, and resilience of financial systems.
• Strengthen the digitization of the region’s economy.
• Develop better payment efficiency in cross-border trade.
• Counter the risks presented by private digital money.

The CBDC is meant to be a reliable and stable digital substitute for and supplement to physical cash. It will become the “one-stop” payment solution for all.

How Will CBDC Improve Payments?

A stable and well-designed CBDC will play a key role in making digital payments and financial services more safely and easily accessible to all people. Businesses and consumers can look forward to having a fully digital payment process with low transaction fees and faster settlement time. It will also allow for greater local governance which will ensure enhanced risk control.

It will further help overcome the high costs, risks, and slow execution of current cross-border payment processes. With the right cooperation between different central banks, the CBDC can bring better interoperability in cross-border trade, making it a seamless and cost-effective process.

CBDC Euro: Pros & Cons

The growth of e-commerce, the advent of cryptocurrencies and blockchain technology, and the post-pandemic emphasis on a cashless economy have heightened the interest in digital currencies. And governments and fintech groups are hopeful that with its introduction, the current limitations of digital finance will be overcome. At the same time, it will help to:

• Provide access to financial services to unbanked people, thus ensuring wider financial inclusion in the region. The CBDC Euro will enable the ECB to play a direct role in helping people to hold accounts directly with them. People can then access their funds through a central bank-issued digital wallet.
• Reduce fraud, terrorist funding, money laundering, or any other illegal flow of money by using stronger laws and regulations. Tech innovations like machine learning and data analytics further bolster the position of financial institutions as strong agents of defense against FinCrime. As such, the CBDC Euro will allow tracing of the flow of funds right from the point of origin to the point of exit. This will wipe away the anonymity factor, and make it easier to control the spread of financial crime.
• Maintain financial stability and sovereignty in the face of tensions like a pandemic, war, natural disaster, banking crisis, inflation, price volatility, slow market growth, etc.

Final Thoughts

Bringing in a central bank digital currency is the next logical thing in the world of payments. But innovations bring their share of opportunities as well as challenges. Hence, as the CBDC Euro develops, there needs to be a strong emphasis on data security, since it will involve processing sensitive user information. Thus, all necessary steps will have to be taken to safeguard consumers and businesses from bad actors and protect privacy. Plus, all parties have to understand the costs of introducing and maintaining the CBDC Euro and its related technology infrastructure.

The idea of a public-serving CBDC is to complement and not compete with new and traditional financial services. And this is where the role of retail banks and fintech service providers becomes prominent. For a practical digital national currency to come into existence, governments have to encourage a public-private partnership more strongly. This is vital to ensure financial integrity, financial stability, and the safety of customer funds.

Jose Augustine

Jose Augustine is the Chief Business Development Officer at Novalnet with extensive experience in European payment industry and a knowledge powerhouse.