How will CBDC impact cross-border payments and the fintech technology companies providing remittance solutions to banks & businesses?
There are over a 100 countries developing CBDCs. The Sand Dollar in the Bahamas has been in circulation for quite a while. In China the launched pilot CBDC, e-CNY continues to grow and is expected to be circulated nation-wide soon. A digital currency flood that promises more social inclusion, more safety and lower costs is all set to bring about huge changes in the financial sector and impact businesses and individuals, if certain challenges are met.
A Central Bank Digital Currency (CBDC) is a digital representation of a country's fiat currency that also serves as a claim on the central bank. Instead of printing money, the central bank issues electronic coins or accounts that are backed by the government's full faith and credit. In simple language, a CBDC (Central Bank Digital Currency) is a type of digital currency that is issued and backed by a central bank. It is similar to traditional physical currencies, such as the Yen, US dollar or the euro, but it exists in digital form and can be used to make electronic payments or transactions. CBDCs are considered to be a potential alternative to traditional fiat currencies, and they have the potential to revolutionize the way that central banks issue, manage money and bring about changes in the cross-border remittance business.
As you are aware, thousands of digital currencies, also known as cryptocurrencies, are already available on the market. The most well-known fully decentralised cryptocurrency is Bitcoin. Cryptocurrencies use distributed-ledger technology, which means that multiple devices all over the world, rather than a single central hub, are constantly verifying the transaction's accuracy. Stablecoins are another type of cryptocurrency whose value is linked to an asset or a fiat currency, such as the US dollar.
There is a lack of trust in cryptocurrencies being used as a standard for cross-border transactions (blockchain cross-border payments), the reasons for which are mentioned below;
Discontinuation or forks: Forks can occur when different crypto miners get misaligned, that is to say there is a blockchain network split. This can result in a price volatility. This can result in that particular digital crypto currency being stopped among other reasons.
Security: There is no guarantee that the crypto network cannot be hacked and technical glitches are common.
Regulations: The cryptocurrency market is still unregulated. Neither the government nor the banks have any significant control over it.
Volatility: Unexpected changes in market sentiment can cause sharp and sudden price movements. It is not unusual for the value of cryptocurrencies to plummet by hundreds, if not thousands, of dollars in a small amount of time.
There are several reasons why governments and central banks may be interested in issuing a CBDC. Some of the potential benefits of a CBDC include:
Increased speed and efficiency of transactions: CBDCs can be used to make fast, secure, and efficient digital payments, which could help to reduce the costs and complexities associated with traditional payment systems.
Greater financial inclusion: CBDCs have the potential to reach people who are currently unbanked or underbanked, such as those living in rural areas or developing countries.
Improved stability and security: CBDCs can be designed to be more stable and secure than other digital payment systems, and they can be backed by the full faith and credit of the central bank.
Enhanced monetary policy: CBDCs can be used as a tool for monetary policy, allowing central banks to directly influence the supply and demand for money in the economy.
Potential to reduce the use of cash: In some countries, there is a trend towards the declining use of cash, and a CBDC could potentially help to accelerate this trend.
Cross-border payments & currency monopolies: CBDCs can help a nation counter the hazards of currency substitution such as becoming an economic hostage of the country providing the substitute currency. The use of digital identification and multi-CBDC provisions will make cross border payments faster, cheaper and more accessible.
Digital vs physical currency: From a retail standpoint, gradually replacing notes and coins with CBDCs saves the state money on the costs of maintaining and replacing notes and coins. It may also significantly reduce transaction costs for individuals and small businesses in some countries or regions that have limited or expensive access to banking services; and it may facilitate financial inclusion.
There are several challenges and risks associated with the use of CBDCs that governments and central banks will need to carefully consider. Some of the potential challenges include:
Privacy concerns: One potential issue with CBDCs is that they could allow central banks and other authorities to track and monitor individual transactions, which could raise concerns about privacy and the potential for abuse of power.
Complexity of implementation: Implementing a CBDC could be a complex and technically challenging process, requiring the development of new infrastructure and systems. With many CBDCs being launched such as a digital rupee, digital yuan, digital euro, as well as a somewhat likely digital dollar, interoperability will become a major challenge. CBDCs, which are built on different technical standards and different platforms, have additional issues, such as the ability and legality of using one outside of its country of origin, as well as differences between wholesale and retail CBDCs.
Impact on monetary policy: The use of a CBDC could have significant implications for monetary policy, and central banks will need to carefully consider how it could affect their ability to influence the supply and demand for money in the economy.
Risk of cyber-attacks: CBDCs, like any digital payment system, could be vulnerable to cyber-attacks, and governments and central banks will need to put in place strong security measures to protect against these threats.
Potential disruption to the financial sector: The introduction of a CBDC could potentially disrupt the traditional banking and financial sector, and there may be unintended consequences that need to be carefully managed.
Source: www.atlanticcouncil.org
Right now, about 114 countries are in phase to develop a CBDC. There is no surprise that China, in its pilot stage CBDC is all set to expand its digital currency to most of the country. It’s CBDC already reaches about 260 million of its citizens. There are about 7 retail cross-border CBDC tests and 9 wholesale cross-border CBDC tests being conducted around the globe. You can know more about wholesale and retail cross-border remittance here.
Of the G20 nations, 18 countries claim to be in the later stage of CBDC development with 7 launching a pilot CBDC. All of the G7 nations have moved into the CBDC development stage and in 2023, pilot CBDCs will be launched by about 20 countries including Russia, Thailand, India, Brazil, South Korea and Australia.
At the time of writing this article, sources reveal that 11 countries have already launched CBDCs. These include Nigeria, The Bahamas, Jamaica and the Eastern Caribbean countries Grenada, Saint Vincent and the Grenadines, Saint Lucia, Dominica, Montserrat, Saint Kitts and Nevis, Antigua and Barbuda, and Anguilla.
China: In the digital economy, China is already far ahead of most other countries, with private payment systems such as TenPay and AliPay competing with Western rivals such as Visa. The ability of these Chinese firms to process large-scale transactions, combined with the Chinese government's strong internal ties to and ability to regulate private companies, gives China a clear advantage in the race to develop a functioning CBDC.
China has made the most progress in developing CBDC of any major economy. Since 2014, China has been researching a potential digital currency, and the e-CNY system saw its first trials during the 2022 Winter Olympics. There are already ambitious expansion plans in the works.
India: Apart from the above-mentioned needs, CBDCs are seen as a method to counter rampant tax evasion and reduce the black/grey market economy in India. One of the primary goals of India's CBDC programme is to regulate the financial system and reduce capital flight.
The digital rupee is all set for launch by the RBI in 2022 or 2023. India, like Russia and China, seeks financial stability by rejecting the decentralised ethos of cryptocurrencies such as Bitcoin, while also avoiding the "dollarization" of local economies that receive foreign investment.
Russia: The recent invasion of Ukraine and the sanctions that have resulted have only fuelled Russia's desire to create an alternative currency that is not dependent on Western market tools like SWIFT and other payment systems, and Moscow sees CBDCs as a way to maintain economic independence in the future.
The Russian government stated in December 2021 that a prototype for the digital ruble was complete and had already successfully completed a number of test transactions. China and Russia are openly hostile to decentralised cryptocurrencies, calling for a total ban on them and other digital assets not under their control.
Thailand: Thailand is also making rapid progress toward the establishment of a CBDC. Thailand conducted four proof-of-concept trials for wholesale CBDCs in 2018, taking a two-pronged approach to their development. In collaboration with several Asian and Middle Eastern economies, the country is investing in local retail CBDC development as well as a mCBDC (multi-currency CBDC).
U.S.A.: With the US dollar remaining the world's preferred financial unit, the implementation of a dollar-backed CBDC would have significant ramifications. Another wave of high volatility and value swings across the decentralised cryptocurrency market in recent months has demonstrated the utility of a more stable digital solution for online payments. The policymakers are divided on the CBDC issue, and the Federal Reserve Bank has stated that it will not move forward unless the White House and lawmakers provide clear support.
Having said that, CBDC is being considered at the government level and is in the development stage in the United States.
Onyx/Multiple wCBDC: The Banque de France completed a successful wholesale cross-border payments experiment in July 2021 with the Monetary Authority of Singapore using JP Morgan’s Onyx.
Project Aber: Saudi Arabia and the UAE successfully completed wholesale cross border transactions (wCBDC) after launching a bilateral CBDC pilot called Project Aber.
Project Helvetia: The BIS, a commercial infrastructure operating company called SIX and the Swiss National Bank. A wholesale CBDC was successfully integrated to the country’s core banking infrastructure in 2020.
Project Jasper: This was a Bank of Canada’s project of wholesale cross-border payments test with the Monetary Authority of Singapore and the Bank of England.
Project Aurum: The BIS Innovation Hub in Hong Kong created a CBDC prototype along with the Hong Kong Monetary Authority which is capable of both retail and wholesale tokens.
Project Rosalind: The BIS Innovation Hub in England along with the Bank of England created a retail CBDC, an intermediated, two-tier model, to know how ledgers of the central bank can communicate with vendors of the private sector.
Project Jura: The Banque de France, the Bank of International Settlements (BIS) and the Swiss National Bank worked with Accenture and were planning on experimenting with wholesale CBDC (wCBDC) on a distributed ledger technology (DLT) platform for cross-border payment transactions.
Project Mariana: The Monetary Authority of Singapore, the Swiss National Bank and the Banque de France along with the Eurosystem BIS Innovation Hub started working on a wholesale cross-border AMM (Automated Market Maker) plan to simplify exchange between Singapore dollar, euro and the Swiss franc.
Project Icebreaker: The Nordic centre BIS Innovation Hub with the Central Bank of Norway, Sveriges Riksbank and the bank of Israel started working on interlinking and interoperability between different CBDCs, for facilitating retail CBDCs across borders.
Project Sela: The BIS Innovation Hub in Hong Kong worked with the HKMA (Hong Kong Monetary Authority) and the Bank of Israel to understand cybersecurity on two-tear retail CBDC.
Project Dunbar: A project between the central banks of Malaysia, South Africa, Australia and Singapore was setup to facilitate cross-border settlements between many CBDCs.
mBridge: To create a faster, more affordable, mechanism for foreign exchange operations and transfers, China, UAE, Hong Kong and Thailand started working on the mBridge project of CBDCs.
A potential impact of CBDCs on international businesses is that they could make cross-border payments faster and more efficient. Because CBDCs are digital, they can be transferred and settled instantly, rather than having to go through the process of physically moving cash or using intermediaries. This could reduce the cost and time required for cross-border payments, which could make it easier for businesses to trade internationally.
Another potential impact of CBDCs is that they could reduce the reliance on traditional intermediaries, such as banks, for cross-border payments. This could make it easier for businesses to access financial services and could potentially reduce the cost of cross-border payments.
However, there are also potential risks associated with the use of CBDCs for cross-border payments. For example, if a CBDC is not widely accepted, businesses may have difficulty using it to make cross-border payments. Additionally, if there are issues with the stability or security of a CBDC, it could create risks for businesses that use it.
A CBDC payments system will increase competition, lower transaction fees, and unbundle services that are currently included in all digital transactions, such as chargebacks and reversibility, transaction risk assessment, intermediation, allowing businesses to pay for only what they require. Small businesses would ideally be able to do so without compromising which customers they can accept payments from, thanks to new forms of interoperability between digital wallets, banks, and legacy payment and card rails. Furthermore, transferring funds directly via blockchain would improve domestic and cross-border payments by reducing the number of intermediaries.
To know how cross-border payment solutions can benefit businesses, read this.
Central bank digital currencies (CBDCs) could potentially have a significant impact on cross-border payment solution providers (cross border payment technology companies), as they may provide a new way for central banks to facilitate cross-border payments. Currently, cross-border payments are often facilitated through intermediaries such as commercial banks, which can add complexity and cost to the process. CBDCs could potentially provide a more efficient way to make cross-border payments, as they could be exchanged directly between central banks without the need for intermediaries. This could potentially disrupt the business model of some cross-border payment solution providers, as they may no longer be needed to facilitate certain types of payments.
It is important to note that the development and use of CBDCs is still in the early stages, and it is not yet clear exactly how they will be implemented or how they will impact the cross-border payments industry. It will likely be some time before the full impact of CBDCs on cross-border payment software companies becomes clear.
In short, there are three pain points which are will arise around the introduction of CBDCs:
Increased competition: CBDC could potentially disrupt traditional cross-border payment providers by offering a cheaper and more efficient alternative.
Regulation: The use of CBDC could be subject to increased regulation, which could impact the way cross-border payment providers operate.
Changes to business models: CBDC could lead to changes in the way cross-border payment solution companies operate and generate revenue. For example, traditional providers may need to adapt their business models to compete with the lower fees and faster transaction times offered by CBDC.
The main purpose of these models being evaluated is interoperability. Although the ideal situation would be all the central banks of the world coming together to agree upon setting common standards to allow interoperability. Below are mentioned two more models being looked at.
Inter-linked CBDCs: An interlinked CBDC system is a system in which different countries' CBDCs are connected and can be used interchangeably. In other words, a CBDC issued by one central bank can be used to make payments in another country that is part of the same interlinked system. This would allow for easier cross-border transactions and could potentially reduce the reliance on traditional cross-border payment systems, such as correspondent banking networks.
Multi-currency CBDCs: A multi-CBDC, on the other hand, is a digital currency that is issued by a central bank and can be used to hold and transact with multiple different fiat currencies. This would allow users to hold and use multiple different currencies within the same digital wallet, rather than having to use separate wallets for each currency. This will entail the development of new multilateral payment platforms with one technical system, one set of participants following one set of rules common for all of them. This will entail the development of new multilateral cross-border payment payments platforms that will allow financial institutions to transact directly with one another in digital currencies issued by participating central banks, eliminating the need for intermediaries and reducing transaction time and cost.
CBDCs could also create new opportunities for cross-border payment solution companies. A CBDC allows banks and fintech firms to reinvent parts of their traditional business. As an entirely new payment use-case is created, several financial intermediaries (payment processors and aggregators, card networks, and e-wallet service providers) are expected to play a significant role in the onward march of a CBDC. For example, they may be able to develop new software solutions to help central banks and other financial institutions manage and use CBDCs for cross-border payments. It is also possible that CBDCs could potentially be integrated into the existing infrastructure used by cross-border payment companies. This could allow these companies to continue to operate as before, but using CBDCs as a settlement asset. Additionally, CBDCs may increase the overall volume of cross-border payments, which could create new business opportunities for companies in the sector.
With the implementation of CBDC seeming inevitable, many major cross border payment providers have already started developing solutions to allow banks and financial institutions to integrate their CBDC into their cross-border payment systems. Fable Fintech has been a silent cross border payments technology partner to some of the biggest global banks in the world To learn more about the right cross border remittance solutions for your business, get in touch with a Fable Fintech cross-border payment solutions team now!
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