With the global mobile payment market currently estimated at US$816.50B and projections that it will reach over US$5.5T by 2025, the way we pay and transact money is about to change drastically. Judging by the buzz around central bank digital currencies (CBDCs), the likelihood that we will soon be spending and exchanging on a blockchain ledger are pretty high. Just this last month at the World Economic Forum annual meeting at Davos, one of the most discussed topics centered around CBDCs and how individual countries can issue, manage, govern and use digital currencies. We even had the former Commodity Futures Trading Commission chairman J. Christopher Giancarlo announcing a new version of a digital dollar.
The promise of central bank digital currencies (CBDCs) for regulated and compliant payments with faster settlement and increased liquidity management, comes at a time when the Bank of International Settlements estimates that over 80% of the central banks are looking at blockchain as a place to issue digital currencies. Just this last month, we heard that the central banks of Cambodia, Japan and the Bank of England are exploring the benefits of CBDCs. They have joined the long list of emerging markets and developed countries that have started working on digital currencies prototypes like Thailand, China, India, Sweden, Singapore and South Africa. Out of which the emerging markets countries are more favorable in issuing and adoption a purely digital currencies strategy than the developed countries which currently face less issues. Even the European Central Bank (ECB) is researching how to digitize the Euro.
But what are the issues now?
As we all know, most of the payments being made in the developed world are already digital per se. When we send money abroad, for example, we do not hold the cash in our hands; rather, the funds are sent from a bank account and hence they are already “digital.” When we speak broadly about payment, we can generally identify two groups of transactions: one is bank to bank or “wholesale,” and the other is between individuals or “retail.” In both situations we can clearly identify the current growing pains, such as availability of the funds, FX transactions fees, operational risks, settlement risks, visibility and traceability. For example, here are the main components of a cross-border transaction fee, which can be reduced with the introduction of a blockchain layer and a real-time gross settlement system (RTGS):
Who will lead this digital transformation?
In 2019 we saw the launch of Facebook Libra, which is an effort to solve some of the mentioned problems, but in fact the initiative faced a lot of scrutiny from regulators based on the level of trust they lack in the originating company Facebook. Apple, another giant technology company, has partnered with Goldman Sachs and issued its own credit card integrated into the popular iPhone, and again this effort faced questions around interest rates and diversity approval rates. At the other end of the spectrum are the central banks, which are generally more trusted than private enterprises when it comes to issuance of money and payments. For example, I see China as one of the first countries to adopt and implement a purely digital currency strategy. This will be a relatively easy task for a highly centralized country that already has an advanced payments infrastructure. In fact, China’s mobile payments market is already controlled by Alipay and WeChat Pay, and with the help of the People’s Bank of China (PBoC) that brings the top-down enforced digital currency electronic payment (DC/EP) initiative, the country can easily deploy a wholesale CBDC.
Well, for a start not all digital currencies or payment systems will need blockchain; for example, the FedNow real-time payment system might not have a blockchain component. Do not get confused, central banks are not looking at any of the existing public blockchain as a viable option, instead they are all researching and testing or private and permissioned blockchain will fit their goals. A typical tiered-enterprise architecture with blockchain at its core is perfectly fine of handling the load and throughput of such payments system. Adding a blockchain or another distributed ledger technology as a base component, the issuing bank can have all the benefits of token based accounts like enhanced privacy, faster back-end reconciliation with fewer errors, funds predictability, end-to-end KYC and AML enriched transactions with cheaper fees, all within a legally robust framework.
One of the main benefits of the current cash money is that they are perfectly fungible, this can be achieved too with enough privacy for the end-user with a calculated balance between transparency and privacy protection encoded into the core blockchain protocol. On top of that, with the introduction of widely accepted CBDCs, we can have even greater safety and insurance coverages from fraud and theft of our digital wallet funds.
One thing is certain: In 2020 we will see a lot of activities around central bank digital currencies and their usage could be the de-facto killer app for the blockchain technology. It’s something that we have been looking at in the past and attributed to digital identities or voting systems, but they have proven to take longer to develop. Now, with China and the U.S. in the digital currencies race, I am pretty sure that CBDCs can be the first production deployment at such a large scale for the blockchain technology.