Building the Digital Currency of the Future

As physical cash use declines and new cryptocurrencies arise, central banks are looking for ways to maintain control over their financial systems. Creating their own digital currency (CBDC) is a leading idea, and in recent years, the appeal has grown rapidly with more than 100 countries, representing over 95% of world GDP, exploring or launching one. Compare that to just 35 countries in mid-2020.

Creating a new cryptocurrency is greatly different from building a system to support a country's financial network as central banks must ensure it provides quality user experience while protecting privacy. To achieve this, cooperation between public and private organizations is necessary, which can provide significant benefits for payments.

What makes a successful CBDC?

Many central banks lack the digital skills to create a CBDC, given most bankers are focused on economics over technology. As a result, several trials worldwide include partnerships with commercial banks and digital wallet companies that have the technology expertise to create a CBDC ecosystem. In India, the ICICI Bank and Kotak Mahindra Bank are helping retailers process CBDC payments to develop a system that provides a convenient solution for consumers. The system ensures transactions can be processed offline or in remote areas, which will increase adoption and ensure the system functions even during outages. Offline functionality is key for a CBDC to be inclusive and resilient.

In addition to convenience, banks must put a strong focus on privacy to gain consumer trust in a relatively new technology. Further, it will be necessary to balance privacy against anti-money laundering policies and financial fraud. Cryptography is one solution that could validate transactions without the need for unencrypted data, allowing banks to protect privacy while still combatting financial crime.

Research shows people spend more using certain payment methods like credit cards versus cash, so new CBDC systems must avoid exploiting consumer spending habits that lead to overspending. Central banks should focus on financial education or built-in limits to promote responsible consumer spending and prevent people from making poor financial decisions.

Why do we need CBDCs?

Even as CBDC experimentation has increased, questions still remain around the benefits over current systems. For instance, some worry that banks can gain too much power in their country’s financial system with the current regulations and models in place. However, CBDCs offer advantages such as improved payment efficiency, cross-border transactions, and competitiveness that traditional systems can’t offer.

For example, programmability and smart contracts allow retailers to improve payment efficiency and provide innovative services for users. Additionally, compatibility with other CBDCs enables faster and cheaper cross-border payments.

Competitively, only a few institutions have direct access to central bank funds, while fintechs must go through traditional banks. By allowing fintechs direct central bank access, a digital currency would let these new players compete, benefiting retailers and consumers as competition would lead to faster payments and lower transaction costs.

Among the few CBDCs with existing trials, they have offered incentives to attract new users. In the Bahamas, the Sand Dollar offers no transaction fees and doesn’t charge interest, incentivizing adoption for businesses and consumers to increase savings.

The future of CBDCs is approaching faster than expected

Though widespread CBDC adoption may seem distant, it is closer than many realize. To avoid falling behind and missing out on early-stage benefits, central banks should start evaluating CBDC offerings now and work with partners that can provide the skills needed to take action today to implement CBDCs before it is too late.

Ashish Bhatnagar heads up Cognizant’s Cards and Payments business across EMEA and APAC. In his role, Ashish is responsible for developing and executing the go to market strategy focused on helping banks, networks, clearing houses, central banks, acquirers, issuers and payment processors navigate the shifting payments landscape and ensuring sustainable growth.