Imagine a world without long wait times or hefty intermediary fees for international fund transfers..
Or purchasing treasury bonds within a few seconds instead of trade date plus two days. These scenarios could come true with the advent of central bank digital currencies (CBDCs). They are expected to simplify and disrupt payment and settlement solutions. The currencies will especially prove useful for cross-border and interbank transactions.
Central banks across the globe are witnessing a decrease in the use of paper currency.
At the same time, cybersecurity threats related to digital payments and financial risks posed by unregulated digital currencies such as crypto currencies are on the rise. Central banks are striving to shield the global financial system from these risks.
They are now exploring ways to issue a ‘digital’ legal tender of their currencies in the form of CBDCs. Several pilots have been conducted to evaluate the technical infrastructure, performance, and user feedback of these currencies. Some prominent pilots include those announced by the People’s Bank of China, the US Federal Reserve, and the Bank of England.
CBDCs can empower investors with access to a wide range of investment assets.
They can decrease transaction and settlement costs and reduce dependency on intermediaries. Issuers can reach a larger pool of potential investors across the globe due to hassle-free, faster, and secure transaction methods.
Further, they have an edge over other modes such as India’s Unified Payments Interface (UPI) and e-wallets in terms of disintermediation and safety features that are backed by central banks. Here are some potential use cases.
Implementing CBDCs will not be easy.
We foresee three key challenges:
CBDCs have significant potential to disrupt payments and settlement solutions in capital markets.
They can lower costs for all stakeholders and facilitate inflow of more retail investors to markets across the globe. However, the implementation of CBDCs will have to pass through several impediments related to regulatory measures, acceptance from market participants, and user privacy. These issues can be ironed out through global partnerships and common implementation frameworks among central banks. Capital market firms and banks would do well to chart out their CBDC adoption strategy in the near future.