Economies are changing rapidly. New technologies are emerging that offer us the opportunity to remove some of the limitations that hold our economy back. We need a payments ecosystem fit for this new era of emerging digital infrastructure.
The central bank digital currency projects presently occupying the agenda of more than 100 central banks around the world can fill this role – if designed and implemented appropriately. Part of this process is acknowledging that launching a CBDC represents a fundamental change in the way we pay and do business, which will have ramifications throughout the economy.
A new report by OMFIF’s Digital Monetary Institute and Giesecke+Devrient, launching on 31 January, finds that the benefits are potentially profound. Incrementally, a CBDC can improve financial inclusion for those in isolated areas, meaning lower costs for merchants, reducing the barriers to entry for businesses, stimulating economic growth and improving competition.
But beyond incremental benefits, there are transformational advantages, representing a leap forward in the functioning of a payments system in a digital economy.
Programmability – the ability to embed logic into transactions – offers the opportunity to change how certain interactions are structured. Effectively integrated with Internet-of-Things devices, these programmable payments can make supply chains function more efficiently and reduce counterparty risk. The process can be more effectively automated, reducing the possibility for humans to introduce errors.
By reducing transaction costs, whole payments of much lower value become economically feasible. These micropayments – made instantaneously and at virtually no cost – make a whole new category of economic activity viable.
Combined, CBDC can deliver low-cost, programmable micropayments. The emergence of this functionality can bring profound benefits across the economy. In practice, machine-to-machine payments might allow road users to be billed automatically based precisely on the roads they use and how. Energy grids might be overhauled, allowing individuals to be accurately charged in real time for their use. Integrated with smart appliances and smart energy grid providers, this will enable a more efficient use of electricity, smoothing out demand.
For the public sector, programmable payments would allow for automated and efficient disbursement of funds. Again, when integrated with an effective digital infrastructure and digital identity system, this might mean the ability to more efficiently tailor payments to individuals’ needs without increasing the resources employed to assess them.
This might mean triggering payments automatically under certain circumstances, like health-related emergencies or unemployment. One payment service provider pointed to the inefficiency of the Covid-19 relief payments. With a comprehensive digital public infrastructure, CBDC-powered payments could have delivered aid quickly and effectively.
The economy is changing in some remarkable ways. It may not be long before the value embodied in digital goods and services overtakes value with a physical existence. These digital assets will be delivered through a variety of methods – financial institutions are working hard on tokenising many of their traditional assets but it may not be long before real world assets follow suit.
With digital assets likely to represent an increasingly broad range of economic functions, the need for a means of effectively paying for these goods will mount. For assets stored on blockchains, this means delivering a means of payment on-chain as well, to ensure that they can be settled without counterparty risk.
While stablecoins would also provide a means of settling cash transactions on-chain, this would not impart the benefit of central bank money, which polls conducted at OMFIF events suggest financial market participants would prefer.
These benefits should affect participants across the ecosystem, but they can only be realised with the collaboration of a variety of stakeholders. Individuals, merchants, businesses, banks, payment service providers, technology providers and governments must all work together with central banks to ensure that the appropriate infrastructure is in place to make these benefits a reality.
That collaboration must start early in the process if central banks are to win the trust of the different participants and build a CBDC-powered payments system that benefits the whole ecosystem.
Lewis McLellan is Editor of the Digital Monetary Institute at OMFIF.
OMFIF’s Digital Monetary Institute and Giesecke+Devrient’s report, ‘The path to a future CBDC ecosystem’ launches on 31 January. Register here.