The exploration, research and deployment of central bank digital currencies marks a significant transformation in how monetary policies could be formulated and executed. However, the path to adopting these digital currencies is laden with challenges and peculiar dynamics, especially in the context of public-private partnerships, market distortions and the interaction between central banking institutions and cutting-edge fintechs.
The necessity for advanced and feature-rich technologies in the development of CBDCs cannot be overstated. To attain this level of sophistication, central banks are increasingly recognising the need to engage in PPPs. The rationale is clear: private sector institutions have the agility, expertise and resources to drive the development of robust and secure digital currencies. They also have the flexibility to fulfill the evolving functional necessities and meet the stringent requirements of a new financial instrument.
Central banks used to stability, not agility
The collaboration between central banks and fintech companies is not without its challenges. Traditionally, central banks have been known for their stability and predictability, not innovation, agility or deep engagement with cutting-edge technology providers. Consequently, many central banks find themselves navigating uncharted waters when it comes to establishing best practices for developing and implementing the next version of a national currency. This major leap for central banks can lead to missteps and inefficiencies, potentially undermining the benefits that CBDCs could offer.
Adding to the complexity is the inherent nature of central banks. Occupying a privileged position within the economy and financial system, these institutions are accustomed to setting terms and having their needs met with little resistance. This dynamic does not translate well into the fast-paced, innovation-driven world of fintech, where success relies on a more collaborative and user-centric approach.
The mismatch in expectations and operational styles between central banks and fintech companies can lead to friction, miscommunication and delays in the implementation of CBDCs. Furthermore, CBDCs need to be effectively marketed to potential users, which is an effort that requires collaboration with integrated private sector payment service providers, merchants, users and other stakeholders.
CBDCs should also address pain points in existing payment streams. The ‘test and deploy’ approach is gaining popularity as it provides the opportunity to test innovations, building on successes and changing course where necessary.
The difficulty in validating retail use cases emerges when we look at the resistance in surveys from Canada, the privacy-concerned citizens of the European Union, the growing anti-CBDC movement in the US and the lack of organic adoption of CBDCs where they have been deployed. Perhaps the best use case for a CBDC could be found in enabling auditability in public spending, where there is a push around the globe for transparency and accountability in how taxpayers’ funds are spent.
Lack of central bank investment limits private sector innovation
The pricing and budgeting for CBDC projects further exacerbate the complicated relationship between central bank and fintech PPPs. As Baker Nanduru, chief product officer at Bitt, pointed out: ‘Central banks seek cost-effective solutions with minimal license and maintenance fees, modest professional services charges, and limited transaction fees. Surprisingly, many projects lack budgets or anticipate unpaid contributions from providers. Such practices challenge the viability of providers’ businesses unless they have substantial financial resources.’
Nanduru is highlighting a peculiar and concerning trend: the reluctance of central banks to pay a fair price for the technology and services they require. This approach not only distorts the market for the provision of national digital currency technologies but also places an unreasonable burden on the providers, which may not have the financial resources to deliver projects below cost.
The consequence of this reluctance to pay market rates is twofold. First, it skews the playing field in favour of large, traditional financial and technology companies that may not possess the most relevant or advanced CBDC-specific technology. These incumbents can afford to engage in unprofitable or no-fee projects due to their substantial financial reserves and not because of their technological superiority.
Second, it potentially leads to suboptimal outcomes in the development and implementation of CBDCs. When the most innovative and capable fintech firms are sidelined due to financial constraints, central banks may end up with digital currencies that do not fully leverage the potential of the latest technological advancements or, worse, lack critical features related to user privacy and security. This is perhaps the reason why many talented fintech developers are increasingly focusing their efforts on building open, decentralised financial technologies where incentives are larger and friction is lower.
While collaboration between central banks and the private sector is imperative for the successful development and deployment of national digital currencies, the path is marred by mismatched expectations that have created market distortions. For CBDCs to reach their full potential, it is crucial for central banks to embrace a new paradigm – one that fosters genuine collaboration and a keen appreciation for the innovation that fintech companies bring to the table.
Once that has been accomplished, the real challenge begins in addressing pain points and providing desirable features and functions to be validated through adoption by market participants. This could come in many forms – from financial inclusion to enhanced business processes, to greater accountability and efficiency in public expenditure.
Simon Chantry is Co-founder and Chief Information Officer at Bitt.
