Why CBDCs still have limited appeal

Written by Kapronasia || November 30 2023

At the Singapore FinTech Festival last week, IMF managing director Kristalina Georgieva made the case for central bank digital currencies (CBDCs) in her keynote address. She succinctly highlighted most of the key reasons central bankers like the concept of a digital fiat currency: the potential for improved financial inclusion where it is most needed, replacing cash, enhanced efficiency, speed and transparency in cross-border payments.

She brought up a crucial point that speaks to one of the major underlying challenges of CBDCs: their lack of market orientation. After all, unlike Alipay, Revolut or Binance, CBDCs are the brainchildren of financial officialdom, not businesspeople. With that in mind, Georgieva said that “country authorities wishing to introduce CBDCs may need to think a little more like entrepreneurs. Communication strategies, and incentives for distribution, integration, and adoption, are as important as design considerations.”

What Georgieva did not say was that many countries may ultimately conclude that they do not need a CBDC because their existing payment rails are good enough. The required investment in financial infrastructure to bring a CBDC to parity with an existing fiat currency will be significant, and probably does not make sense for many of the world’s advanced economies given the limited benefits for them. However, there will very likely be niche applications, especially on the wholesale side, while certain countries looking to fast-track financial inclusion and payments digitization will want to adopt both a retail and wholesale digital fiat currency.

Inconclusive feasibility studies

Ever since China surprised the world with its brisk CBDC progress, the race has been on to not be left behind. Of course, not being left behind is a relative term here – as most countries do not even know what they want from a digital fiat currency. At least China is clear on that point: It aims to bring digital payments that have been dominated by Alibaba and Tencent under greater state control, and sees a potential opportunity in the cross-border space with mBridge, which also includes Hong Kong, Thailand and the United Arab Emirates (UAE).

However, if we look at the 130 countries exploring a CBDC – up from just 30 – in 2020, we have to wonder how many ultimately will roll one out and how many will quietly shelve their respective feasibility studies. The Bank of Japan, for instance, has been working on a study for several years, the conclusion of which that no decision has been made on whether to issue a digital yen. The same holds true for the Bank of Korea, which found problems with the underlying blockchain technology used in one of its digital won pilots. For its part, the U.S. Federal Reserve continues to experiment with a digital dollar, but it will not issue one if there is not strong support from the White House and Congress.

Meanwhile, the Reserve Bank of India (RBI) plans to widen use of the digital rupee after trials thus far have not led to significant adoption. India’s CBDC is currently in a pilot phase across the retail and wholesale segments. The central bank has set a target of one million transactions a day by the end of 2023. To put that modest number into perspective, transactions on India’s paramount United Payments Interface (UPI) rail are now at around 1 billion per day.

The outliers

There are just a few countries that have adopted a CBDC and put it into use. China is the most notable of these countries, and it continues to push forward with the digital renminbi. What makes China unique, besides the strategic and geopolitical considerations it has, is the size of its market. China is so big that even if the digital yuan is only used in a few provinces to start, such as Jiangsu (it is currently being widely tested in the city of Changshu), that will probably be enough to get a sense of the digital currency’s potential. Jiangsu has a population of 85 million, which makes it more populous than any European country.

Meanwhile, the Bahamas, which says it launched the world’s first digital currency – the Sand Dollar – in October 2020, has yet to see widespread use of its CBDC despite being a small island nation of about 408,000. In October, the Central Bank of the Bahamas said that it planned to collaborate with local commercial banks to leverage their existing customer base to boost the adoption of the Sand Dollar in 2024. Central Bank officials say that 35% of Bahamans have activated wallets for the Sand Dollar and they are targeting 50% of the population by the end of next year. However, to increase usage of the Sand Dollar, it will be imperative to offer adequate incentives both for consumers and banks.

Perhaps the most successful CBDC thus far is Cambodia’s Project Bakong, the brainchild of the Japanese blockchain firm Soramitsu. According to the National Bank of Cambodia’s (NBC) semi-annual 2023 report, the Bakong payment system includes 70 financial institutions as members, 49 of which are active. In the first six months of 2023, Bakong recorded over 35.4 million transactions, amounting to more than $12 billion. Additionally, thanks to an agreement signed at the Singapore FinTech Festival by the NBC and Alipay, vendors in Cambodia can now use the KHQR network of the Bakong system to make payments to over 80 million Alipay merchants globally.

Case By case

Looking ahead, we expect that CBDC adoption will proceed on a case-by-case basis that takes into account the unique financial conditions of each country testing out a digital fiat currency. The cross-border space is the most intriguing and also the most challenging, and we are watching the mBridge project carefully to see how it evolves. The ostensible purpose of mBridge is to improve speed, efficiency and transparency in cross-border payments. Its ledger supports instant peer-to-peer and atomic cross-border payments and FX transactions using wholesale CBDCs.

However, we are not yet convinced mBridge significantly improves on SWIFT gpi, Visa and MastercardMA +0.2% rails, or Ripple’s blockchain-based cross-border payments rail. Only time will tell.

Meanwhile, it does seem that wholesale CBDCs will generally be adopted faster than their retail counterparts. The Monetary Authority of Singapore (MAS) announced at the FinTech Festival that it plans to pilot a wholesale CBDC in 2024 to instantaneously support payments across commercial banks in the city-state. MAS managing director Ravi Menon noted that in the pilot “clearing and settlement occurs in a single step on the same infrastructure, unlike the current system in which clearing and settlement take place on different systems and settlement occurs with a lag.”

While that sounds like an improvement, the jury is still out on the “so what” factor.