Long reads

Central bank digital currencies: Why it's time for commercial banks to lead

Gilbert Verdian

Gilbert Verdian

Founder and CEO, Quant

Anyone who has ever been involved with a technology project will know that they are notorious for being overtime and over budget. We’ve recently completed one that bucks this trend. It has the potential to significantly reshape our underlying monetary system and the nature of currency – creating a slew of opportunities for banks and payments firms that get ahead of the game.

This is an excerpt from Future of Payments 2023.

Headed by the Bank of International Settlements (BIS) London Innovation Hub, Project Rosalind is an experiment involving more than a dozen commercial banks and payment companies. Since June 2022 it has been testing how to safely distribute and settle a retail central bank digital currency (CBDC) issued by the Bank of England.

The project specifically looked at a public-private sector collaboration model, in which the public sector would issue the currency and provide basic infrastructure, while the private sector worked to produce innovative consumer-facing applications. With our Overledger platform, Quant provided the technology to facilitate interoperability between blockchains and legacy systems, as well as the secure smart contract and tokenisation expertise which served as the foundation for this project.

Although the experiment itself was a resounding success – demonstrating amongst other things that a  CBDC will enable citizens and businesses to automate cumbersome payments and processes and implement logic into money – it would be naïve to ignore the fact that the banking industry as a whole – and indeed its customers – still have questions and, in some cases, concerns.

The first, and most existential challenge is the tendency for onlookers to ask, ‘why do we need a CBDC anyway?’. It is a fair question. Many of us are very satisfied with the real-time payments and internet banking offerings already available. The introduction of open banking in recent years has led to the creation of even more convenient payment options. But this overlooks the fact that a key responsibility of any central bank is to make central bank money useful and accessible to citizens. Cash alone is now struggling to fulfil this mandate, given it has become commonplace for vendors to refuse to accept it.

CBDCs, running on blockchains and benefitting from embedded secure smart contracts, are a form of programmable money that could usher in a range of improvements in terms of efficiency, security, and transparency that will benefit banks and their customers.

For example, one of the banks participating in Rosalind allowed users to program the CBDC to create a form of automated escrow. In this use case, a customer would purchase goods from a vendor using their CBDC account, though the funds were temporarily held to ensure that the seller and goods were genuine, and the money could not simply disappear into the ether – a situation that sadly occurs with thousands of online transactions every day. The courier then acted as the third-party verifier who signalled that the delivery had been successfully accepted, and the funds could be released.

In the UK, victims of authorised push payment (APP) fraud paid out more than £500 million to criminals over the past year, with purchase scams making up more than half of this, according to UK Finance. Meanwhile, the Payments Systems Regulator is ushering in new rules that will mean banks must reimburse virtually all victims of APP scams. Imagine how much of this fraud could be prevented with the enhanced verification described above – a huge cost saving for banks, and one that spares customers the distress of being scammed.

The next counter challenge that is raised against CBDCs is the ‘big brother’ theory: the idea that this form of currency will allow the state to spy on us and directly view what we are spending our money on. Privacy was a key focus for Rosalind, and we implemented a system in which only the institutions which own the customer relationship can see who owns an account.

Meanwhile, the key idea behind a CBDC – that it is the digital replacement for cash – saw Rosalind participants create an ‘offline’ payments system which allowed users to send CBDCs between their digital wallets, outside of the formal banking system. This is rather like withdrawing cash and handing it to a friend who is then free to spend it or deposit it into their own bank account – a more private transaction than those made via traditional online payment rails.

The BIS has published an in-depth report on the findings from the project. From our perspective, one of the most exciting aspects of CBDCs is the opportunity they present for the private sector. CBDCs, together with other forms of tokenised, programmable money, are just a few years away and, far from being a threat or a cost to business, they represent a once in a generation opportunity for forward-thinking banks and payment firms to differentiate themselves with new products hitherto impossible.

Our advice is to start today, lay the foundation for the future of payments, by ensuring you have the infrastructure in place to tokenise deposits, issue them as smart digital currencies, and integrate – in due course – with central bank digital currencies. The key is to make this trustworthy and ready for the future. Those that do that will seize the lead.

Comments: (0)