In the 1960s, the Space Race symbolized humanity’s drive to push beyond earthly boundaries and explore new frontiers. It wasn’t just a competition; it was a period of groundbreaking innovation and collaboration as nations sought to break barriers in technology and science. In fact, NASA's development of the Apollo Guidance Computer, which helped land humans on the moon, was a key technological achievement that influenced computing advancements for decades. Today, central banks are embarking on a similar, but less competitive, journey with the development of central bank digital currencies (CBDCs). Much like the early days of space exploration, CBDCs represent uncharted territory, offering the promise of modernized payments and enhanced financial inclusion. However, just as the space pioneers faced numerous challenges, central banks must navigate complex issues such as security, privacy, and technological constraints as they chart the future of digital currencies. At least 86 central banks are developing CBDCs, with over 50% of this group working on proofs of concept and roughly one-third already operating pilot programs. This is a direct response to the rise of mobile banking and digital currencies, but also a way to modernize current payment systems and increase financial stability.What CBDCs Mean for the Banking IndustryWith CBDCs in development, a thoughtful, methodical approach is necessary. At least two-thirds of jurisdictions working on CBDCs and stablecoins are also working to create comprehensive guidelines and frameworks to ensure that adequate safety measures and oversight are put into place. These should be considered requirements before financial institutions begin to adopt CBDCs into their digital payments services. Among the things central banks are focusing on in particular are interoperability with current payment systems, holding limits, and offline capabilities. To do this, central banks are casting a global net as they seek input for the design and regulation of CBDCs, within both the financial and technology industries. The Benefits CBDCs provide consumers and businesses with a number of key advantages, including the following:
- Inclusive access. Because CBDCs don’t rely on or require traditional financial services, individuals who are unbanked or underbanked will have an easier time accessing CBDCs.
- Cross-border capabilities. CBDCs don’t need days or weeks to process international transfers — they only need minutes, if that. This particularly applies to stablecoins. Unlike cryptocurrencies already in circulation, stablecoins provide central banks the ability to assign a specific value to them, equivalent to the way traditional currencies are valued. As a result, stablecoins are already being embraced by many financial institutions, such as PayPal’s PYUSD and Societe Generale’s ERU CoinVertible.
- Absence of fees. Consumers can take advantage of a digital currency that does not have fees attached. According to a report from the Federal Reserve Bank of Philadelphia, 63.5% of individuals amenable to the idea of CBDCs indicated that no fees would be the biggest factor that would help them embrace a new digital currency.
The Challenges While central banks see the promise of global usage of stablecoins and CBDCs, there is acute awareness of the risks as well. If such currencies are not thoughtfully designed and adequately overseen by regulators, the high potential for fraud and misuse could extend beyond consumers to the payment system and monetary policy as a whole. A recent survey conducted by the Bank of International Settlements (BIS) uncovered some of the top concerns surrounding CBDCs:
- Security issues. Because of how complex CBDC technology is, security vulnerabilities are a concern, and cybersecurity efforts would have to drastically increase to account for that complexity and scale. Cyber threats, such as data breaches, third-party relationships, and the loss of private keys are just some of the security risks that would need to be addressed.
- Technology constraints. CBDCs have data storage requirements that may prove challenging for financial institutions — particularly community financial institutions. There are also platform operations to consider: hardware, software, or network issues could result in delays or losses, such as if stored data becomes corrupted or a network disruption occurs.
- Lack of privacy. The very thing that functions as a benefit for financial institutions — the transparency and visibility of the blockchain — is a concern for customers. According to an ICBA statement, one of the primary reasons that unbanked households choose not to participate in the banking system is having financial privacy. Consumers might resist having transactions done using CBDC be a matter of public record.
- Wholesale vs. retail CBDC. In the US, a wholesale CBDC would be designed for large-scale, institutional transactions and could improve the efficiency of cross-border payments, enhance enforcement of sanctions, maintain the US dollar as a trusted global currency, and streamline foreign aid. However, with retail CBDC, one of the main risks is the potential for deposits to move from community financial institutions to the central bank, thus reducing the ability of smaller institutions to support their local economy.
As central banks get closer to making CBDCs and stablecoins a reality, security is one of the biggest concerns they are grappling with. Consumers have indicated that they are prepared to back digital currencies, but privacy and security could prevent widespread adoption — a fact that central banks are well aware of and working to prevent.
