What role will Central Bank Digital Currencies play in reducing financial risks?

As an integral part of the digital value web, CBDCs are likely to reduce costs, improve service and mitigate settlement risks, in addition to paving the way to better data gathering to fuel innovation.

CBDCs are a fast advancing and inevitable innovation which is likely to impact most large national economies in the near future.

As a financial services innovation, Central Bank Digital Currencies (CBDCs) are likely to play a pivotal role in shaping the Future of Value Transfer. Most Central Banks worldwide are now in various stages of their evaluation of launching their national digital currencies. Globally, the need for CBDCs is being driven by the push for faster payments, rapid digitization, better mitigation for clearing and settlement risk. There is also a demand for more efficient domestic and cross-border value transfers and financial inclusion.

The four key drivers that are pushing Central Banks to evaluate CBDCs include need to bring Central Banks back to the center of currency creation and trust; potential to bring efficiencies in the financial system; improving financial access and financial inclusion; and enhancing monetary and fiscal policy.

As Central Banks embark upon their inevitable digital journey with CBDCs, it will lead to a paradigm shift in the way global and domestic economies operate and will have implications on the commercial banks, their profitability as well as operations. Combined with the twin forces of Open Data regulation and cross-industry ecosystem play, CBDCs have the potential to play the role as a catalyst in disrupting the existing value transfer paradigm and truly creating innovation beyond what we have seen over years.

In addition to the digital representation of currencies and other assets, the future of value transfer will entail value creation leveraging customer data. The creation and representation of value in digital form will amplify the broader move from value chains to value webs. As an integral part of the digital value web, CBDCs are likely to reduce costs, improve service and mitigate settlement risks, in addition to paving the way to better data gathering to fuel innovation.

When you add to that the value-driven by digital presence, the move from customer centricity to empowerment, and the exponential pace of change in technology – the future of value transfer will have a profound and lasting effect on the future of financial services. Digital currencies, including CBDCs, crypto, stable coins, fungible and non-fungible tokens, are just some of the ways that the very fabric of commercial and social transactions is being transformed. But that is just the beginning – in a world where we increasingly see the creation and representation of value in digital form, that the future of value transfer will encompass the exchange of value derived from customer activity, in addition to digital representations of currencies, real and digital assets, fractions of assets, and entitlements to those assets.

Customers will look to combine the value of their digital presence with their other digital stores of value and will ultimately demand to be empowered to create and capture value from their choices. The future of value transfer will foster a change in mindset from market taking to market-making—from seeking market share by meeting current needs to creating a world of a new opportunity by redefining what future wants are going to be.

Depending on the extent of its use, CBDCs will be a close watch for banks and financial institutions. Early participation in CBDCs pilots and early adoption with the Central Banks as well as counterparties would help banking players in gaining early inroads into the new technologies as well as ecosystem plays.

Banks and Financial Institutions are likely to act as the custodians of a shared, distributed computer-based ledger. They would play a role in validating and registering the end-users in the CBDC blockchain by creating a private/ public key pair and tying it to the user’s identity by assigning private keys. They would essentially serve as the processor of the centralized/ distributed customer ledger, competing to process a transaction and getting rewarded with a small fee for its service. Besides monetization of the data, they would have other opportunities to create wealth management products with the CBDC as an additional risk-free asset in the portfolio.

CBDCs are a fast advancing and inevitable innovation which is likely to impact most large national economies in the near future. The issuance and design for CBDCs are likely to be sovereign decisions for each jurisdiction based on their own assessment of CBDC objectives, market maturities and related local factors. As digitization and globalization increase, CBDCs have an important role to play in providing a safe, risk-free digital medium of exchange, store of value and unit of account. Banks and other financial services players need to prepare for this new category of asset class, its impact on their balance sheets, as well as customer value propositions and the benefits that it offers in terms of atomic transactions and reducing settlement risks.

Digital currencies are likely to ultimately create a series of new opportunities that would free up capital for more productive uses, and transform the current payments and value transfer system into one that is faster, more secure, less expensive to run.

(By Shweta Shetty, Partner, Deloitte India)

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