CBDCs must close the gap between old and new financial systems | Opinion

The concept of a central bank digital currency predates crypto’s most recent down market. However, it has steadily gained momentum as governments recognize the need to modernize payment systems while addressing various economic and technological challenges. There are currently some 134 nations and currency unions that have explored or are exploring the use of CBDC, of which three have already launched: Jamaica, Bahamas, and Nigeria. 

These nations and currency unions have different yet sometimes overlapping motives for wanting to explore the option of digitizing their money, and they may not always be in the public’s best interest. 

On the positive side, however, many governments seek to strengthen financial inclusion by providing unbanked individuals with an accessible digital payment option while enabling easy transfer of funds, such as welfare payments, for example. They do so in the hope of reducing reliance on banks to handle transactions, enabling ordinary people to send remittances easily and affordably, and allowing for streamlined international trade. 

Additionally, exploring CBDCs can enhance economic transparency due to blockchain’s immutability, which would combat laundering, tax evasion, and other financial crimes. CBDCs would also promote the further expansion of the fintech sector by future-proofing the economy and encouraging advanced financial innovation. 

Ethiopia, Africa’s second-largest nation and fifth-biggest economy, has made headlines following the approval of an updated monetary policy framework by the National Bank of Ethiopia that, among other things, includes a plan for a CBDC. Economists believe this move would be a major boost for financial inclusion and efficiency in a country once seen as a growing economic power before a recent civil war disrupted momentum. 

As the country rebuilds after the 2022 peace agreement, the NBE sees an opportunity to liberalize the economy and attract foreign investments. Ethiopia hopes to reform its economy, and much of its success may depend on how it implements a CBDC. 

CBDCs can undoubtedly unlock economic advantages that could help developing and underdeveloped countries improve their financial standing while playing a larger role on the global stage. However, whether a specific CBDC is for retail, wholesale, or a hybrid, the development of these digital currencies can enable governments to assert more control over financial systems. 

From a crypto perspective, if CBDC adoption becomes the norm, it could disrupt the blossoming decentralized finance space. For one, CBDCs could threaten privately issued stablecoins, which serve an infrastructural role, facilitating DeFi activity. 

For countries like Ethiopia who are strongly considering issuing CBDCs, Nigeria’s use case should serve as a cautious tale. When Nigeria’s Central Bank issued the eNaira, it used the open-source Hyperledger Fabric protocol, which is secure and can process up to 3,000 transactions per second. However, CBN never connected eNaira to existing or developing financial infrastructure. 

Ultimately, CBN controls all nodes and blocks outside access to blockchain data, raising concerns about centralized authoritarian control. Since its launch in late 2021, the eNaira has not been widely adopted and is viewed as a failure. 

If CBDCs are about future-proofing national economies, they must be compatible with all digital financial systems, including interoperability with public blockchains. In this case, technical and regulatory considerations are relatively simple to implement; it comes down to the policies and vision of financial decision-makers. 

Any CBDC program must collaborate with all licensed banks operating in the country while working with fintech and blockchain technology providers to ensure the CBDC is interoperable with traditional financial systems, DeFi, and other digital payment rails. 

Kima, an interoperability protocol that bridges crypto and fiat, represents the type of technological infrastructure that can enable CBDCs to facilitate real economic advancements. Last year, Kima participated in a pilot project administered by the Bank of Israel to assess the feasibility of adopting a CBDC. As part of the project, Kima successfully demonstrated a transfer of a tokenized stock via a digital shekel. 

Showcasing its protocol’s utility, Kima built a demo trading platform to facilitate an atomic swap of the tokenized stock. Kima’s decentralized settlement layer handled the transaction, linking the buyer interested in purchasing the share using digital shekels with the seller, who held the tokenized stock in a crypto wallet. The seller received the payment directly into their bank account in the form of regular shekels. Utilizing two API calls, Kima ensured the transaction was safe and verified as it took place instantly without any intermediaries or smart contracts. 

This process—linking a CBDC, tokenized asset, digital wallet, and bank account—is what governments need to envision as the goal of any CBDC initiative. If they intend to future-proof their economies, governments must use CBDCs to bridge old financial systems with modern digital financial tools in a secure and accessible way.