CBDCs Must Bridge the Gap Between Traditional and Modern Financial Systems | Opinion

CBDCs Must Bridge the Gap Between Traditional and Modern Financial Systems | Opinion

The concept of central bank digital currencies (CBDCs) predates the recent downturn in the cryptocurrency market, but it has gained significant momentum in recent years. Governments around the world are increasingly recognizing the need to modernize payment systems and tackle various economic and technological challenges. To date, approximately 134 nations and currency unions have explored or are in the process of exploring the use of CBDCs. Among these, three countries—Jamaica, the Bahamas, and Nigeria—have already launched their own digital currencies.


While the motivations behind CBDC adoption differ from country to country, many share a common goal: modernizing the financial system. However, governments' intentions may not always align with the public’s best interests.


The Positive Potential of CBDCs

On the positive side, CBDCs can greatly enhance financial inclusion, particularly for the unbanked. By offering accessible digital payment options, CBDCs can provide individuals without traditional bank accounts the ability to conduct financial transactions, thus reducing reliance on banks for day-to-day activities. They could also simplify the process of sending remittances, making it more affordable and efficient, which would be a boon for many households in developing nations. Furthermore, CBDCs can streamline the transfer of welfare payments and other government disbursements, ensuring that aid reaches the intended recipients swiftly and securely.


Another significant advantage of CBDCs lies in their potential to improve economic transparency. Built on blockchain technology, CBDCs can leverage the immutability of the ledger to combat financial crimes such as money laundering, tax evasion, and corruption. Additionally, CBDCs could catalyze the further expansion of the fintech sector, driving innovation and future-proofing the economy.


One country that is making strides in this direction is Ethiopia. As Africa’s second-largest nation and fifth-largest economy, Ethiopia has approved an updated monetary policy framework that includes plans for a CBDC. This initiative is seen as a vital step towards increasing financial inclusion and boosting the country’s economic efficiency. Following a civil war that disrupted economic progress, Ethiopia aims to leverage a CBDC to liberalize its economy, attract foreign investment, and facilitate recovery.


Economic Advantages for Developing Countries

For developing and underdeveloped countries, CBDCs present an opportunity to improve their financial systems and establish a stronger foothold in the global economy. However, the implementation of CBDCs comes with its challenges. Whether a CBDC is designed for retail, wholesale, or as a hybrid, it can provide governments with increased control over their financial systems. This centralization could disrupt the growing decentralized finance (DeFi) ecosystem, where privately issued stablecoins currently play a significant role in facilitating transactions.


Take Nigeria’s example, for instance. In 2021, the Central Bank of Nigeria (CBN) launched its digital currency, the eNaira, using the open-source Hyperledger Fabric protocol. Despite its potential to process up to 3,000 transactions per second, the eNaira failed to integrate with Nigeria’s broader financial infrastructure. Moreover, CBN controls all nodes, restricting access to blockchain data and raising concerns about centralized authority. These factors have contributed to the lack of widespread adoption, with the eNaira widely considered a failure.


The Need for Interoperability

The key lesson from Nigeria’s experience is clear: if CBDCs are to be successful and future-proof, they must be compatible with existing and emerging financial systems. Interoperability is essential for CBDCs to function effectively alongside traditional financial systems, decentralized finance, and other digital payment platforms.


Achieving this interoperability is not an insurmountable challenge. Technical and regulatory measures can be implemented with relative ease, but success will ultimately depend on the vision and policies of financial decision-makers. Governments must collaborate with licensed banks, fintech companies, and blockchain providers to ensure that their CBDCs can seamlessly integrate into a broader digital economy.


An example of the type of infrastructure required is Kima, an interoperability protocol that bridges the gap between fiat and crypto systems. In 2022, Kima participated in a pilot project with the Bank of Israel to explore the potential for a CBDC in the country. As part of the project, Kima demonstrated the transfer of tokenized stocks via the digital shekel, showcasing the potential of CBDCs in facilitating real-time, cross-platform transactions. Kima’s decentralized settlement layer enabled a buyer using digital shekels to purchase tokenized stock from a seller, with the payment directly transferred to the seller’s bank account in regular shekels. This seamless transaction took place without intermediaries or smart contracts, underscoring the importance of a robust and interoperable system.


The Path Forward for CBDCs

Governments must recognize that the true potential of CBDCs lies not just in digital currencies themselves, but in their ability to bridge the old and new financial systems. If CBDCs are to fulfill their promise of modernizing economies and driving innovation, they must be designed to work alongside existing financial tools and infrastructure, as well as decentralized financial networks. Only then will CBDCs be able to create real economic advancements and secure their place in the future of finance.


For governments looking to future-proof their economies, the goal should be clear: use CBDCs to foster economic development, ensure accessibility, and create a system that is truly inclusive, transparent, and interoperable with both traditional and digital financial tools. Only by doing so will CBDCs truly realize their potential to transform the global financial landscape.

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