4 ways to ensure Central Bank Digital Currencies promote financial inclusion

Most people take digital payments for granted. Long ago credit cards and e-commerce gave us the ability to complete transactions online around the world. But the ability to participate in financial systems via digital means isn’t universal. Central Bank Digital Currencies (CBDCs) offer new ways to democratize finance – giving the unbanked buying power, introducing them to financial tools, and increasing competition and diversity in global markets.

But to make digital money a tool for equality rather than another exclusive system, several conditions must be met. Future digital currencies must be designed with inclusion in mind to ensure central banks realize the potential of digital money.

Central banks must consider the following four areas when designing CBDCs to ensure they empower individuals around the globe. Leading architects of CBDCs can help us plot a course forward.

An Economist survey found that the majority of people surveyed about digital currency were more likely to trust a product issued by their government than a crypto enterprise. This is promising. But the survey also found we have a long way to go in educating the public about digital money. Respondents noted privacy and security as hurdles, but the primary reason people were hesitant about digital money was that they simply don’t understand what it is.

If CBDCs are to reach unbanked regions and empower marginalized communities with new financial tools, they must be accompanied by robust education efforts. This starts with basic financial literacy – understanding of lending, liquidity, and debt – and extends to the very practical teaching of digital money. Where is it made and stored? How does a digital wallet work? What are the benefits and risks?

Retail CBDCs can establish a more inclusive financial ecosystem. They can decrease the cost of transactions, eliminate barriers to lending, and power microfinance initiatives. At the same time CBDCs should aim to help un- and underbanked individuals create financial identities. A digital wallet should allow people using CBDCs to build credit, establish a lending track record, and, if designed appropriately, access more traditional financial instruments with the history they gain using government currencies. With appropriate considerations given to privacy, an individual’s CBDC profile could be shared with lending platforms, supplementing traditional credit markers like income history, debt load, and repayment record data many unbanked people lack.

Blockchain-backed finance allows individuals to quickly create liquidity. Physical assets can be represented digitally and placed as collateral to secure a loan. Used properly, this is a tool that can help underbanked businesses secure financing, reach markets with products, and compete at scale.

“The role of central bank money in payment systems has traditionally been to eliminate or reduce credit, liquidity and systemic risks, enable the interoperability of private (commercial bank) money and offer cash/coins to the general public as legal tender,” said Dilip Rao, Program Director, CBDC, Digital Finance Cooperative Research Centre (DFCRC).

“CBDCs may fill some of these needs by leveraging the form factor most suited to the exchange of tokenized assets, whether real-world or financial, for risk-free value. 'Atomic' settlement with CBDC – in which both assets and value are exchanged simultaneously with certainty – offers the potential to power new markets at low risk and cost.”

Working with the DFCRC, the Reserve Bank of Australia is conducting research to explore potential CBDC use cases. This research will help quantify the impact of digital currencies and inform the strategic transformation of payment ecosystems.

“Such new marketplaces could potentially expand volumes and reach,” said Rao. “By reducing parcel sizes and removing entry barriers, reducing transaction costs or enabling new market operators to be established with less regulatory friction.”

In a race towards a widely-adopted retail CBDC there are geo-political implications. Central banks see the digital realm as a new arena in which to compete and the first to viability may have an edge. This competition is great for innovation but detrimental if being first takes precedence over interoperability, cross-country communication, and inclusion.

“A focus on interoperability, the ability for different CBDCs to connect with each other around the globe, is critical to making digital currencies a tool that welcomes people into global markets,” says Steve Cerveny, Co-founder and CEO of Kaleido, a blockchain platform that collaborates with central banks. “What we want to avoid is a hundred different currencies that become siloed and make collaboration more difficult.

“Interoperability adds value to the global supply chain in that financial networks integrate seamlessly, but it also has implications for the individual. If a person’s location is key to making their particular digital currency work with global markets then we will fail to capitalize on the true promise of CBDCs.”

In a joint report with the International Monetary Fund and the World Bank, the Bank of International Settlements agreed “To promote coexistence with other forms of money and payment instruments and a reasonable level of adoption of CBDC, interoperability with non-CBDC systems, both domestically and cross-border, is fundamental. Users benefit from having a choice of different payment methods. To fully achieve this, users must have the ability to effortlessly go from one method to another.”

For central banks, the incentives to bring a retail-focused digital currency to market are clear. Central banks want to maintain control of financial levers jeopardized by decentralization and cryptocurrencies. They want to monitor digital payment networks for fraud. And they hope to engage more citizens in the global economy. This last, inclusive goal of CBDCs may pose the largest challenge in designing a widely accepted CBDC. Increasing accessibility of global markets largely depends on how well we plan the solutions of tomorrow, today.