Money is going digital, full steam ahead. Within the past five years, interest around Central Bank Digital Currencies (CBDCs) has exploded. Nearly 100 CBDCs are currently in research or development stages, with CBDCs in Nigeria and the Bahamas already launched. Unlike volatile cryptocurrency assets (e.g., bitcoin and stablecoins), CBDCs offer promising development benefits through central bank backing. To ensure the effectiveness and uptake of CBDCs, critical steps remain to avoid user exploitation and incorporate safeguards that mitigate the digital divide, in line with USAID’s Digital Strategy. Still, the promise remains: by prioritizing the principles of digital development of security and inclusive user-centered design, trust can be built to mitigate the risks of CBDCs while preserving their potential in driving inclusive economic growth. Our lessons from traditional finance, or TradFi – our current mainstream centralized financial system and institutions – will illuminate a path for future CBDC implementation and adoption.
Financial Inclusion and Economic Formalization
Opportunities and Risks. CBDC adoption can reinforce financial inclusion by presenting a new means to digitally establish credit history for SMEs, rural communities, and other marginalized groups unable to do so with traditional banks. This has been the driving thrust behind the Bahamian sand dollar – a CBDC designed to serve the unbanked across more than 30 of its islands. Increased transaction digitalization can also lead to multiplier effects in the economy, spurring greater private sector formalization by establishing credit history, reducing illicit flows, and generating greater tax revenues.
Yet sufficient CBDC demand and uptake is met with both technical and behavioral challenges. To ensure domestic and cross-border interoperability, CBDCs need to seamlessly integrate with existing payment systems and infrastructure. CBDCs must also be presented as a credible alternative to physical cash to accelerate demand and ensure local stakeholders are ready and able to support its adoption.
Our TradFi Lesson: User-centered Design. To achieve sufficient uptake, digital financial services need to be ‘Designed With the User’ and embedded within the unique context and behaviors of end users. During implementation, the USAID Colombia Rural Finance Initiative (RFI) found that despite the presence of sophisticated contactless payments and app-based loan disbursements, most citizens preferred cash-based transactions. To boost uptake, build trust, and ensure equity when reaching rural customers, RFI paired the launch of new digital finance products with concurrent communications campaigns that required internal cultural shifts towards digital within partner FIs. This approach allowed partner financial institutions (FIs) grow client uptake of their new digital offerings while remaining interoperable with their internal systems. Through meaningful dialogue with non-financial actors to better understand user behavior and hands-on support on migrating some traditional users to digital users, the project avoided potential distortionary effects for FIs’ existing customer bases.
Reducing Transaction Costs and Boosting Speed
Opportunities and Risks. The ability of financial technology to reduce transaction costs is not news. For instance, RFI helped ACH-Colombia negotiate with 16 banks to develop and launch Transfiya, the country’s first platform for small-value, real-time transactions, which processed over 10 million transactions worth over $316 million within two years after launch. By reducing the number of intermediaries, CBDCs can support even faster, near instantaneous payments both domestically and across borders for transactions between financial institutions in different currencies. The Bank of International Settlements’ (BIS) Project Dunbar initiative developed successful prototypes which proved feasibility of implementing a multi-CBDC platform to facilitate international settlements using virtual currencies, with growth-catalyzing implications including boosting remittances, global value chain-integration, diaspora finance, and more.
Close collaboration is required among regulators and domestic agencies and across jurisdictions to align regulatory guidance and policy regarding privacy, consumer protection, and anti-money laundering standards, which is currently lagging compared to virtual currencies’ rapid proliferation. Without proper forward analysis and financial safeguards, deploying CBDCs may lead to capital flow volatility, and at worst, bank runs that present structural risks to the banking system.
Our TradFi Lesson: Inclusively Designed Regulatory Protection. Understanding the inherent regulatory risks with financial innovation, RFI facilitated active dialogue between financial institutions, fintech providers, and regulators when developing policy guidance around the deployment of mobile and digital cash agents. This public-private dialogue expanded access to remote, underserved populations by allowing banks to engage community members to provide mobile cash agent services, developing a framework that reinforced trust and feedback loops at the hyper-local level. By helping regulators design and test a new “SmartSupervision” software platform, RFI strengthened regulators’ ability to keep banks accountable to resolving customer complaints. When adopting CBDCs, employing such active stakeholder engagement – on all levels of society – will be essential in designing an airtight, comprehensive, and inclusive regulatory framework.
