A woman in a store in the Philippines holds up a sign advertising mobile payments

Making Central Bank Digital Currencies Work for Development

| 5 Minute Read
Access to Finance | Digital Development | Economic Growth and Trade
Digital Development
Digital currencies have the potential to make a lasting impact on global development by being more inclusive and secure.

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.

Central Bank Digital Currencies must be presented as a credible alternative to physical cash to accelerate demand and ensure local stakeholders are ready and able to support adoption.

Financial Continuity in Fragile Environments

Opportunities and Risks. In fragile settings, CBDCs present an alternative means to make payments and store funds amid high inflation or disrupted banking infrastructure. By mostly relying on distributed ledger technology, CBDCs and other virtual currencies increase resilience to economic shocks by minimizing vulnerable spots and securing transaction records, which can pay dividends in situations with limited time and resources for transaction verification. This feature is particularly powerful in volatile contexts where offline technology for digital payment is available despite limited internet access.

Effortless payments through digital channels bring accompanying security risks by limiting insights into the source and destination of funds and undermining anti-money laundering financing controls. While DLT presents exciting opportunities to facilitate effective collection and storage of personally identifiable information (PII), its decentralized nature presents cybersecurity concerns that would damage consumer trust – including PII theft, unauthorized disclosure of consumer financial information, or cyberattacks on the ledger, which may be more pronounced in fragile contexts with lower capacity to mitigate such leakages.

Our TradFi Lesson: Comprehensive Cybersecurity Approach. When implementing its e-payment activities, the USAID Philippines E-PESO project saw increased attempts at fraudulent activities amid growing utilization of digital financial services. To tackle this challenge, E-PESO innovated an approach centered within the principle for digital development of privacy and security. First, it strengthened the enabling environment by supporting the Philippines’ Central Bank (BSP) in establishing a Payment System Management Body that implemented settlement security accounts to eliminate risks for real-time transactions and other policies related to anti-money laundering. Second, in partnership with the BSP, the project conducted a cybersecurity policy review aligning with globally recognized cyber resiliency frameworks to identify gaps and deploy appropriate solutions (including implementing a regulatory technology system to oversee the banking industry). Third, the project addressed demand-side cybersecurity concerns by co-creating a cybersecurity awareness program with regulators. This approach boosted trust in digital payments by encouraging basic digital and cybersecurity concepts supporting messages of reliability, privacy, and security. Effective CBDC deployment will similarly necessitate a comprehensive behavioral approach to mitigate cybersecurity risks and boost user trust.

Looking into the Future of Money

For CBDCs to effectively bridge the digital divide and drive financial inclusion, public and private sector actors must collaborate to make investments that build an inclusive, reliable, and trust-based ecosystem rooted within the principles of digital development. Initial investments should focus on aligning technology and local behavioral change strategies, improving regulatory clarity, and designing robust cybersecurity measures to boost stakeholder trust. These investments should be accompanied with targeted initiatives addressing last-mile hurdles to inclusion (i.e., unstable electricity and internet access) to ensure CBDCs protect users and remain accessible to all.

To delve more into the principles for digital development and virtual currency concepts, explore these resources from the Digital Impact Alliance as well as this USAID Examining Virtual Currencies primer.

Banner image caption: A merchant in the Philippines advertises the availability of mobile payments in her store. Photo taken by the USAID Philippines E-PESO project.

Posts on the blog represent the views of the authors and do not necessarily represent the views of Chemonics. 

About Daniel Kim

Daniel Kim is an international development professional with technical, strategy, and management expertise in USAID project implementation, business development, and thought leadership. Daniel currently jointly serves as specialist on Chemonics’ Economic Growth and Trade (EGT) Practice and coordinator on the USAID Innovative Finance Task Order, covering economic growth topics of results-based financing, entrepreneurship, enterprise development,…

About Eugénie Lund-Simon

As the Senior Specialist for Chemonics’ Digital Development practice, Eugénie Lund-Simon supported the design and implementation of programs promoting open, secure, and inclusive digital ecosystems. Her work focused on exploring how technology can reduce the spread of disinformation, counter violent extremism, and support media ecosystems in conflict and post-conflict settings.