CBDCs must bridge old and new financial systems

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The concept of a central bank digital currency predates cryptocurrency’s most recent down market. However, this has steadily gained momentum as governments recognize the need to modernize payment systems while addressing various economic and technological challenges. There are currently approximately 134 countries and monetary unions exploring or exploring the use of CBDC; three of these are already available: Jamaica, Bahamas and Nigeria.

These nations and currency unions have different but sometimes overlapping reasons for wanting to explore the option of digitizing their currencies, and these may not always be in the public’s best interest.

On the positive side, many governments are working to strengthen financial inclusion by providing unbanked individuals with an accessible digital payment option, enabling easy transfer of funds, such as welfare payments. They do this in the hope of reducing dependence on banks to process transactions, allowing ordinary people to send money easily and affordably, and facilitating international trade.

Additionally, the discovery of CBDCs can increase economic transparency due to blockchain’s immutability; This can combat money laundering, tax evasion and other financial crimes. CBDCs will also encourage further expansion of the fintech sector by future-proofing the economy and encouraging advanced financial innovation.

Ethiopia, Africa’s second largest country and fifth largest economy, hit the headlines after its updated monetary policy framework, which included the CBDC plan among other things, was approved by the National Bank of Ethiopia. Economists believe the move will be a huge boost to financial inclusion and productivity in a country that was once seen as a growing economic power before a recent civil war disrupted the momentum.

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

CBDCs can undoubtedly unlock economic advantages that can help developing and underdeveloped countries improve their financial situation as they play a greater role on the global stage. However, whether a particular CBDC is retail, wholesale or hybrid, the development of these digital currencies could enable governments to gain greater control over financial systems.

From a crypto perspective, if CBDC adoption becomes the norm, this could disrupt the emerging decentralized finance space. First, CBDCs could threaten privately issued stablecoins that serve as infrastructure by facilitating DeFi activity.

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

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

If CBDCs are about future-proofing national economies, they need to be compatible with all digital financial systems, including interoperability with public blockchains. In this case, the technical and regulatory aspects are relatively simple to implement; It depends on 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 CBDC is interoperable with traditional financial systems, DeFi and other digital payment channels.

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

Showcasing the utility of its protocol, Kima created a demo trading platform to facilitate atomic swaps of tokenized stocks. Kima’s decentralized payment layer processed the transaction by connecting the buyer who wanted to purchase the share using digital shekels to the seller, who held the tokenized share in a crypto wallet. The seller received the payment in the form of regular shekels directly into his bank account. By using two API calls, Kima ensured that the transaction was secure and verified as it occurred instantly, without any intermediaries or smart contracts.

This process that connects a CBDC, tokenized asset, digital wallet, and bank account is what governments should envision as the goal of any CBDC initiative. If they want to future-proof their economies, governments must use CBDCs to bridge legacy financial systems with modern digital financial instruments in a secure and accessible way.