Understanding Central Bank Digital Currencies (CBDCs) and their Implication for Merchants

Central Bank Digital Currencies CBDCsIn recent years, the global financial scene has been swiftly changing, with digital currencies at the heart of this evolution. One significant development in this area is the concept of Central Bank Digital Currencies (CBDCs), which are set to reshape our understanding of money and how it circulates. So, what are CBDCs? What has been their impact so far? Will digital currency replace other forms of currency? And, perhaps most importantly, what impact are they set to have on consumers and merchants in the future? 

What is digital currency? 

Before we delve into CBDCs, it’s important to understand the foundations upon which they sit. Digital currency, or digital coin is any currency existing purely in electronic form, without physical notes or coins. Unlike traditional fiat currencies regulated by governments, digital currencies operate independently, often in a decentralised way using blockchain technologies to record deposits, payments and any other transactions. 

Examples include cryptocurrencies like Bitcoin (BTC), Ethereum (ETH), Ripple (XRP) and Litecoin (LTC), as well as stablecoins that are designed to provide an alternative to the high volatility of the most popular cryptocurrencies, examples of which include Tether (USDT), Dai (DAI) and USD Coin (USDC). 

What are Central Bank Digital Currencies? 

CBDCs are digital versions of traditional currency that are issued by a country’s central bank, for example, the Bank of England (BoE) in the United Kingdom. CBDCs serve as a digital form of legal tender, usable for transactions and payments. In effect, CBDCs are centralized governments’ answer to cryptocurrencies. 

CBDCs come in two primary forms: wholesale and retail. Wholesale CBDCs are used for transactions between financial institutions, such as banks, credit unions and insurance companies. Retail CBDCs, on the other hand, are accessible to the public and businesses, offering a digital alternative to cash. 

The rise of CBDCs is quite significant. As of March 2024, 3 countries have officially introduced CBDCs, including The Bahamas, Jamaica and Nigeria. 134 countries and currency unions, including China and those in the Eurozone, which represent a staggering 98% of global GDP, are currently exploring CBDCs, with 68 countries being in the “advanced phase of exploration, development, pilot or launch”. 

How are CBDCs different from cryptocurrencies? 

Cryptocurrencies have already been widely influential within global economics, with over 420 million (4.2%) users worldwide invested in one of the world’s 8,985 “active” crypto variations, and it was only a matter of time before governments capitalised on this with a state-owned version. 

While both CBDCs and cryptocurrencies are forms of digital currency, they differ significantly in their underlying architecture and regulatory framework. 

Central bank’s interest in digital currencies stems from their goal of blending the efficiency of digital currencies with the stability of traditional fiat currencies; in other words, CBDCs are regulated and have respective mandate and legal frameworks that must be adhered to, whereas cryptocurrency regulation varies significantly by jurisdiction, with some countries having minimal or no regulation in place. 

Moreover, the value of CBDCs is tied to the value of traditional fiat currencies, such as the US dollar or the euro, making them inherently more stable than most cryptocurrencies, which are known for their price volatility. The stability they offer should make them more attractive to savers and risk averse investors and avoid the shocks that can stem from a cryptocurrency collapsing in value. 

Additionally, CBDCs are designed to comply with existing financial regulations, such as anti-money laundering (AML) and know-your-customer (KYC) requirements, whereas cryptocurrencies often operate in regulatory gray areas with much weaker protections. 

Examples of CBDC initiatives 

Several countries and central banks around the world have begun exploring the concept of CBDCs and even piloting or implementing CBDC initiatives. One notable example is the digital euro project announced by the European Central Bank (ECB). The ECB is currently conducting research and consultation on the potential issue of a digital euro, which would complement physical cash and existing forms of electronic payment. 

China is also at the forefront of CBDC development, having launched pilot programs for its digital currency electronic payment (DCEP) initiative, commonly known as the digital yuan. The People’s Bank of China (PBOC) aims to enhance financial inclusion, improve payment efficiency, and strengthen regulatory oversight through the adoption of a digital currency. 

How will CBDCs positively impact merchants and consumers? 

As CBDCs continue to gain traction globally, they will impact merchants and consumers in several ways: 

  1. Better payment efficiency: CBDCs promise to streamline payment processing for merchants and consumers alike. With transactions occurring digitally and directly through central bank-backed currencies, the need for intermediaries and associated transaction fees could diminish. Merchants can benefit from faster settlement times, reduced processing costs, and enhanced liquidity, leading to more efficient business operations.
  2. Greater accessibility: For consumers, CBDCs hold the promise of greater financial inclusion and accessibility. By providing a digital form of legal tender backed by the central bank, CBDCs can enable individuals without traditional banking access to participate in the digital economy. This can open up new markets for merchants, allowing them to reach previously underserved demographics and expand their customer base.
Potential challenges with CBDCs for merchants and consumers 

The adoption of CBDCs also raises various challenges and considerations for both merchants and consumers. Privacy concerns may arise as transactions conducted through CBDCs could be subject to increased monitoring and surveillance by the authorities. Additionally, cybersecurity risks must be addressed to safeguard against potential cyber threats and attacks targeting digital currency systems. 

As CBDCs become a reality, merchants and consumers will need to adapt to the everchanging advancements of digital payments. Merchants may need to invest in updated payment infrastructure and technologies to support CBDC transactions securely. Similarly, consumers may need to become familiar with using digital wallets and other CBDC-enabled payment methods. 

While it’s natural to wonder if digital currencies will eventually replace physical forms of money, its widespread adoption as a sole replacement is still unknown. Right now, there are many challenges that would suggest blanket replacement is unlikely, namely in public trust and acceptance, as well as infrastructure and widespread regulation adoption. This means that for now, merchants should still offer all types of payment options to their customers, whilst always keeping both an open mind and one eye open to possible changes in the future. 

As merchants need to offer various payment methods in-store to meet their clients’ demands, it’s crucial for merchant-serving businesses to make this process as easy as possible. In an ever-changing market with an increasing number of currencies and payment methods, staying competitive requires laying a foundation for quickly adopting new technologies without disrupting daily operations. Merchant-serving businesses should connect to an orchestration platform that facilitates seamless integration of new features. 

Aevi consistently monitors market innovations to ensure its cloud-based, open platform meets the demands of next-generation payments. The company remains attentive to developments in Central Bank Digital Currencies (CBDCs) and recognises the potential they hold for the future of finance. 

*** 

This article was first published by Aevi and has been republished on our website with permission. 

Aevi is a member of our Terminal Hardware, Software and Management Panel

***

If you enjoyed reading this article and would like to be notified when future articles are posted, please sign up for our email newsletter.

Are you interested in reading articles on a particular payments topic, company, payments industry executive or author? Click the search icon, it’s that magnifying glass on the top right-hand side of the website and type in the keywords that interest you. You will then be presented with a list of any articles that match your search criteria.