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The concept of a central bank digital currency predates crypto’s most recent market downturn. However, it has steadily gained momentum as governments recognize the need to modernize payment systems while addressing various economic and technological challenges. Currently there are approximately 134 nations and currency unions that have explored or are exploring the use of CBDC, three of which have already launched: Jamaica, Bahamas and Nigeria.
These countries and currency unions have different, but sometimes overlapping, motivations for exploring the possibility of digitizing their money, and they may not always be in the public’s interest.
On the positive side, however, many governments are trying to strengthen financial inclusion by providing the unbanked with an accessible digital payment option while allowing easy transfer of money, such as social benefits. They do this in the hopes of reducing dependence on banks to handle transactions, allowing ordinary people to transfer money easily and affordably, and facilitating streamlined international trade.
Furthermore, exploring CBDCs can increase economic transparency due to blockchain’s immutability, which would combat money laundering, tax evasion, and other financial crimes. CBDCs would also promote the further expansion of the fintech sector by future-proofing the economy and encouraging cutting-edge financial innovation.
Ethiopia, Africa’s second-largest country and fifth-largest economy, has made headlines after approving a updated monetary policy framework of the National Bank of Ethiopia that includes a plan for a CBDC. Economists believe the move would be a big boost for financial inclusion and efficiency 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, the NBE sees an opportunity to liberalize the economy and attract foreign investment. Ethiopia is hoping to transform its economy, and much of its success may depend on how it implements a CBDC.
CBDCs can undoubtedly unlock economic benefits that can help developing and underdeveloped countries improve their financial position while playing a greater role on the global stage. However, whether a specific CBDC is retail, wholesale, or hybrid, the development of this digital currency could allow governments to exert greater control over financial systems.
From a crypto perspective, CBDC adoption could become the norm, disrupting the booming decentralized finance space. First, CBDCs could pose a threat to privately issued stablecoins, which serve an infrastructural role and facilitate DeFi activities.
For countries like Ethiopia that are strongly considering issuing CBDCs, Nigeria’s use case should serve as a cautionary tale. When the Nigerian Central Bank the eNairait used the open source Hyperledger fabric protocol, which is secure and can process up to 3,000 transactions per second. However, CBN has never connected eNaira to existing or developing financial infrastructure.
Ultimately, CBN controls all nodes and blocks outside access to blockchain data, raising concerns about centralized authoritarian control. Since its launch in late 2021, the eNaira has not been widely accepted and is considered a failure.
If CBDCs are about future-proofing national economies, they must be compatible with all digital financial systems, including interoperability with public blockchains. In this case, technical and regulatory considerations are relatively easy to implement; it comes down to the policies and vision of financial decision makers.
Any CBDC program must work with all licensed banks operating in the country while also working with fintech and blockchain technology providers to ensure that the CBDC is interoperable with traditional financial systems, DeFi and other digital payment rails.
Kima, an interoperability protocol that bridges crypto and fiat, represents the type of technological infrastructure that will enable CBDCs to facilitate real economic progress. Last year Kima took part in one pilot project managed by the Bank of Israel to assess the feasibility of implementing a CBDC. As part of the project, Kima successfully demonstrated a transfer of a tokenized share via a digital shekel.
To demonstrate the utility of the protocol, Kima built a demo trading platform to enable an atomic swap of the tokenized shares. Kima’s decentralized settlement layer handled the transaction, matching the buyer interested in purchasing the stock using digital crescents with the seller, who held the tokenized shares in a crypto wallet. The seller received the payment directly into his bank account in the form of regular shekels. Using two API calls, Kima ensured that the transaction was secure and verified as it took place immediately without any intermediaries or smart contracts.
This process – linking a CBDC, a tokenized asset, a digital wallet and a 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 and modern digital financial tools in a secure and accessible way.
