Three ways Nigerian CBN, others can overcome digital currency challenge

On October 25, 2021, Nigeria emerged as the second country with a central bank digital currency (CBDC) – eNaira that is fully open to the public after the Bahamas.

About 80 percent of Central Banks around the globe are actively exploring CBDCs, according to a recent survey by Ripple, a global payment solution.

Despite the many benefits of CBDCs, the San Francisco-based company said most Central Banks are understandably cautious about pursuing real-world initiatives.

“Everything, from how people pay bills and buy groceries to how businesses transact and governments are run, depends on a stable financial system. CBDC initiatives raise many challenges for Central Banks, who must balance the desire for transformation with the need to maintain stability on a global scale,” Ripple said.

According to the ‘Future of CBDC’ report by Ripple, most existing digital assets are based on decentralized blockchains where every transaction is validated by a public network of hundreds, often thousands of validators.

It explained that one of the challenges of CBDC is the fact that Central Banks will not be willing to relinquish control to a completely distributed model, as they need the ability to direct and influence their economies through currency management.

“While a fully centralized model would provide the required control, Central Banks would miss out on innovations like programmable money and smart contracts that blockchain technology enables. It would also reduce the ability of private sector players to access and collaborate with CBDCs.”

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As half of the world’s population is expected to use digital wallets for transactions that will be valued at more than $9 trillion annually by 2024, the following are ways the Nigerian central bank and others can overcome the challenges that may daunt digital currency growth.

Interoperability

For a digital currency to have any utility to people and businesses, Ripple said it needs to coexist and interact with other payment schemes in that domestic market.

The next level of interoperability for CBDCs as highlighted by the payment solutions company is the ability to work for global transactions. Without seamless cross-border functionality, most CBDC projects will significantly underachieve their potential, it said

“Just as the global internet thrived by early agreement on common protocols like TCP/IP, HTTP and FTP, so too should Central Banks start coordinating on CBDC standards to cover basic functions, including transaction-level operations, such as escrow and hash time-locks, identity and addressing schemes and flexible routing to determine most efficient ways of transmission,” Ripple recommends.

According to the report, interoperability will allow CBDCs to connect with other domestic services, as well as each other, thereby enhancing their utility, lowering transaction costs and reducing barriers for new market entrants — while allowing each Central Bank to retain sovereignty.

Public and Private Partnerships

According to the San Francisco-based company, CBDC technology cannot replace what already exists in the financial services industry because infrastructure supporting the existing financial system is vast and varied and not likely to be redundant any time soon.

As a result, the company recommends a layered architecture model, where new systems are built on top of the existing infrastructure.

“ A major benefit of layered architecture is that Central Banks can call on the expertise of the private sector to implement CBDC infrastructure without compromising the integrity of the rest of its system,” it said.

Neutral Bridge Currencies

While interoperability will support the direct exchange of a CBDC in domestic transactions, many of the same, old issues with cross-border transactions will remain, according to the report by Ripple.

In particular, it said supporting immediate real-time foreign exchanges, as opposed to the current 3-5 day process, will likely still require the need for pre-funded currency accounts.

“Like any commercial bank or global business, Central Banks will want to avoid the increased costs and risks associated with this familiar liquidity issue. They would also welcome the ability to free up capital that could be generating value elsewhere and skew the financial system in favour of the most liquid currencies – typically those of the most powerful nations.