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Last updated: Aug 2, 2022

What CBDCs can do for your business

Author: Thomas Morgenroth
Last updated: Aug 2, 2022
What's inside

As the iconic hip-hop group and occasional economic analysts Wu-Tang Clan famously observed: "Cash rules everything around me."

The influence and utility of cash has been a constant since its invention. What is changing though — with the advent of online banking, NFTs, and crypto — is the definition of "cash." One particular emerging technology has massive implications for global markets, domestic policy, and individual businesses: Central Bank Digital Currencies (CBDC).

Despite the game-changing potential of this burgeoning legal tender, there's not a lot of understanding of what it is. So first things first: What is a CBDC and how does it work?

What's a CBDC?

For decades, banks have utilized digitized representations of currency — certified by third-party institutions known as clearing houses — to facilitate the transfer of funds without physically exchanging cash between locations. But those digitized credits aren't legal tender; they're not currency. Rather, they're electronic vouchers that can be exchanged for actual, spendable currency.

CBDCs are fully electronic national currencies backed by central banks that can be spent and exchanged — drum roll — without requiring certification by a clearing house. They come with the same "full faith and credit" pledge as the dollar in your wallet, only with the security and utility of online banking.

Just like any currency before it, a CBDC is a unit of value, tracked electronically and issued by a single, central entity in the form of a central bank. This currency unit is issued to an eWallet certified by that same entity, and the transactions to and from that wallet are likewise recorded electronically and available for retrieval at a moment's notice.

Like every other form of money, CBDC's purpose is to serve as payment for individuals and businesses to facilitate the exchange of goods or services. Functionally, digitized currency works exactly the same as traditional currencies. For example, a CBDC transaction can be as simple as the holder of digital currency paying for their meal at a restaurant by sending digital currency to the account of the restaurant.

That's all the dry stuff. Now, for the fun stuff.

Digitized currencies and the private sector

Clearing houses — the third-party institutions that are responsible for making sure that money used in purchases is accounted for and where it's supposed to be — are required for electronic transactions relevant to every business. But they're also involved in more niche activities like securities exchanges and derivatives transactions.

Currently, a standard digital transaction works like this: When Account A sends money to Account B, the Automated Clearing House (ACH) confirms the validity of the transaction on behalf of the banks for both the sender and recipient. And like every great go-between, the ACH takes a cut. Every single transaction is reviewed, confirmed and certified by an ACH with an accompanying fee of approximately 1% of the amount transferred. So how do clearing houses factor into CBDCs?

That's the big-ticket item: They don't. CBDCs don't require a clearing house.

Clear out clearing houses

In a whitepaper published by MIT and the Federal Reserve Bank of Boston, researchers projected that CBDCs would deliver an equal or faster transaction verification time than current ACH processes, all without needing an intermediary. Every CBDC transaction is issued, verified, and confirmed entirely through institutions approved by the Federal Reserve.

Now, why is this such huge news for a business? Currently, ACHs charge a fee of 0.5% to 1.5% on every electronic retail transaction (securities and dividends transactions are even pricier). With CBDCs, those transaction fees are eliminated, meaning every single transaction a business makes with CBDC eliminates a full point of overhead (or more).

Those savings constitute pure profit for every business that no longer relies on a traditional clearing house. Transactions are certified by a central bank, processed at standard speeds, and deposits go directly into the wallet of the recipient.

Of all the ways that technology has revolutionized financial services, this might be the first time the benefit has directly meant more money for businesses doing exactly what they've always done. Voilá. The magic of cutting out the middleman.

New customer bases

The benefit of CBDCs from a domestic policy perspective is demonstrated neatly by Project Sand Dollar. One of the first-ever rollouts of a live digitized currency, Sand Dollar is backed by the Central Bank of The Bahamas as a way to offer online banking and financial services to unbanked communities.

Project Sand Dollar allows Bahamian citizens to receive a free eWallet through any approved financial institution, providing access and convenience to citizens who otherwise might not be able to participate in online transactions for lack of a traditional bank account. While Project Sand Dollar is currently only available for domestic transactions, the program is already reporting increased efficiency in transactional capacity as well as reduced service delivery costs.

Project Sand Dollar shows that CBDCs can provide more bank access and improved quality of life for citizens. They also mean businesses will get access to consumers that otherwise wouldn’t be able to access the goods and services of online or electronic-only goods and services. Increasing access as a matter of public sector policy also results in a win for private sector (digitized) cash flow.

Online and locked up

Security is always a major concern when considering any implementation of new tech, particularly in finance. "Time-tested" sounds a lot better than "brand new" when you think about what's keeping our money safe. That said, the Project Hamilton study estimates that the infrastructure available to CBDCs possesses protection capabilities equal or superior to existing value instruments.

The reasons for this become fairly apparent when you look at the structure of a digitized currency. A digital unit of value, issued by a single, central entity in the form of a central bank, is transferred to an eWallet certified by that same entity, and the transactions to and from that wallet with digital currency are all recorded electronically. It essentially moves around within the same vault, so there's a triple bang for the non-literal buck: It’s transparent, it's unfettered by third-party profits, and it's secure.

Plus: CBDCs are fully traceable at every step of their journey while being backed by a government to ensure stability and accountability (the lack of which has led to more than one painful episode in crypto markets).

One giant leap for banking

CBDCs represent a meaningful step forward in both the evolution of fintech and its mainstream applications. CBDCs offer access to — and the benefits of — modern finserv to unbanked communities. And they do the previously unthinkable: They remove the intermediate clearing houses from the banking process, an overhead cost of bank transactions that's existed for literally centuries. It all results in increased profits for businesses, and fee-free transactions for their customers. That's something worth getting excited about.

(And if you want another thing to get excited about, hop on over to our fintech practice to get a sense of how Vention's ace fintech consultants and developers can help you execute a game-changing software solution.)

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