Karina Kapliar. CBDC as a challenge to commercial neo-banks

DOI: https://doi.org/10.62204/2336-498X-2023-1-4

CBDC as a challenge to commercial neo-banks

Karina Kapliar,

postgraduate student,

Taras Shevchenko Institute of International Relations, Ukraine

karina.kapliar@gmail.com; ORCID: 0000-0002-3502-4980

Annotation. As more central banks investigate the possible advantages and drawbacks of issuing their own digital currencies, CBDC have gained a lot of momentum in recent years both on micro-level and macro-level. In this respect CBDC have posed not only opportunities for supporting monetary policy changes and boosting financial inclusion, yet also created challenges for private digital currencies and neo-banks operating them. Aim of this paper is to identify current situation and future tendencies in terms of CBDC launch progress with a special focus on legislative and governance and its impact on private digital currencies. Major benefits of CBDCs (i.e., programmability, financial inclusion, and security & privacy) are outlined. Current statistics on CBDC development trends is analyzed, namely more than 110 nations are considering a CBDC at some stage of development. Nigeria’s case as the first nation in Africa to introduce a CBDC (eNaira) is analyzed. It is outlined that eNaira has potential advantages such as improved transmission of monetary policy, convenience, effective payments, increased financial inclusion, and increased remittance inflow. This research stresses that digital illiteracy, cyberattacks, data theft, and the shifting role of banks are key hazards to successful CBDC launch and future functioning. Outlined experience of Nigerian CBDC launch is transferred to Ukrainian case of CBDC launch initiative. This study emphasizes that successful launch of CBDC in Ukraine will positively influence economic growth and changes in monetary policy. Legislative changes, monetary policy changes, and major governance structure changes may all be necessary for the CBDC implementation to be successful. This study may be used by researchers and analysts in the field of digital currencies, central banks and other regulators, banking associations, commercial banks, state authorities. Future perspective of this research may lay in considering CBDC functioning peculiarities from the point of view of major user groups.

Keywords: central bank, private digital currency, neo-bank, financial inclusion, governance.

Introduction. Central Bank Digital Currency (CBDC) is a digital version of a nation’s sovereign currency that is issued and governed by that nation’s central bank. It is meant to serve as a reliable, safe, and effective form of payment, settlement, and value storage that can coexist with more conventional physical forms of currencies. In response to the explosive expansion of digital payments, cryptocurrencies, and other technical breakthroughs in the financial industry, the development of CBDCs has accelerated significantly in recent years. CBDCs have the same legal tender status as conventional money and are backed by the full confidence and credit of the government, in contrast to cryptocurrencies like Bitcoin or Ethereum that are issued and controlled by the issuing nation. Moreover, CBDCs have an impact on monetary policy. CBDCs may provide central banks new instruments for carrying out monetary policy, such as the capacity to more successfully apply negative interest rates or target certain economic sectors. China, Sweden, and others are just a few nations that have already started trial programs or completely adopted CBDCs. The prospective creation and implementation of their own CBDCs are now being actively researched and considered by other central banks, including the Federal Reserve and the European Central Bank. Therefore, CBDCs are one of the major research lines in terms of analyzing both macro-level and micro-level financial behavior and policy.

Literature review. A number of research papers consider different aspects and issues of CBDCs. In this context Ammous (2018) researched CBDC nature in the aspect of fulfilling money functions. Further, Yao (2018) analyzes nature of CBDCs in comparison with private digital currencies and electronic currencies. In turn, Brunnermeier, Niepelt (2019) study nature of private and public money with a focus on CBDC. Adrian, Griffoli (2019) analyze key trends of micro-level and macro-level in terms of CBDCs development. Further, Griffoli, Peria, Agur, Dell’Ariccia, Kiff, Popescu, Agur (2018) analyze various stakeholder groups in terms of developing and implementing CBDCs. In turn, Andolfatto (2021) analyzes impact of CBDC on privately-owned commercial banks. Wadsworth (2018) researched major challenges of issuing CBDC in terms of technological, safety and policy aspects. Lee, Yan, Wang (2021) consider a conceptual framework for CBDC adoption from the perspective of different stakeholders (e.g., user groups and central banks). Further, Zhang, Li, Xiong, Wang (2021) study various aspects of risk concerning cryptocurrencies and response on behalf CBDCs. In turn, Qian (2019) overviews aspects of optimizing CBDCs issuance and operational functioning. Fernández-Villaverde, Sanches, Schilling, Uhlig (2020) research differences between CBDCs and privately owned digital currencies with a focus on financial sector stability. Further, Mishchenko, Naumenkova, Mishchenko (2021) overview future trends in institutional transformation of financial sector in terms of CBDCs. Bossu, Itatani, Margulis, Rossi, Weenink, Yoshinaga (2020) research legal grounding for CBDCs in the operational and strategic aspects. Further, Agur, Dell’Ariccia (2019) analyze the major issues of designing CBDCs in response to various stakeholder needs in terms of technological and financial inclusiveness, and planning and realizing policy. Niepelt (2020) researched peculiarities monetary policy planning and realization with a component of CBDC.

However, issue of framework of successful launch of CBDCs in developing countries and its impact on private digital currencies is not sufficiently studied in the existing body of research.

Aim of this research is to determine the current state and future trends of CBDC launch progress with a special focus on legislative and governance and its impact on neo-banks operating private digital currencies.

Methodology. This study uses several research methods. Namely, synthesis methods were used to identify and summarize the key findings regarding the current state of CBDCs in the context of the tasks of different stakeholder groups, as well as to form trends in its development in the future under the influence of micro-level and macro-level challenges. Statistical analysis methods were used to analyze the key indicators of the state of CBDCs. Strategic analysis, another research technique employed in this study, establishes the top benefits for CBDC development. The framework of this technique makes use of the instruments listed in the BIS Innovation Hub (2022) methodology, which aids in the identification of significant exogenous and endogenous development concerns for CBDCs. The methods used by a variety of regulators and international organizations, Asian Development Bank (2021), G7 – UK (2021), as well as the best practices of relevant research, were used to design this research. Data collected by Atlantic Council (2023) was used for the purposes of statistical analysis in this research.

Results. CBDCs are using cutting-edge technologies like blockchain or distributed ledger technology (DLT) – therefore CBDCs are produced, stored, and transferred electronically. This lowers the price of printing and managing actual cash while enabling quicker and more secure transactions. However, actual benefits of CBDCs at both macro-level and micro-level are far wider. Key benefits of CBDCs that are outlined on Figure 1.

Fig. 1. Key benefits of CBDCs

Source: compiled by author.

We consider the outlined benefits in more detail:

Programmability: CBDCs may be built with features that are programmable, allowing for the deployment of smart contracts, automated transaction execution in response to particular situations, and other sophisticated features. This may increase transaction efficiency, make new financial services possible, and make it easier to comply with rules.
Financial Inclusion: CBDCs may help to advance financial inclusion by providing underbanked and unbanked people with simpler and more affordable access to digital financial services.
Security & Privacy: Depending on the laws in each area, different degrees of privacy may be included into CBDCs. However, given that they are governed by central banks, transaction monitoring will probably be used to some extent in order to stop money laundering, financing of terrorism, and other illegal activities.

CBDCs mark an ascent due to a number of exogenous and endogenous factors. In reaction to the acceptance of cryptocurrencies that have no official support and the rising cash-lessness of many societies, central banks have introduced digital currencies. Intentional initiatives are being taken by several central banks to create their own CBDC. According to a poll of central banks conducted in 2021 by the Bank for International Settlements (BIS, 2022), 86% are actively examining the possibilities of CBDCs, 60% are experimenting with the technology, and 14% are implementing CBDC pilot projects. While some central banks, like those in China, Sweden, and the Bahamas, have advanced in their development of a CBDC, others, like those in Canada and the U.S., Thailand and Singapore are still in the early stages. Additionally, while other central banks adopt different technologies, some are implementing blockchain and cryptography to develop their own CBDC.

According to Atlantic Council data (Atlantic Council, 2023) more than 110 nationals in total representing over 95% of the world’s GDP, are considering a CBDC at some stage of development. However, only 35 nations were exploring a CBDC as of May 2020. By December 2022, every G7 economy would have advanced to the CBDC development level. Project Cedar, a large-scale CBDC experiment by the New York Federal Reserve, has moved the US from research to development. More than 10 nations have fully launched a digital currency by end of 2022, also China’s pilot, which reaches more than 0.25 billion people, is set to expand to most of the country in 2023. Jamaica is the latest country to launch its CBDC (JAM-DEX). Over 20 nations plan a considerable progress in launching a CBDC in 2023. In 2023, Australia, Thailand, Brazil, India, Korea, plan to either start or continue pilot testing.

Additionally Atlantic Council outlined dynamics for CBDC development and launch progress for 1.5-year period (April 2021 – December 2022). On April 2021 38% researched nations were researching CBDCs, 19% nations have been developing CBDCs, 24% nations have been piloting CBDCs. At the same time, in 1.5-year time by December 2022 27% researched nations were researching CBDCs, 30% nations have been developing CBDCs, 16% nations have been piloting CBDCs, 10% nations have launched CBDCs. That demonstrates a significant progress in terms of CBDCs. In more detail statistics on CBDCs progress by researched nations sample is presented in Figure 2.

Fig. 2 CBDCs global progress state, %, April 2021 – December 2022

Source: compiled based on Atlantic Council data.

It has to be outlined that CBDCs may lead to the collapse of private digital currencies as a major product and tool of neo-banks. Firstly, due to confidence in CBDCs, and secondly, due to authority of central banks. The first factor is confidence in CBDCs. The future of fiat money will be represented by CBDCs. People already trust fiat money, so it will be very simple for them to believe in fiat digital currency when it is introduced because it is backed by governments, a central bank liability, and is subject to regulation. The ability of central banks to declare all non-fiat digital currencies unlawful is the second justification. The central bank is authorized by law to be the only issuer of a legal tender currency in the majority of nations. This gives the central bank the authority to declare all neo-bank private digital currencies unlawful when necessary and to create new money, such a digital currency. While many central banks have strongly cautioned against using neo-bank digital currencies for financial transactions, other nations like Algeria, Bolivia, Morocco, Nepal, Pakistan, Vietnam have outright banned them.

Central banks are under a lot of pressure to take the lead in the digital currency field since private digital currencies are attracting a lot of attention from economic actors, particularly from people and enterprises. Because of this, it is likely that central banks will give in to pressure by launching their own fiat digital currency and then declare that other non-fiat private digital currencies, notably bitcoin, are prohibited from being used as money in the economy. A central bank or government action like that might cause cryptocurrencies to disappear. Cryptocurrencies may be utilized as investment assets by central banks who do not wish to outlaw them, but not as a medium of exchange for fair-trade transactions.

Nigerian CBDC case analyzed by Ozili (2021) is worthwhile to be considered in the respect of financial sector transformation at both macro-level and micro-level. Nigeria is the first nation in Africa to introduce a fiat digital currency, sometimes referred to as a CBDC. In order to be utilized alongside paper Naira, the eNaira CBDC was created. Opportunities presented by CBDC to Nigeria include enhanced transmission of monetary policy, convenience, effective payments, increased financial inclusion, and increased remittance inflow. Digital illiteracy, a rise in the likelihood of cyberattacks, data theft, and the shifting role of banks in a fully developed CBDC economy are just a few of the hazards that have been highlighted. Nigerian economy may benefit from a CBDC issued by a central bank in a number of ways outlined in Table 1. These changes are concerning first of all:

Transition to cashless policy,
Lowering costs of banking system;
Increase in financial inclusion.

Concerning other developing countries cases – including Ukraine – CBDCs will likely face the same progress pathway, with a reservation for national legislative aspects and local financial market aspects. In this respect Mishchenko, Naumenkova, Mishchenko (2021) outline that CBDC launch in Ukraine will positively influence trend of contraction of shadow economy – since monetary transactions will be more transparent to the regulator and commercial banks. Therefore, significant boost bot economic growth and changes in monetary policy are expected due to successful launch of CBDC. In light ofthese, Tereshchenko, Aleksin (2019) stress that such changes will require an informed governance framework in order to, firstly, enable successful long-term functioning of these changes, secondly, make Ukrainian market more transparent to international stakeholders who expect the same control and monitoring mechanisms as they have established internally and internationally. Grytsay (2022) additionally outlines need for legislative changes in order to support both monetary policy changes in the light of CBDC launch and its adequate functioning in Ukraine among households, corporations, banks and other economic agents. However, successful launch of CBDC in Ukraine will further support economic transformation and bring Ukraine among the selected group of developed and developing economies with CBDC effectively functioning.

Table 1

Potential advantages of the eNaira launch in Nigeria

Benefits	Comments
Transition to cashless policy	Incentive on CBDC launch in Nigeria may improve the push toward a cashless policy, offer cash alternatives and lessen the dependence on cash, promote diversified payment options in the nation, increase remittance inflows by making diaspora remittance transfers quicker and less expensive, and increase financial inclusion because consumers will be able to send direct payments to government officials using the eNaira.
Lowering costs of banking system	Nigerian CBDC may lower the cost of managing cash by lowering the cost of handling cash, printing cash, and destroying cash, saving the government money; it will lower settlement risk; it will make cross-border transactions simpler. As a result, that will lower illegal activities like fraud and money laundering. This is because eNaira-based digital payments and transfers will be simpler to identify and link back to the specific ID of the originator, lowering the risk of fraud and money laundering.
Increase in financial inclusion	CBDC in Nigeria will boost financial inclusion making it simple for people in remote areas who have long been financially excluded to access financial services, and it will make tax evasion in Nigeria more challenging when it is used to pay for goods and services. It will also stop money from being hidden and transferred outside the financial system. Cross-border transfers will become more affordable and secure thanks to the eNaira, which will also make taxable assets traceable and impose transparency in the taxation system.

Source: compiled by author based on Ozili (2021)

Discussion. Thus, the peculiarities of the development of CBDC from the point of view of the evolution of the financial services market and competition trends in the banking sector, including impact on neo-banks, are established. This study indicates that globally, the adoption of CBDCs is gaining speed, with various central banks actively doing research, creating, and putting experimental programs into practice. Research byYao (2018) supports this result outlining that nature of CBDCs (in comparison with private digital currencies) is formed under both need for an adequate response on macro-level and fulfillment of stakeholder needs on micro-level.

This study indicates that programmability, financial inclusion, improved security and privacy are outlined as a few advantages that CBDCs provide. Due to growing confidence in CBDCs and central bank authority, the introduction of CBDCs might potentially result in a drop in the popularity of cryptocurrencies. Research by Wadsworth (2018) supports this result indicating major challenges of issuing CBDC in terms of technological, safety and policy aspects. Additionally, this result is supported by study by Zhang, Li, Xiong, Wang (2021) in terms of multiple aspects of risk concerning cryptocurrencies and role of CBDCs.

This study shows that CBDCs are being adopted by developing nations (like Nigeria and Ukraine) to encourage economic development, financial inclusion, and transparency. Implementation of CBDC has the potential to have a beneficial economic effect by eliminating the shadow economy, allowing more transparent financial transactions, and promoting global collaboration. This result is supported by study by Mishchenko, Naumenkova, Mishchenko (2021) overviewing future needs in institutional transformation for developing countries in terms of CBDCs launch.

However, this study indicates more complex challenges in the light of CBDC development, signaling a significant change in the financial industry that might have an impact on monetary policy, financial services, and the state of the economy as a whole. Therefore, an adequate legislative and governance instrumentation is required to better manage the consequences, difficulties, and potential of CBDCs as central banks continue to investigate and deploy them.

Conclusions. CBDCs have a number of key benefits, such as programmability, financial inclusion, security and privacy. Central banks are actively examining the possibilities of CBDCs, 60% are experimenting with the technology, and 14% are implementing pilot projects. More than 110 nations in total representing over 95% of the world’s GDP are considering a CBDC at some stage of development. More than 10 nations have fully launched a digital currency by the end of 2022, and China’s pilot is set to expand to most of the country in 2023. Over 20 nations plan to either start or continue pilot testing. CBDCs may lead to the collapse of orivate cryptocurrency due to two factors: confidence in CBDCs and the authority of central banks. Central banks are under pressure to take the lead in the digital currency field due to private digital currencies attracting attention from economic actors.

Central banks are likely to launch their own CBDCs and declare that other private digital currencies, notably bitcoin, are prohibited from being used as money in the economy. Nigeria is the first nation in Africa to introduce a CBDC, known as eNaira. The potential advantages of the eNaira include improved transmission of monetary policy, convenience, effective payments, increased financial inclusion, and increased remittance inflow. However, digital illiteracy, cyberattacks, data theft, and the shifting role of banks in a fully developed CBDC economy are just a few of the hazards. Nigeria’s CBDC will boost financial inclusion, make tax evasion more challenging, and make cross-bordertransfers more affordable and secure.

In other developing countries, such as Ukraine, CBDCs will likely face the same progress pathway, with a reservation for national legislative aspects and local financial market aspects. Successful launch of CBDC in Ukraine will positively influence economic growth and changes in monetary policy. Legislative changes, monetary policy changes, and major governance structure changes may all be necessary for the CBDC implementation to be successful.

Future line of this research may be developed in the direction of considering in more detail aspects of CBDC functioning from the point of view of major user groups which will enhance researchers’ understanding of CBDCs future development trends.

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