Central Bank Digital Currencies (CBDCs) have become well-established as a major talking point in the academic mainstream and geopolitics — not to mention the crypto community and its rowdy public discourse on X. While national leaders and supranational financial institutions such as the World Bank and International Monetary Fund have come to a broad consensus that CBDCs stand to provide great benefits, very little has been said detailing where CBDCs are best designed to provide support, and where their adoption may be, so to speak, out of bounds.
In order for CBDCs to have a net positive effect on the global economy, it is imperative for global leaders to recognize their advantages and limitations. CBDCs can help central bankers to implement more effective capital controls, stimulus plans, and other forms of monetary policy as they issue debt to banks — that is, at the wholesale level.
Within these bounds and only within these bounds, CBDCs can help central banks to smooth market downturns, minimize recessions, and expedite growth — necessary practices in supporting stable national and regional economies.
Stablecoins will soon be one of the largest sources of demand for US treasuries on the planet. https://t.co/qjMyN4QjQ7
— Will Clemente (@WClementeIII) September 26, 2023
Implementing CBDCs at the retail level to serve individuals and corporations directly, on the other hand, is far too complex and nuanced an undertaking for central banks to manage.
The right product-industry fit
In the private sector, identifying a proper product-market fit is always a primary consideration for any startup. In the public sector, conducting a similar process with any nascent technology is equally important. In the case of CBDCs, the objective may be most appropriately described as a “product-industry fit” of sorts.
Wholesale CBDCs and the blockchains (more broadly, distributed ledgers) where they live can help central bankers to do their jobs more effectively because they confer superior security, transparency, and streamlined issuance, and because central bankers have the experience and know-how to draw on those benefits within the scope of their work.
Like any nascent technology, CBDCs should not be conflated with a replacement for any such specialized expertise, nor should they be extended to industries or economic sectors based on their technological capabilities alone. CBDCs only stand to add value when they can be properly accompanied by professionals with adequate expertise to leverage their benefits.
Overreach: Bypassing commercial banking
In addition to their utility in wholesale applications, CBDCs open the doors for central bankers to cannibalize and consume the entire commercial banking industry by issuing CBDCs directly to individuals, businesses, and other organizations at their own discretion. Though tempting and ostensibly more efficient, implementing such a system is an extremely complex undertaking and the adoption runway is fraught with challenges — as has been the case for Nigeria’s eNaira and China’s digital Yuan..
Put simply, central bankers should not take action simply because it is feasible to do so. Although retail CBDCs grant central banks the ability to bypass commercial banks and act as direct issuers at the retail and corporate levels, they do not confer the nuanced wisdom and rigorous experience required to do so effectively. Innovation is not a replacement for specialization; rather, innovation tends to refine specialization.
Commercial banks have cultivated deep expertise over the course of centuries developing models and algorithms for credit score evaluation, loan disbursement, account management, restructuring, reserve management, and servicing a broad range of retail clients across jurisdictions and wealth profiles –and that doesn’t even begin to touch corporate finance and corporate debt issuance. It is critical for central bankers to recognize that, just as their line of work is exceptionally nuanced and refined, so too is the landscape of commercial banking — and perhaps even more so.
Employing CBDCs in an attempt to undercut, circumvent, or cannibalize the entire commercial banking sector is as much a pipe dream for efficiency maximalists as it is a recipe for failure. The practice of issuing currency to corporations and individuals, as well as assessing loan applications, business models, credit score algorithms, and an extensive array of other relevant variables requires fully dedicated institutions that operate independently from the mechanisms and decisions shaping monetary policy.
The bright side: Commercial banking will not be left in the dark ages
Commercial banks and money transmitters will not be left in antiquity — they too have an emerging suite of on-chain tooling rapidly becoming available. Stablecoins, deposit tokens, and related DLT-based tools enable commercial banks to extend enhanced efficiency, transparency, and security to retail and corporate clients, just as CBDCs benefit central banks in their line of work.
Banks and money transmitters are well equipped to draw on wholesale CBDCs as collateral to issue stablecoins and deposit tokens for use in commercial applications. Additional on-chain integrations will allow commercial banks to streamline cross-border transfers, open direct trade corridors between nations, and integrate cutting-edge Know Your Customer (KYC) procedures to enhance security and privacy for their customers.
Commercial banks have deep experience managing deposit accounts based on central bank collateral and monetary policy, and are best positioned to continue managing those responsibilities in the digital era. If all goes well, the global adoption of CBDCs will marshal a new financial paradigm where central banks implement superior monetary policy at the wholesale level while allowing commercial banks to do what they do best at the retail level with stablecoins and deposit tokens.
Bradley Allgood is the founder and CEO of Fluent Finance, a project focused on pioneering deposit token infrastructure to bring banks and financial institutions on-chain. Before founding Fluent, Bradley designed the Web3 banking platform and its associated legal framework for the first Special Economic Zone (SEZ) in the United States.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.