Central Bank Digital Currencies Could be a Viable Alternative to Cryptocurrency

Moody's Investors Service has said that the launch of central bank digital currencies (CBDCs) could help lower costs for individuals sending remittances and reduce settlement and counterparty risks for banks in cross-border transactions. CBDCs are the digital version of a country’s money issued by its central bank and are similar to cryptocurrencies, but their value is fixed by the monetary authority and equal to the country’s fiat currency. CBDCs are expected to provide a middle ground for the highly volatile cryptocurrency market by reducing the risks associated with using cryptocurrency and providing a stable means of exchanging digital assets. “Interoperable CBDCs would likely lower costs for individuals sending remittances abroad, as well as for merchants, especially importers and exporters,” Moody's said. The rating agency highlighted that the capacity of CBDCs to reduce costs, wait times and settlement risks associated with international payments would be particularly beneficial to small businesses and start-ups, as well as established corporates.

Moody's added that to unlock the full potential of CBDCs, they will need to operate interchangeably with other payment systems and enable instantaneous cross-border transactions. Moody's also warned that if CBDC payment systems were widely adopted, they could reduce banks’ profits from payments, correspondent services and foreign-exchange transactions. However, the rating agency emphasized that global correspondent banks would lose the most as their roles would diminish.

The United Arab Emirates (UAE) Central Bank has started implementing its digital currency strategy, Digital Dirham, as it prepares for the future of finance. The regulator signed an agreement with Abu Dhabi's G42 Cloud and digital finance services provider R3 to be the infrastructure and technology providers for the implementation of its central bank digital currency (CBDC), according to a statement released on Thursday.

The implementation of the CBDC will provide a widely accessible, reliable retail CBDC, which could support economic growth by speeding payment transaction times, reducing transaction costs and fostering financial inclusion. Direct and immediate exchange of retail CBDCs in different currencies could also be achieved by individuals in different parts of the globe, leaving banks and other financial intermediaries completely or partly out of the process.

Almost all central banks globally are exploring the feasibility of a national digital currency, with some countries such as China already in the pilot phase, according to Moody's Investors Service. Retail CBDCs will have a critical advantage over privately-owned digital currencies in that they would provide the same rapid and convenient means of payment, with the formal backing of the central bank removing any credit risk.

Interoperable CBDCs could transform global payments, allowing instant payments across different currencies, eliminating the settlement risk banks currently face, according to the rating agency. However, Moody's warns that the adoption of CBDCs could reduce banks' profits from payments, correspondent services and foreign-exchange transactions. Global correspondent banks will lose out the most as their roles diminish.

Moody's also cautioned that central banks need to incorporate interoperability into the infrastructure from the beginning. If not, central banks run the risk of creating a CBDC that cannot be smoothly converted into other digital assets, such as deposits, stablecoins, a foreign CBDC, or cash. This would increase the risk of a globally fragmented CBDC system as nations group into independent cliques, missing the opportunity to create a more interoperable global system.