Factum Perspective: Central Bank Digital Currencies and Emerging Economies – Part II

By Kasun Thilina Kariyawasam

In general, Central Bank Digital Currencies (CBDCs) can help businesses and individuals engage in international trade and investment, by providing a stable, regulated, and transparent currency that mitigates some of the risks associated with cross-border transactions.

CBDCs for firms

A CBDC can help firms streamline their cashflows. EMEs can offer wallet solutions in the form of programmable coins, through which firms can streamline their finances. This can help reduce the potential for fraud, and expedite internal auditing.

CBDCs also enable tokenization. This process involves converting a physical asset or financial instrument into a digital token, which can then be stored on a blockchain or another digital ledger.

Physical assets such as real estate and commodities can be tokenized, facilitating ownership transfers and provenance tracking. This can improve the efficiency of business processes and flows. It can also allow firms to create structured collaterals, which can facilitate greater access to credit.

Tokenization helps firms to enhance financialization. Once assets are tokenized they can be structured into various types of financial assets, such as bonds and derivatives (options and futures). It also creates new types of data layers that enable firms understand their internal flows better. Bringing transparency to the business process allows firms to explore new paths of monetization and ownership.

Moreover, businesses can build new partnerships and ownership models, such as fractional ownership, Capital as Service (CaS), Special Purpose Vehicles (SPVs), trusts, Employee Stock Ownership Plans (ESOPs), and Community Land Trusts.

Since most EMEs lag in digitalization, CBDCs not only create a new form of financial infrastructure for firms, but also incentivizes them to digitize.

CBDCs for banks and other financial institutions

CBDCs can automate many processes now performed manually by banks, such as clearing and settling transactions. Digital transactions can be made in real-time and securely using Distributed Ledger Technology (DLT) or blockchain technology.

CBDCs can reduce the need for intermediaries, such as correspondent banks. As intermediaries can add significant costs and complexity to cross-border payments, reducing the need for them can reduce costs for banks and consumers. With built-in compliance checks and fraud detection, CBDCs can also facilitate faster and more secure transactions. The whole process can be made more efficient by reducing the risk of fraudulent transactions and increasing the speed at which payments are processed.

CBDCs can also increase transparency and reduce the risk of errors in clearing and settling transactions, since all transactions are recorded on a tamper-proof digital ledger. In addition to boosting efficiency, this can also boost trust and confidence in the financial system.

There are many benefits in using CBDCs to clear and settle transactions, including reducing costs and intermediaries, increasing speed and security, and improving financial system transparency.

CBDCs can provide additional liquidity to the financial system during times of stress, helping to stabilize the economy. During a period of economic turmoil, CBDCs can provide a source of funding since they are issued and backed by a Central Bank.

CBDCs can also provide additional liquidity through digital wallets, which can be used to store and transfer CBDCs. Even in times of financial stress when traditional banking channels may be disrupted, individuals and businesses can access funds quickly and easily.

CBDCs can also provide additional liquidity through “smart contracts”, which can automate the process of issuing and distributing CBDCs. In this way, the Central Bank can provide liquidity to banks and other financial institutions that may be experiencing liquidity shortages quickly and efficiently.

CBDCs can also act as a “lender of last resort”, which would allow the Central Bank to provide additional liquidity to banks in times of stress. By ensuring that banks have access to sufficient funds, can help stabilize the financial system.

These currencies can provide additional liquidity by enabling individuals and businesses to access funds easily, and by using smart contracts to automate the issuing and distribution of CBDCs.

In most EMEs, personal remittances play a significant role. CBDC not only enables cost-effective cross-border remittances but also is faster than existing cross-border remittance solutions. With programmable coins, senders and receivers can devise innovative uses for money.

CBDCs for governments

Due to various historical reasons, Emerging Markets have had to endure somewhat inefficient State sectors. A CBDC can provide EMEs with the impetus to improve State capacity and pave the way towards modernization, eliminating bottlenecks in the development process.

Because of limited resources, EMEs struggle to strike a balance between enhancing and streamlining welfare systems. A CBDC can enable EMEs to enhance these systems through optimization and monetization. By using programmable coins and smart contract options these governments can not only automate some of their servicing capacities but also finetune their welfare targets.

Through this process, they can issue “colored coins” specific to each segment (for instance, agriculture) of the economy, in terms of planning and budgeting. This helps not just to streamline State expenditure but to provide better oversight.

Smart contracts, also known as programmable coins, help governments reduce corruption and fraud by embedding specific rules and conditions into the digital currency. Programmable coins, for example, can be designed to execute transactions only under certain conditions, such as adequate funds.

Such coins can also include built-in tracking and auditing features, providing a tamper-proof record of all transactions and reducing the risk of corruption. In other words, by using programmable coins, governments can create a more secure and transparent financial system.

Uneven economic growth is a serious problem in EMEs, with capital often flowing from rural to urban areas. To address this challenge, governments can use geo-tagged programmable coins, or digital currencies embedded with location-based information. By linking the use of these coins to specific geographic locations, governments can encourage investment and economic activity in rural regions, boosting their economic prospects and reducing capital outflows to urban areas.

For instance, governments can incentivize businesses to invest in rural regions by offering tax breaks or subsidies for transactions made using geo-tagged programmable coins. They can also create programs that incentivize individuals spending in rural areas, which can support local businesses.

Additionally, governments can use geo-tagged programmable coins to track economic activity in rural regions, providing real-time data on investment and spending patterns.

By using geo-tagged programmable coins, governments can address the challenge of uneven economic growth. This can lead to more balanced and sustainable economic growth, improving standards of living and contributing to a more equitable and prosperous society.

As can be seen from this analysis, there are many benefits of a CBDC for EMEs. However, CBDCs should not be limited to monetary systems, but should be applied holistically to the whole economy. To get the full benefits of Central Bank Digital Currencies, all stakeholders (State, Central Bank, industry, and the general public) have to work together in harmony and synchrony.

Kasun Thilina Kariyawasam is a macroeconomist who works for the fund management sector in Sweden. He can be reached at kasunkt@hotmail.com.

Factum is an Asia Pacific-focused think tank on International Relations, Tech Cooperation and Strategic Communications accessible via www.factum.lk.

The views expressed here are the author’s own and do not necessarily reflect the organization’s.