Will digital currency disrupt payments?

The Central Bank of Kenya (CBK) published a discussion paper on central bank digital currencies in February 2022. (CBDC). The CBK is essentially seeking feedback from the general public on the viability of a future CBDC in Kenya through this document. But from where does the CBK originate? Growing discontent with the existing fiat system has been observed, particularly among young people.

In essence, you have a generation of young people that want to create their own culture and financial system. Governments print money under the “fiat” system, which has no backing whatsoever (except for the faith that populations have in their governments).

The fiat financial system is centralised because central banks have always been concerned with money – how it is made, how it is held, how it is exchanged, and how money or monetary value is transported (and controlled by governments).

Cryptocurrencies, a form of decentralised money that is not governed by governments, were created as a result of dissatisfaction with the centralised fiat system. Blockchain and distributed ledger technology underpin cryptocurrencies.

It is a system that runs on the idea that there is no single entity in charge of managing and authenticating transactions.

On the basis of agreement among the participants, this role is instead managed and validated in independent records (or “blocks”). In the subject of payments, the underlying blockchain technology has been used in a number of contexts, most notably the development and subsequent spread of various cryptocurrency and cryptoasset forms, decentralised finance, and stablecoins.

The variety of cryptocurrencies has grown significantly, but their core characteristics remain mostly the same. The use of distributed ledgers (or records) as the foundation for doing business and verifying transactions without consulting a single, centralised authority is included in this.

There were reportedly more than 1,500 cryptocurrencies in existence as of 2018. The market is so vibrant that central banks all around the world are starting to give in to people’s FOMO about digital currencies.

Several central banks have started investigating CBDC, and some have even started proof-of-concept and pilot tests in anticipation of the product’s introduction.

They are the following: Brazil, China, Turkey, Russia, Saudi Arabia, Ukraine, the Eastern Caribbean Central Bank, Japan, Norway, Sweden, Switzerland, the United Kingdom, the United States, and the European Central Bank.

A number of nations, including Venezuela, the Bahamas, and Nigeria, have already introduced digital legal money. By means of this discussion paper, Will digital currency disrupt payments?,the CBK seeks to get on board (ostensibly driven by FOMO).

It’s possible that Kenya has used digital currencies before. M-Pesa is technically already a type of electronic money (e-money), and since its 2007 inception, it has completely changed Kenya’s domestic payments market.

A CBDC in Kenya should address present and foreseeable problems in the domestic payments ecosystem in light of this. The two main obstacles are cost and interoperability.

In addition to being expensive, M-Pesa, for instance, is still so tightly ringfenced that cross-platform interactions are not conceivable. Consider transferring funds from an M-Pesa wallet to an Airtel Money wallet.

This then influences the best CBDC design. According to CBK literature, the three main design options that have emerged so far are the direct model, in which a central bank controls nearly all aspects of a CBDC, the hybrid model, in which some functions are shared with third-party or private sector institutions, such as banks, and the intermediated model, in which the central bank’s sole responsibility is to process wholesale transactions.

The environment and architecture of domestic payments are the second factor to be taken into account. Using intermediate or hybrid models, nations with more advanced payment systems can benefit from the capabilities of the private sector.

This enables the private sector to concentrate on CBDCs’ distribution and account administration while the central bank concentrates on providing the essential infrastructure.

It would, in my opinion, be preferable if the CBK utilised the direct models in its roll-out to handle the two anticipated difficulties of affordability and interoperability, as well as taking into account the level of development of the domestic payments ecosystem and architecture.

However, the domestic payments environment in Kenya would gain from a CBDC in a number of ways, including a decrease in the use of physical currency, considerably more affordable access to and maintenance of electronic money, streamlined recordkeeping, and improved end-to-end processing.

As a result, present e-money suppliers need to prepare for adaptation or risk dying out completely.

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