CBDC’s and Smart Contracts

CBDC’s and Smart Contracts

Over 100 central banks are developing Central Bank Digital Currencies like the Digital Dollar. It is still unclear how exactly these CBDC’s will be implemented and what the impact for the financial services industry will be. One thing is clear to me is that the role of Banks will change when CBDC’s are widely adopted.

In principle, a Digital Currency enables central banks to bypass the role of banks altogether since record keeping could be done on a Distributed Ledger like a blockchain, this is sometimes referred to as a Unilateral CBDC. However it is unlikely that Central Banks will go for a disruption like this and will opt for a model with Payment Interface Processors aka an Intermediated CBDC.

Several use cases have been floating around where CBDC’s add significant value over fiat currencies such as cross border payments, micro-loans and the likes. Although these use cases are valid use cases, they are primarily focused on making the system for financial services more efficient which is a step forward but not quite revolutionary.

 A much more impactful change to the way we structure financial services comes when we combine CBDC’s with the capability of Smart Contracts. That combination allows consumers and financial institutions to participate in distributed contracts with a fiat-like currency. It not only removes the friction to participate in distributed contracts, it will lead to a slew of new distributed financial services that change the role of the Financial Services industry. Suddenly Banks will be able to participate in Smart Contracts which they cannot do today.

Participation in distributed financial products based on Smart Contracts not only leads to interesting new revenue streams but it will disrupt the way Banks operate. Banks will need to become comfortable with the fact that participation means that they don’t own the process for e.g. a distributed loan or mortgage. However participation allows them to pick and choose portions of these contracts that match their own risk/reward profile that they are missing out on today.