As central bank digital currencies expand, there’s enormous potential for banks to benefit, especially in the lucrative payments sector.

The headlines couldn’t be worse for cryptocurrency. Far from the private currency’s recent freefall, however, central bank digital currencies (CBDCs) are a hotbed of innovation.

The government-backed monies—vastly different from private crypto because the central banks that issue them are public financial institutions subject to regulation—point to a clear path forward for incumbent banks to a faster, more streamlined approach to payments. Digital money moves with a speed and ease that fiat currency can’t match. For bankers, this is a source of both attraction and fear, especially when it comes to protecting their currently legacy-based (and lucrative) payments revenue streams.

The fact is, digital currency holds much promise for banks. CBDCs are emerging at a time when banks’ built-in risk controls have never looked better to retail and commercial customers. By pooling their inherent strengths and existing modernization efforts, banks are in an advantageous position to ready their organizations—and technology infrastructures—for a major role in the future of payments.

CBDC enthusiasm runs high

Among central banks, interest runs high in the development of government-controlled digital currency. When the Bank for International Settlements (BIS) surveyed its members at the end of 2021, 90% of central banks were experimenting with CBDCs.

Cryptocurrency’s crash-and-burn performance over the last 12 months has done little to dampen the enthusiasm. The Atlantic Council CBDC tracker reports 17 countries are running pilots, including Australia, China, India and Sweden. According to new research from the Digital Monetary Institute (DMI), two thirds of central banks expect to issue a CBDC within a decade.

Much of the innovation underway is aimed at improving financial settlements. In the US, which is unlikely to stand up a CBDC pilot before late 2023 or 2024, a group of large banks and the Federal Reserve Bank of New York have launched a proof of concept of a shared digital asset settlement platform.

So far, CBDC settlement throughput times are promising—and speedy. Another collaboration’s initial design for a CBDC, this one by the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology’s Digital Currency Initiative, handles 1.7 million transactions per second, and settles in under two seconds.

CBDC attraction mixed with fear

Banks’ enthusiasm for CBDCs is fueled by market pressure and a sense of inevitability. CBDCs offer tremendous potential yet also undermine the competitiveness of banks’ services, especially in the lucrative area of payments. Currently, payments are dominated in the US by legacy channels such as ACH and Fedwire, and internationally by the financial messaging service provider SWIFT.

Payments using blockchain, whether through CBDCs or private coin, can complete and settle in seconds compared with the multiple days it can take payments to wend their way through the domestic, regional and international banks and clearinghouses. With digital currency, a payer just enters the payee’s cryptocurrency wallet address and the amount to pay and clicks Send. As payments and immersive digital experiences converge, it’s critical for banks to be ready to compete.

News that the Bank of England is seeking to develop a CBDC mobile wallet is a sign that digital assets are becoming increasingly tangible for the banking industry. But while there’s no question the digital dollar is happening, it remains directionally unclear. China opted to implement the Digital Yuan without blockchain, ostensibly to facilitate flow and participant transparency and central control. And while Project Jura recently wrapped up a CBDC pilot between French and Swiss commercial banks on a single distributed ledger, the Digital Monetary Institute’s survey found few central banks are tackling the interlinking of CBDCs for cross-border payments.

How banks can embrace the CBDC opportunity

Amid the uncertainty, the key question for banks and financial institutions is more business than technology: How will they shape new value propositions that let them compete in decentralized finance while protecting their payment revenue streams and offsetting the loss of revenue?

For example, as digital wallets rise as a channel for instant money transfers and eliminate the need for traditional gatekeeping services, how will banks replace the revenue generated by wire transfers that flow through the SWIFT network?

The answer is by creating solutions and services that provide customers with compelling reasons to stay with them. The good news is that banks and financial institutions bring significant resources to bear to capitalize on digital currency’s flexibility.

Banks have more opportunities than they think to bring value to crypto commerce. Here are the strengths we advise them to prioritize:

• Double down on reliability. Timing is everything in business, and retail banks and investment firms bring a safety net to digital currency that’s been notoriously absent in the peer crypto world. There’s no small irony that the “trustless” quality inherent in the decentralized blockchain was a key contributor to the crypto disaster. Among incumbent banks, trust is a longstanding offering that has never looked better.
  
  Layering built-in risk controls like fraud protection and compliance over digital currency services is a big part of banks’ appeal and market offerings, especially for individual payers. Safety measures and better connectivity mechanisms will be the killer combo needed to retain business customers such as fund managers who want to move large amounts of money instantly using digital currency.
  
  
• Leverage the modernization that’s already underway. Preparing for the interbank connections that will move digital currencies is a surprisingly natural next step for the modernization efforts many banks are already undertaking. This includes connecting their payment hubs to RTP and aligning with the ISO 20022 standard for exchanging electronic messages.
  
  ISO 20022 promises improved payment transaction data quality, greater interoperability between international payment schemes and—importantly—the ability for current payments infrastructures to process instant payments.
  
  Banks’ payment hubs have the workflow and setup for compliance checks, Know Your Customer and fraud protection. By extending their existing safeguards and providing connectivity to new CBDC and private coin-enabled payment rails and marketplaces, banks can not only retain customers through a portfolio of competitive services but also attract new, tech-savvy ones.
  
  
• Promote secure alternatives for international money transfer now happening through private exchanges. This move would put banks in direct competition with SWIFT, whose November 2022 adoption of the ISO 20022 standard has the potential to bring greater speed and transparency to cross-border payments.
  
  The stepped-up competition could bring true democratization of international money movement. The biggest impacts may be to SWIFT and, for consumers, to solutions such as online money transfer service XOOM, which competes in the cross-border payments space where costs to the consumer remain high.

The future of digital currency is evolving in real time. While it remains unclear who the major players will be, the trend is real. Banks have plenty of competitive tools at their disposal. It’s a matter of putting them to work.