What you need to know about the Central Bank Digital Currency: The Central Bank of Nigeria (CBN) eNaira by Ngozi Egbuna, PhD

·????????Introduction

Traditionally, Central bank money has two forms namely: cash and reserves held by eligible financial institutions at the central bank. But recently the interest of central banks in the digital currency known as CBDC has grown in response to revolutionary changes in payments, finance, and technology, as well as the disruption caused by the Covid-19 pandemic. A 2021 BIS survey of central banks found that 86% are actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects.

Broadly, Central bank digital currency (CBDC) is a term used for the third version of currency that could use an electronic record or digital token to represent the digital form of a nation's currency. CBDC is issued and managed directly by the central bank and could be used for a variety of purposes by individuals, businesses, and financial institutions. Simply, a central bank digital currency (CBDC) would be a digital banknote. It could be used by individuals to pay businesses, shops, or each other (a "retail CBDC"), or between financial institutions to settle trades in financial markets (a "wholesale CBDC"). It is an electronic record or digital token of the official currency and is issued and is regulated by its monetary authority. ?

·???????Types of CBDCs

Fundamentally, depending on the actors involved in the transaction, there are two types of CBDCs. The two types of CBDCs are not mutually exclusive. It is possible to develop a combination of both and have them function in the same economy.

1.?????Wholesale CBDCs

Wholesale CBDCs are used to settle transactions between existing financial transactions. They use the existing tier of banking and financial institutions to conduct transactions. An example of wholesale CBDC transactions involves the transfer of assets or money between two banks, subject to certain conditions. The current process for such transfers, also known as interbank payments, involves considerable counterparty risk. In a real-time gross settlement payment system (RTGS), the risk can be magnified.

But a digital currency's ledger-based system enables the setting of conditions. Thus, a transfer will not occur if these conditions are not satisfied. Wholesale CBDCs can also expedite and automate the process for cross-border transfers. Current real-time settlement systems mostly work in single jurisdictions or with a single currency. The distributed ledger technology (DLT) available in wholesale CBDCs can extend the concept to cross-border transfers and expedite the process to transfer money across borders.

2.?????Retail CBDCs

Wholesale CBDCs improve upon a system of transfers between banks. Retail CBDCs involve the transfer of central government-backed digital currency directly to consumers. In doing so, they eliminate the intermediary risk or the risk that banking institutions might become illiquid and sink depositor funds.

Depending on the type of access they provide, two variants of retail CBDCs are possible:

• Value or cash-based access: These CBDCs are passed onto the recipient through a digital wallet that is pseudonymous. The wallet will be identifiable on a public blockchain and, much like cash transactions, it will be difficult to identify parties in such transactions.
• Token- or account-based access: This type of access is similar to that provided by a bank account. Thus, an intermediary will be responsible for verifying the identity of the recipient and monitoring illicit activity and payments between accounts. It provides for more privacy. Personal transaction data is shielded from commercial parties and public authorities through a private authentication process.

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·????????The CBN e Naira

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In Nigeria, the eNaira is a CBDC, which is expected to take off on October 1, 2021, as a result of extensive research and consultations which commenced in 2017. It will be fully backed and guaranteed by the Sovereign wealth of Nigeria will be issued, distributed, and redeemed by the Central Bank of Nigeria. It needs no legislative approvals to commence operations as the extant Central Bank Act has provisions that authorized the Bank to introduce digital currency. The only approval that will be sought will be administrative that will be obtained from the Federal Executive Council before takeoff.

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The full modalities are being finetuned but basically, it will operate using a digital ledger to be centrally managed by the Central Bank and would be electronically operated. Some of the basic facts about the eNaira as the CBDC include the following; it will have legal tender status equivalent to the Naira, have the same value as our fiat currency the Naira, it will only serve the need for transactions and will not be a store of value. Thus, no interest payments will be involved. There will be no transaction charges using digital currency. It will be integrated with the Central Bank’s foreign exchange and Forex Control policies. Its users will be able to send money using Peer-to-Peer (P2P) transactions through their wallets to other wallet holders and person-to merchant/business transfers to those who have eNaira wallets and vice versa, and finally, overseas remittances could be cashed out in digital currency by beneficiaries in Nigeria.

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Once it is issued, interested parties will be able to download the speed wallet validated by using their bank account details, Phone numbers, National Identity numbers, or Bank Verification Numbers (BVN). Banks will send codes for onboarding to use the digital currency to carefully selected customers upon commencement.

The forecast is that a tiered customer approach will be adopted.

1) Tier one will be for customers without bank accounts. Using their passport pictures, phone numbers and house addresses will be allowed to transact using digital currency. This will be available to customers who will be subjected to a daily limit of N 50,000 which they can send or receive with a daily cumulative balance of N 300,000.

2) the Tier 2 customers will be those with bank accounts who can send or receive up to N 200,000 per transaction subject to a daily cumulative maximum of N 500,000.

3) Tier 3 customers can send or receive up to one million Naira subject to a cumulative balance of Five million Naira. All transactions for account holders must be linked to their respective Bank Verification Numbers.

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There are a lot of expected benefits from the eNaira amongst which are the following: ?

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1) Cross-border transactions would be speedily accelerated for parties who have digital wallets including a faster inflow of overseas remittances.

2) There will be faster and cheaper transfers of money

3) The payments systems will be significantly enhanced.

4) It will facilitate tax payments and collections

5) Promote CBN’s cashless policy and engender financial inclusion.

7) It will be a great support for the tracking of financial frauds. It will enhance transparency and there will be no opportunity for counterfeiting.

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·????????Advantages and Disadvantages of CBDCs

The advantages of CBDCs are as follows:

ü?CBDCs simplifies the implementation of monetary policy by making it easier to propagate money through the economy. The current tiered system relies on intermediaries, such as commercial and retail banks, to distribute money between themselves and throughout an economy. CBDCs automate the process between banks through wholesale CBDCs and establish a direct connection between consumers and central banks through retail CBDCs.????

ü?A well-designed CBDC system has the potential to revolutionize the remittance industry by making it easy and simple to transfer money across borders using the rails of technology.

ü?Disbursement of money through intermediaries introduces a third-party risk into the process. What if the bank runs out of cash deposits? What if there is a bank run due to a rumor or an external event? Such events have the potential to upset the delicate balance of a monetary system. A CBDC eliminates third-party risk. Any residual risk that remains in the system rests with the central bank.

ü?It is possible to calibrate privacy features in a CBDC system. A value-based retail CBDC functions like cash and preserves privacy by making transactions pseudonymous. On the other hand, account-based access to CBDCs functions like a regular bank account and can be equipped with privacy features.??

ü?One of the roadblocks to financial inclusion for large parts of the unbanked population especially in developing and poor countries are the costs associated with developing banking infrastructure to enable them to access the financial system. CBDCs can establish a direct connection between consumers and central banks, thus eliminating the need for expensive infrastructure.

ü?CBDCs can simplify government functions. Just as they can promote financial inclusion by simplifying the process to disburse money, CBDCs can also minimize effort and processes to other government functions, such as distribution of benefits or calculation and collection of taxes. The COVID-19 pandemic, when the U.S. government sent out stimulus cheques to its citizens, is an example of the ease with which such transfers can be made and accounted for.

ü?CBDCs can prevent illicit activity because they exist in a digital format and do not require serial numbers for tracking. Cryptography and a public ledger make it easy for a central bank to track money throughout its jurisdiction, thereby preventing illicit activity and illegal transactions using CBDCs.

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ü?The Disadvantages includes

ü?CBDCs does not solve the problem of centralization. A central authority, in this case, a reserve bank, is still responsible for and invested with authority to conduct transactions. Therefore, they still control data and the levers of transactions between citizens and banks.

ü?CBDCs have the potential to erode privacy. Centralized authority is responsible for collecting and disseminating digital identification to conduct transactions in such a system. In effect, the government (or third-party provider) would become privy to all monetary transactions for a person. Such a system could open up Pandora's box of privacy issues, similar to the ones that plague tech behemoths and providers of services on the internet. For example, identification information could be hacked or misused by criminals, or central banks could misuse their power and disallow transactions between citizens.

ü?The legal and regulatory issues about CBDCs are a black hole. What will be the role of such currencies in an economy, and who will regulate them? Considering their benefits in cross-border transfers, should they be regulated across borders? Experiments in CBDCs are ongoing, and this could translate to a long-time frame.

ü?The portability of CBDC systems means that a strong CBDC issued by a foreign country could end up substituting the local currency of a weaker country. For example, a digital U.S. dollar could substitute the local currency of a smaller country or a failing state. An example is that of Ecuador. The country replaced its official currency sucre with the U.S. dollar in 2000 after high inflation in its local currency forced citizens to convert their money to U.S. dollars. More recently, opposition to Facebook's Libra has centered around the fact that it could similarly replace the currency of weaker countries.

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·????????Conclusion

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The launch of the eNaira is not the same as the usual cryptocurrency because it is not private sector driven with little or no regulation, which is susceptible to unanticipated sudden fluctuations in value that can lead to losses. Therefore, all the fears and risks associated with cryptocurrency would be absent with the Central Bank promoted version of the digital currency. The anticipation that the digital currency may be a channel for money laundering has also been alleviated by the assurance that deliberate steps have been taken to protect users of this digital currency and to ensure the availability of the capacity to track flows of transactions.

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It is anticipated that the coming on stream of eNaira will particularly facilitate financial inclusion in Nigeria to help deepen the financial sector and to enhance the effectiveness of monetary policy in the Nigerian economy.

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