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As an increasing number of Latin American and Caribbean (LAC) countries are pursuing the development of a central bank digital currency (CBDC), VIXIO takes a look at some of the main drivers behind the trend in the region, and some of the risks and opportunities involved.
According to recent analysis carried out by the Bank for International Settlements (BIS), close to 30 percent of LAC economies said they are likely to issue a retail CBDC within the next one to three years.
Among the latest Latin American markets to announce plans to issue a CBDC over the next couple of years are Brazil, Mexico and Venezuela.
In the Caribbean, the Bahamas has already launched its Sand Dollar and the Eastern Caribbean Central Bank is piloting its DCash in seven of its member states and is considering turning the project into full release.
While developed economies in Europe and North America are taking cautious steps to research the policy and feasibility aspects of digital money, LAC countries seem to move quicker with plans to create a digital fiat.
Digitalisation key to financial inclusion
Financial inclusion, efficiency and the safety of their payments systems are typically among the most frequently cited use cases for a digital fiat in LAC. In addition, CBDCs could help further aid the process of digital acceleration that is driving innovation and market development across the region.
Venture capital money is pouring into Latin America’s fintech sector, e-commerce has doubled in each of the last three years and people there spend 1.5 times more time on the internet than UK residents, noted Anca Bogdana Rusu, head of public sector at Celo Labs.
“This effectively forces a digital evolution of logistics, sales platforms and overall payments.”
Recognising these trends, the governments are seeing a great opportunity to capitalise and the need to keep up with the latest developments on the market.
“You cannot keep pursuing monetary, financial stability or financial inclusion policies in cash if your economy is pushing more and more towards online,” Rusu told VIXIO.
“Ultimately, driving the creation of a more digital economy is a catalyst for economic growth,” Huw Davies, co-founder and chief commercial officer at Ozone, an open banking API software developer, added.
At the same time, CBDCs could help address the pressing need to improve financial inclusion. The region has traditionally had a large amount of unbanked population. According to the most recent 2017 World Bank survey, just over half of the Latin American population (55 percent) had a bank account.
Although this changed dramatically during the pandemic, there is still a significant divide in the provision of financial services between large cities and rural areas. Most people living outside the large cities have no bank account and small towns typically have no bank branches.
“With many countries in the region seeing high levels of financial exclusion, a digital currency creates fast and efficient means of supporting micro payments,” Davies said, noting that “this could be very important to reduce costs and better serve those at or outside the [reach] of the traditional financial services players”.
CBDCs could also improve cross-border remittances, which is vital to many LAC economies. It has the potential to reduce costs and friction, and improve efficiency.
“With many economic migrants sending money across borders, the impact of the slow settlement, high fees and uncertainty can be significant,” noted Davies.
“Digital currencies can be transferred instantaneously without the complexity of global bank clearing systems, correspondent banking networks or other closed networks.”
Seeing the benefits that a CBDC could bring to these markets, some countries in the region have moved swiftly to embrace the idea of digital fiat.
In many markets around the world, a potential factor and concern around CBDCs is the issue of privacy and the possibility of the government having oversight of citizens’ financial transactions. In the US, EU and UK, for example, a key design element during discussions has been around striking the right balance between privacy and the fight against money laundering.
However, according to David Schwartz, president and CEO of the Financial and International Business Association (FIBA), “in Latin America, they do not have these impediments when it comes to privacy”.
Countries such as Panama and El Salvador have pushed through crypto-friendly legislation very quickly as part of their efforts to increase financial inclusion and attract more investment into their countries.
And they were able to do so and move very quickly without the same concerns being raised as we see in the US or the UK, Schwartz added.
Real problems to solve
For some senior government officials and bodies in the UK and the US, CBDC has been described as “a solution in search of a problem”, with any potential benefits being modest and achievable through less risky alternatives.
However, this is not a position shared by the central banks of Brazil, Venezuela and Mexico.
Although some Latin American countries have recently modernised their payments infrastructure, they believe CBDCs have the potential to both complement and improve upon their current payments ecosystem.
Real-time payment systems have helped increase efficiency and financial inclusion, but “instant payment systems take you halfway to where a CBDC could take you”, Rusu said.
Instant payment networks can reduce transaction costs, but CBDCs have the potential to lower the costs to almost zero.
Crucially, provided that the CBDCs are token-based and run on blockchain, their use will not require a bank account, ensuring reach to the unbanked population, Rusu added.
For instance, PIX has become a great success story in Brazil, largely contributing to increasing financial inclusion. Nonetheless, there are still an estimated 60m adults that do not have a bank account in the country.
A digital real could be a tool to “help bring more into the digital economy if, for example, the government starts to pay out benefits via digital currency”, Davies said.
“If the digital currency can then become the foundation of bank accounts it can bring more users into the financial mainstream and increase the volume of digital payments through channels like PIX,” he added.
Financial inclusion could be further enhanced via the transparency and traceability features of the transactions on the blockchain.
A lot of countries in emerging markets are suffering from de-risking post 9/11 because the level of identity checks that are required by international standard-setting bodies are too high for people in some emerging markets in Latin America, according to Rusu.
For those people, it became harder to open accounts and they were de-risked out from the traditional financial system.
“With the traceability of blockchain, financial intermediaries could easily perform these types of anti-money laundering (AML) checks much better, faster and more reliably than they can do right now,” she added.
For the same reason, this transparency could help individuals and businesses to get better access to loans and be an important tool in the fight against crime, tax evasion and corruption.
Ultimately, all these changes could help address the question of the shadow economy in the region. According to 2021 figures published by the EU, the informal economy still accounts for slightly over half of all jobs in the region. Lots of the transactions among businesses take place with cash.
CBDCs could help to bring the shadow economy “outfront from the underground and put these transactions in the mainstream”, Schwartz said.
It is also important to point out that CBDCs will likely be a complementary approach to existing real-time P2P payment networks.
In Brazil, interoperability of PIX and other payment methods with the digital real plays a key role in the country’s LIFT Challenge, Luigi Lervolino, head of open finance at Bip, pointed out.
Early mover disadvantage
One of the biggest use cases for CBDC, acknowledged by even those who do not see the benefits from a retail payments perspective, is its use in cross-border commerce.
According to a recent study by J.P. Morgan and Oliver Wyman, interoperable CBDCs can cut out the middlemen from cross-border transactions that could save institutions hundreds of billions in transaction fees annually.
In addition, CBDCs will be issued by the central bank of their countries, meaning they will have credibility that cryptocurrencies or stablecoins may not have.
As a consequence, CBDCs have the power to speed up processes that today depend on registering international financial contracts and even foreign exchange, Lervolino noted.
“This implementation could mean the creation of an instant payment system that works 24/7 on a global scale,” he stressed.
Nevertheless, as LAC markets forge ahead with CBDC for either retail or for cross-border trade, there is a significant challenge involved in being a pioneer and an early mover on the global stage, Davies said.
“We have seen this with open banking. The UK went first and paved the way for the rest of the world. Markets like Brazil have benefited from the advantage of going next, building on the learnings, avoiding the mistakes and ultimately delivering an open banking ecosystem more quickly and effectively,” he noted.
“The same will likely be true as central banks embark on the digital currency journey.”
Central banks will have to decide “how to govern it, how to manage it, how to ensure liquidity and the integrity of the system and how to enable participants in a controlled way. These are all things central banks can do, but there will be new considerations when introducing a digital currency into an economy.”
