Digital Dirham: A Paradigm Shift in UAE’s Monetary Landscape

With the announcement by the UAE’s central bank on March 23, 2023, that it has started implementing its central bank digital currency (CBDC) strategy, the GCC nation joins the exclusive club of 100 other nations that are either researching or getting ready to introduce a central bank digital currency (CBDC).

This debut represents a significant development in the nation’s monetary and payment systems. The Central Bank Digital Currency (CBDC), one of the nine programs under the Financial Infrastructure Transformation (FIT) Programme, is a strategic step towards the digital transformation of the UAE.

A CBDC is a digital currency issued by the government. They are comparable to cryptocurrencies in that their value is determined by the monetary authority and is equal to the value of the country’s fiat currency. They seek to be a safe, cost-effective, and efficient method of payment as well as a store of value.

The Central Bank of UAE (CBUAE) has been lately synonymous with driving innovation and attaining certain milestones. Under the project name “Aber,” the Saudi Central Bank and the UAE Central Bank affirmed the feasibility of utilizing a digital currency to settle cross-border payments in 2020. Following that, the CBUAE completed its first real-value cross-border CBDC experiment in 2022 as part of the “mBridge” initiative with the Hong Kong Monetary Authority, the Bank of Thailand, the People’s Bank of China’s Digital Currency Institute, and the Bank for International Settlements.

The CBUAE is now ready to embark on the next important step in its CBDC journey and put its CBDC Strategy into action. The first phase of the CBDC Strategy will consist of three major pillars: the soft launch of mBridge to facilitate real value cross-border CBDC transactions for international trade settlement, proof-of-concept work for bilateral CBDC bridges with India, one of the UAE’s top trading partners, and proof-of-concept work for domestic CBDC issuance covering wholesale and retail usage.

The widespread adoption of the digital dirham is anticipated to significantly speed the Gulf country’s digital transition and multiply its financial inclusion activities. The country has been ranked one of the “most progressive” in CBDCs in 2023, joining Australia, Brazil, Canada, China, India, Japan, Jordan, Kazakhstan, Laos, Montenegro, the Philippines, Russia, Saudi Arabia, Turkey, Ukraine, the United Kingdom, and the United States.

What does this imply?

Digital Dirham will have variable degrees of impact on various sectors of the UAE economy once deployed.  CBDC is said to assist address the pain points of domestic and cross-border payments, improve financial inclusion, and move the UAE closer to a cashless society as part of the UAE’s digital transformation.

Inclusion

The CBDC would assist in addressing issues more smoothly and comprehensively, including ensuring that the population is fully included in the banking system and minimizing fraud and money laundering.

Efficient Cross-Border Payments

Cross-border payments are incredibly common in the UAE and the majority of Gulf states overall due to the region’s huge expatriate population, who work there but send money home. Due to the participation of numerous intermediaries, these kinds of cross-border payments are sometimes time-consuming and expensive. In Q1 2021, the average cost for sending $200 in remittances was 6.38 percent globally. These international financial transfers frequently include lag times, which expose counterparties to credit and settlement risk. Settlement of a typical foreign exchange transaction takes longer than two days. Digital Dirham will highly alleviate this problem by providing seamless digital transfer of payments. The CBDC platforms will enable financial institutions to deal directly with one another in digital currencies issued by participating central banks, removing the need for middlemen and reducing transaction time and cost.

Operational changes

The Digital Dirham will bring about a significant change in how CBUAE operates, particularly concerning printing, moving, and handling currency notes. As they would have immediate access to and influence over economic transactions, it will also offer CBUAE more authority over monetary policies.

Robust Financial System

It will significantly boost the UAE’s payment infrastructure by providing new robust payment channels and ensuring a resilient and stable financial system. It is considered to be in line with the CBUAE’s aims to ensure the readiness of the UAE to integrate the payment infrastructures with the future potential tokenization world, the tokenization of financial and non-financial activities. Tokenization is the process of replacing sensitive data, such as bank and credit card details, with alternative codes called “tokens” on the blockchain. This increases security by deleting the most valuable information that cybercriminals can steal during the transaction process.

Global Competitiveness

As cryptocurrencies rise in prominence as an asset class among regular and institutional investors, central banks around the world are investigating the growth of digital currencies. As of March 1, 65 countries are in advanced phases of CBDC development, with over 20 central banks already launching experimental projects. Countries that participate in the CBDC mechanism are better positioned to appreciate and reap the benefits of globalization, as well as stay up with the most recent worldwide FinTech breakthroughs. As a result, the UAE’s strategic decision puts it at a competitive edge.

Potential to redefine Retail Consumer Payments

This sector will determine the success of Digital Dirham to a large extent. The potential for Digital Dirham to redefine retail consumer payments is dependent on how it is designed and implemented. Retail customers may benefit significantly if Digital Dirham is designed to be secure, convenient, and affordable. These advantages include faster, less expensive, safer, and more frictionless payments. To ensure smooth adoption, the design should also take into account the needs of non-tech-savvy consumers. They may be hesitant to adopt a design that raises privacy concerns or is unfriendly.

Growth Opportunities

The Digital Dirham will provide numerous opportunities for fintech to innovate on multiple levels. The shift represents the most significant opportunity for fintech to date, which can be capitalized on by creating user-friendly customer journeys for transactions.  

The Way Forward

While the preceding highlights the potential economic impact of Digital Dirham, it is still too early to predict what the future holds. The UAE’s economy will be determined by key considerations such as model, user-friendliness, and data privacy concerns. However, to stay in line with global standards and maintain a competitive edge, businesses and corporations must closely monitor advancements. Following that, businesses must consider the best practices tailored to their business models before incorporating strategic initiatives such as the CBDC.

It is important because companies will see the actual monetary benefits of the Digital Dirham. Some of the major benefits include:

• Low transfer costs, which are currently relatively high,
• Reduced settlement risk when trading internationally, and
• Improved cash management with real-time transfers

Complementing Digital Dirham with advanced technology like smart contracts, automatic tax payments, etc. will provide more concrete impact analysis. However, it will take some time for this to develop, and until it does, there may be some levels of confusion. To navigate this time of transition, corporates must have a well-defined plan.

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