The emergence of Central Bank Digital Currencies (CBDCs) has accelerated rapidly over recent years. Although not originally considered to be a popular initiative, central and commercial banks are now exploring the use of central bank-backed digital currency in local markets.
However, financial institutions and markets should be assessing how they can incorporate CBDCs into the evolving global payments landscape. In time, this can contribute to seamless interoperability and frictionless cross border payments.
"Globally, so much potential can be harnessed from CBDCs for payments. Ensuring interoperability and collaboration are at the forefront of all developments will lead to CBDCs being connected across global markets in the future.”
While the rise of CBDCs has been focused on how digital versions of existing central bank money can achieve domestic policy goals, many haven’t considered their cross-border potential. CBDCs offer many opportunities for the financial industry but challenges will still arise regarding their adoption. In particular, there will be multiple CBDC platforms in development parallel to existing traditional payment systems.
Although CBDCs are new forms of fiat currencies with the potential for new payment capabilities, they are not necessarily a replacement for payment infrastructures and processes. Therefore, CBDCs and traditional infrastructures will need to learn to co-exist and work together as the industry trials how to integrate them with existing payment systems.
As numerous central banks develop digital currencies based on their different technologies, protocols and procedures, the risk of fragmentation can arise if left unaddressed. This would ultimately lead to a range of digital islands for CBDCs globally. Therefore, the need to develop a process for transactions to flow between different CBDC platforms will become critical. A multilateral interoperability solution will be needed to connect CBDC networks and existing payment systems globally and thus enable CBDC transactions to flow across borders in a seamless and frictionless way.
With continual innovation and CBDC development globally, any interlinking solution will need to work straightforwardly for all institutions and markets across the world and solutions will need to allow banks to easily integrate their domestic CBDC flows with their cross-border payments system. Connector gateways can be utilised to enable the communication between different CBDC networks and payment systems.
Fortunately, integrating CBDC connectors into existing cross border payment systems will not require a reinvention of new practices to ensure security, compliance, authentication and tracking. Leveraging industry standardised approaches such as ISO 20022 will also ensure CBDC transactions carry rich, standardised payment data. Establishing a solution to bring interoperability to CBDCs will not be a quick process however continuous industry collaboration, innovation and experimentation will pave the way to a frictionless future for digital currencies.
In October, Swift announced it had developed a solution that enabled CBDCs to move between distributed ledger technology (DLT) and fiat-based systems using the existing financial infrastructure. The testing was set up so central and commercial banks could experiment with and validate the effectiveness of the solution and share insight to guide its continual development. The solution was then tested in a sandbox environment with 18 central and commercial banks.
During the 12-week testing period, almost 5,000 transactions were simulated between two different blockchain networks and with existing fiat-based payment systems. Central and commercial bank participants expressed strong support for the solution’s continued development, noting it enabled a seamless exchange of CBDCs, even those built on different platforms. Many of the participants had a clear desire for continued collaboration and interoperability, something vital for the financial industry as it continues to evolve. However, industry experimentation and collaboration should not stop here.
While Swift’s experiment for CBDC connection has proved successful, more collaboration and innovation will be needed globally from financial institutions to achieve the goal of frictionless cross-border CBDC payments and transactions.
Sandbox testing that invites banks from around the world to trial solutions will allow the industry to engage, collaborate and improve. Moving forward, institutions should look to incorporate multiple blockchain technologies in sandbox testing and experimentation as it not only enables bilateral testing but also facilitates opportunities for our customers to provide their feedback in real-time and contribute to the design of next generation CBDC solutions.
CBDCs will only continue to evolve and rise in focus for the financial industry. It is important to keep the vision of a frictionless CBDC transaction future in mind when developing platforms and solutions for the currencies to operate on.
Globally, so much potential can be harnessed from CBDCs for payments. Ensuring interoperability and collaboration are at the forefront of all developments will lead to CBDCs being connected across global markets in the future.
Julie Bolan is Head of Payments APAC at Swift
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
03 Mar 2023
18 May 2022