Central bank digital currencies (CBDCs) promise enormous potential for establishing a more dynamic and modern global financial infrastructure underpinned by blockchain technology. But as with any innovation, they must be designed prudently with interoperability in mind, and embracing the kind of open standards and protocols that have been so successful in the globalization of information access on the internet.
With a majority of central banks around the world considering the feasibility and utility of digital currencies, there is a risk of fragmentation through the creation of new so-called “digital islands” as a widening range of technologies and standards are being tested. For CBDCs to achieve their potential, three core areas of interoperability need to be addressed in order to deliver long-term benefits and broad adoption.
First, central banks will need the means to exchange assets and interact with shared ledgers, rather than issuing instructions via an application programming interface (API). Just as the global internet thrived by early widespread consensus on common technology protocols like TCP/IP, HTTP and FTP, so too should central banks start coordinating on CBDC standards to cover basic functions, including transaction-level operations, such as escrow and hash time locks, identity and addressing schemes and flexible routing to determine most efficient ways of transmission.
Second, for a digital currency to have any utility to people and businesses, it needs to coexist and interact with other payment schemes in that domestic market. While each CBDC can adopt its own rules and policies that best suit its domestic market, CBDCs should also be united and guided by collective protocols that will enable them to cooperate seamlessly with other CBDCs and digital currencies.
Finally, CBDC interoperability must have seamless cross-border functionality to enable global transactions. While focusing on domestic use cases is logical for individual countries, the global economy is increasingly interconnected. It will be critical to bridge the gaps between the various CBDC initiatives with existing payment systems as well as other digital currencies to ensure they are successful on a global scale. Without seamless cross-border functionality, most CBDC projects will significantly underachieve their potential.
Taken together, CBDC systems that are interoperable by design with domestic and international cross-border transfer arrangements will avoid fragmentation and increase efficiencies, making payments nearly frictionless compared to incumbent systems of today. In addition, simultaneous transactions across borders and without intermediaries will offer tremendous opportunities to improve the user experience, empower new, more dynamic business structures and help lower the cost of participation in these systems — thereby contributing to financial inclusion to those who need it the most.
At the consumer-to-business level, the use of a digital currency can help remove existing frictions for small business transactions. For example, digital currencies promise to enhance the efficiency of recurring merchant transactions and reduce credit card charges and risk to the merchant through enablement of real-time payments—regardless of amount, frequency or location.
The use of digital currencies can also bolster risk management protections in business-to-business transactions, which have historically been complex payment arrangements involving an interconnected web of relationships, from senders and receivers to banks and other financial intermediaries. Through the use of digital currencies, alternative, more efficient options also become available, including conditional payments (e.g., contingency payments when a good is delivered or service is completed), micropayments (e.g., payment is made at each incremental delivery of value) and platform service arrangements for more complex, multiparty payment agreements without intermediaries.
Moreover, if appropriately designed and implemented, the application of digital currency technology could also have a tremendous and nearly immediate positive impact on access to financial services. With the use of a digital currency, something as simple as loaning money to a friend or sending funds across borders to a family member can be made faster, more efficient and secure — a widely uplifting force particularly among nations and regions which are heavily cash-reliant or depend on remittances.
As with any government and public project involving personal or personalized information regarding citizens, privacy is a key consideration for the implementation of CBDCs. The degree of privacy, reasons for it and prioritization can vary significantly between jurisdictions and use cases. As countries launch more CBDCs projects, mounting concerns over consumer privacy and cybersecurity dominate conversations. However, this unease is misplaced. Similar to existing financial systems, this is a comprehensive and legal process that shouldn’t change with CBDCs, and, in fact, technology can enable central banks to ensure both privacy and cybersecurity are embedded in the design as a core principle.
By modernizing digital payments and serving as a gateway to access financial services, CBDCs hold the potential to dramatically change the landscape for the better, making the world more financially inclusive.
We are just beginning to scratch the surface of what a digital asset-backed system can achieve. The opportunities of CBDCs are nearly limitless but, ultimately, mainstream adoption of CBDCs in cross-border payments — and beyond — hinges on their usability by both individuals and businesses.
As we move forward, I’m confident that the public and private sector and society as a whole can work together to overcome interoperability hurdles and create a clear path forward as we continue to prove out the technology pilot projects around the world, and ensure equal and equitable access.