As the world becomes more digitised, countries globally are continuously looking at leveraging new technologies to make financial transactions smoother and easier. The most recent step in that direction is the introduction of Central Bank Digital Currencies (CBDCs), which are defined as a legal tender issued by the Central Bank of a country in the digital form and is equivalent to the fiat currency of that country, exchangeable one-to-one with it.
According to a recent report by Atlantic Council, 130 countries, representing 98 percent of global GDP, are already exploring the launch of a CBDC and by March 2023, over 40 countries had approached the International Monetary Fund (IMF) to request assistance through CBDC capacity development (CD). However, as most nations concentrate on local usage and applications, there is a risk that this growth might result in a fragmented environment across international boundaries, which will lead to increased sprouting of ‘digital islands’.
CBDCs — an evolution in the payments world
As of today, 11 countries including India, Nigeria, China, and the Bahamas are already live with their own digital currencies following a wide variety of approaches. The pilot CBDC model in China uses private-sector banks to distribute and manage digital currency accounts for their customers. On the other end of the spectrum is the model explored in Europe, where authorised financial institutions each run a permissioned node of the blockchain network for the distribution of a digital euro. The current trend of the digital evolution of currencies and payments systems comes with a set of concerns such as standardisation and interoperability.
Digital currencies have a huge potential to shape the way the world would transact in future, but this potential will only be realised if the different approaches that are explored have the ability to connect and work together.
Fragmentation between designs and standards would lead to building ‘digital islands’, where systems would operate in isolation and not be able to interact with each other. Hence, there lies a dire need for a well-equipped and multilateral interoperable infrastructure which would not only connect multiple Distributed Ledger Technology (DLT) platforms together, but also operate well with existing payment systems, without any disruption.
A high level of interoperability will allow for transparency in transactions, rich data, and add value across platforms. In addition to that, it will enhance efficiency by reducing reliance on intermediaries and simplify cross-border payments, increase financial inclusion and financial stability, and bolster regulatory compliance.
Simplicity and collaboration are the way forward
With so many digital currencies in development across the world, any interlinking solution must be straightforward for central banks to implement. Therefore, it is essential to build a solution which can enable banks to easily integrate their domestic CBDC flows into their cross-border payments system.
Banks should also be capable of capitalising on use cases, such as trigger-based payments for digital trade platforms, foreign exchange models, liquidity saving mechanisms and delivery vs payment. This will help in forging a more inclusive, interoperable, and resilient global monetary system no matter the currency.
In an effort to bring interoperability among various CBDCs as well as with fiat currencies, Swift conducted an experiment in late 2022, to test whether its existing payments infrastructure could enable CBDCs to flow between DLT-based and fiat-based systems, and the results proved to be positive. Recognising the potential of the experiments, the financial community has initiated as second phase of sandbox testing in which more than 30 commercial banks, central banks and financial market infrastructures are exploring additional use cases, including trigger-based payments for digital trade platforms, foreign exchange models, liquidity saving mechanisms and delivery vs payment.
Collaborative innovation is need of the hour to ensure that different countries and economies are ready to support future CBDC transactions across borders. The successful integration of CBDCs into the financial ecosystem requires careful navigation of existing complexities. By pooling expertise and resources, stakeholders can navigate the challenges of CBDC implementation more effectively, ultimately paving the way for a more resilient and inclusive financial future.
—The author, Kiran Shetty, is CEO & Regional Head, India & South Asia, at Swift. The views expressed are personal.
(Edited by : C H Unnikrishnan)
