Will CBDCs Tests be Next Step for Seamless Payments?
The Shift From Local to Global
CBDCs are digital representations of currency that central banks issue. Greater emphasis has been placed on how CBDCs can achieve domestic policy objectives. However, there is a growing interest in their use for international purposes. Nonetheless, one risk comes with their use: international transactions.
The Chief Innovation Officer at SWIFT, Thomas Zschach, has made it known that for the company to maximize the use of CBDCs, they must facilitate their collaboration and connection with different companies that can help. Different central banks are developing their digital currencies based on different technologies, standards, and protocols, threatening the global CBDC ecosystem.
This could lead to creating "digital islands" throughout the globe. Therefore, different systems and CBDCs must be able to work well together. If not, businesses and consumers won't be able to use CBDCs to make cross-border payments without problems."
In 2021, SWIFT conducted a series of CBDC tests to demonstrate that they could successfully manage an international transaction. The test involved a single entity using a DLT-based CBDC network and a second entity using well-established real-time gross settlement (RTGS) technology.
Right now, they have reached the next stage and are collaborating with Capgemini to determine how SWIFT will connect the numerous new CBDC networks that are increasing around the world. This will thereby facilitate the use of CBDCs for cross-border payments.
Determining how to use decentralization can be challenging due to the vast number of available technologies, business models, and policy considerations. However, Capgemini's well-defined taxonomy has accelerated the process of establishing connections between CBDC and SWIFT. Right now, the company is eager to continue collaborating with SWIFT to establish industry standards and frameworks.
Identification and Resolution of the Connectivity Problem
Several issues must be resolved. If this is not the case, they may hinder the widespread adoption of CDBCs. Despite CBDCs present numerous opportunities, they have to resolve several significant issues before they can be used. One is that multiple CBDC platforms will be constructed concurrently with the current traditional payment systems.
CBDCs are new types of fiat currencies that may enable new or better payment methods. They do not, however, replace traditional payment systems and infrastructure. As a result, CBDC and conventional infrastructures will have to work together for some time.
However, the use of CBDCs raises numerous concerns regarding their compatibility with existing payment systems. In addition, some CBDC platforms are under development with a centralized structure for the entire nation. Meanwhile, others use distributed ledger technology.
CBDCs will be used similarly to how various forms of currency are used in various payment systems. However, the important factor is that all of these components must work together for CBDC payments to proceed smoothly without any issues.
Will this be the Next Step for Seamless Payments?
SWIFT is currently evaluating its potential to address the interoperability issue. They are doing this by using their vast expertise in developing international payment standards and best practices.
Through the company's 2021 research, it has been demonstrated that it is possible to establish interoperability between CBDCs and existing payment systems by using banks that communicate via standardized messaging.
The company's most recent tests with Capgemini are more extensive. For example, they are evaluating the possibility that SWIFT can connect CBDC platforms, regardless of technology, on the network level to the existing payment system. SWIFT also investigates whether interlinking could be a highly efficient and easily integrated method for making CBDC networks payment-ready for international transactions.
The company establishes and demonstrates its capacity to install a gateway on an existing local CBDC network in these tests. The gateway will be able to intercept transborder transactions traversing the network. Then they will convert them and then forward them to the SWIFT platform for transmission to another CBDC network or an established payment system.
This collaborative proof of concept investigates the interdependence of multiple CBDCs. In addition to using existing banking authentication models and messaging standards such as SWIFT's Private Key Infrastructure and ISO 20022, the solution also uses existing banking messaging standards and authentication models. The main objective of SWIFT is to ensure that the solution they provide is accessible across the company's unique network of nearly 11,000 financial institutions in over 200 countries.
Will CBDCs Replace Cryptocurrency?
The rise of cryptocurrencies, the decline of cash usage, and the rise of stablecoins have prompted governments worldwide to consider launching their electronic currencies. For example, India announced last month that it will launch an electronic rupee at the beginning of 2023. This has provided a boost to these efforts over the past few months.
Also, China will test its digital currency during the Beijing Winter Olympics in 2022. They will also raise fundamental questions regarding the nature of money and consumer expectations. Cash has endured for countless years. This is because it is a convenient method of payment that is also relatively secure and private.
Proponents of cryptocurrencies want to extend this anonymity to the digital sphere while releasing central banks from control (though it is possible to trace back transactions to the individual). As a result, many people use and accept Bitcoin as payment.
Stablecoins, typically tied to a currency, such as a dollar, attempt to solve these issues. However, it ends up creating problems and risks within the financial system.
Are Digital Currencies (CBDCs) Issued by Central Banks the Solution?
On the surface, CBDCs resemble the digital currency we store in bank accounts and use on our mobile devices. The main distinction is that commercial banks lack an intermediary bank. Like cash, CBDCs are directly liable to the state. With a high risk of financial instability, this secure electronic currency may be appealing.
Challenges
CBDCs do not exist in a vacuum. However. one of its risks is the elimination of commercial banks, which are a vital source of financing for the economy. As a result, many central banks are weighing the possibility of limiting the amount of digital currency that consumers can own.
If CBDCs go mainstream, developing nations' lack of technological infrastructure can also lead to financial exclusion. Perhaps most alarmingly, CBDCs can facilitate government surveillance and increase susceptibility to cybersecurity threats.
How central banks combat these cross-border cbdc risks will be crucial. It is not unreasonable to believe that CBDCs could eventually contribute to making the global financial system more efficient, safer, faster, and reliable, which is an area in which cryptocurrencies and stablecoins have yet to prove their worth.
Conclusion
SWIFT believes its project could result in a flexible solution with a straightforward interface that can rapidly make any CBDC network ready for cross-border payments. The proof of concept guarantees that SWIFT provides efficient transaction management regardless of the platform used. Together with Capgemini, the company examines three potential scenarios: CBDC to CBDC, CBDC to fiat, and CBDC for fiat.
Successful experiments will demonstrate that SWIFT has the capability and technical components to interconnect different networks. This will aid in the resolution of the enormous technological and business problem faced by CBDCs. It could also enable central banks to establish CBDC networks that are cross-border-ready.
Both companies will release the results of their experiments to the general public in the nearest future as they have reached an advanced stage. Additionally, they will examine CBDCs to determine how they can facilitate interoperability with other currencies and digital assets when they are developed and globally regulated.