EDITOR NOTE: The Bank for International Settlements’ (BIS) innovation hub in Hong Kong is working on a project in conjunction with the central banks of China, Hong Kong, Thailand, and the UAE to create a cross-border central bank digital currency (CBDC) platform to cut the time and money it takes to send and receive payments across international borders. Today, these types of cross-border payments generally take 3-5 days with all the banking middlemen involved. The recent CBDC trial shows that it could take as little as 2-10 seconds and cost half of what it does now. The next step for BIS is to test the scalability and connectivity of the project.
Cross-border CBDC project seeks faster, cheaper payments by cutting out middlemen
A cross-border central bank digital currency (CBDC) platform has the potential to shorten the time of cross-border wholesale payment transfers by 80% and halve costs, a report said.
The “multi-CBDC bridge” project, or simply “mBridge”, which is being co-ordinated by the Bank for International Settlements’ innovation hub in Hong Kong, has concluded its second phase and is set to move on to a third. The central banks of China, Hong Kong, Thailand and the UAE are working with the BIS on the project.
Three participating central banks managed to “control the flow of their CBDC and to monitor transactions and balances of their issued CBDC”, says the BIS report, published on September 28.
The delay in cross-border CBDC transactions on the prototype platform is estimated to be just 2–10 seconds, down from as much as 3–5 days in existing systems due to cumbersome work of middlemen, the report said.
Payments can be sent faster because the CBDC platform directly links payer and payee. In traditional payment routes, both sides are connected by multiple layers, including local banks and correspondent banks.
The transactions by CBDC are facilitated by distributed ledger technology (DLT), which allows records to be stored in multiple places at the same time.
Besides a simpler payment model, the prototype also deployed smart contracts, self-executing programs that run automatically when conditions are met, to speed up operations.
The report estimates that mBridge could cut the costs of cross-border transactions by up to 50% by reducing liquidity, foreign exchange and compliance costs, among others.
In the second-phase trial, central banks were able to issue and redeem their CBDC, submit peer-to-peer payments, monitor transactions, set currency limits, and extract surveillance data on the prototype.
The “enhanced prototype” could also offer central banks the ability to improve the level of privacy in CBDC transactions, and automate certain compliance functions, said the Hong Kong Monetary Authority in a statement.
Despite the DLT-enabled infrastructure showed potential in facilitating payments, the project still needs to go through more tests before morphing into a live pilot.
“The scalability and performance of DLT in handling large transaction volumes will need to be assessed further if more jurisdictions or currencies are added onto the platform,” the report says.
In addition, certain functions of the prototype need refining, including the liquidity saving mechanism (LSM), a system used to avoid liquidity “gridlock” in settlement. Gridlock occurs where two or more transactions await each other to settle. Each relies on the liquidity that would be provided by the other arriving.
In an LSM, when gridlock occurs, a central bank calculates which transactions can be netted and then injects liquidity to settle any remaining payments. In the prototype, privacy constraints meant the system was “unable to calculate an optimal netting solution” for higher transaction volumes.
In future, the project plans to explore multi-party networks, test out business use cases, and continue to study policy, regulation and legal requirements.
The project’s next phases will involve partnerships with commercial banks and other market participants to conduct trials in a safe and controlled environment, the BIS said in a press release.
The multiple-CBDC project led by the BIS was originally a partnership between the central banks of Hong Kong and Thailand, named “Inthanon-LionRock”, launched in May 2019. The first phase was concluded in January last year.
After the BIS team brought China and the UAE onboard in February this year, the project was renamed to mBridge in the hope it would eventually become a network that bridges countries.
The multiple-CBDC platform could potentially offer an alternative to the existing cross-border transfer system, with its heavy reliance on correspondent banking. The system has been impaired by the retreat of many banks from their correspondent relationships.
“Enabling faster and cheaper cross-border wholesale payments, including to jurisdictions that don’t benefit from a vibrant correspondent banking system, would be positive for trade and economic development,” said Bénédicte Nolens, head of the BIS innovation hub in Hong Kong.
Originally Posted on CentralBanking.com