Cross-border payments are a major railway for facilitating the functioning of the global economy.
Yet they face significantly greater challenges including slower speeds, more restricted access, higher costs, and less transparency than domestic payments.
That’s why as the way that money moves, along with its very nature, continues to evolve, nations around the world are conducting experiments using central bank digital currencies (CBDCs) to explore the technical viability of multilateral platforms that improve cross-border payments by transforming foreign exchange transactions, risk sharing and financial contracting.
This, as the New York Federal Reserve’s New York Innovation Center (NYIC) and the Monetary Authority of Singapore (MAS) Friday (May 19) published the results of Project Cedar Phase II x Ubin+, a joint project investigating whether distributed ledger technology (DLT) could be used to improve the efficiency of cross-border wholesale payments and settlements involving multiple currencies.
The study found that they could.
Phase II of the project, which was conducted in a test environment where payments were settled using simulated wholesale CBDCs, validated the team’s ingoing hypotheses relating to cross-border CBDC interoperability, speed, and atomic settlement.
“Our research collaboration with the MAS reveals key opportunities for central bank innovation to play an important role in easing wholesale payment flows globally and improving settlement outcome,” said Michelle Neal, head of the Markets Group at the New York Fed.
“Central banks can enable interoperability of wholesale CBDCs to facilitate more efficient cross-border payment flows including for less liquid currencies, without requiring a common infrastructure,” added Leong Sing Chiong, deputy managing director (markets and development), at MAS.
See also: International CBDC Aims to Unify Fragmented Digital Currency Landscape
Many cross-border payments are also cross-currency payments, but most cross-border transactions take place using major currencies, most famously the U.S. dollar, due to their wide acceptance and price stability relative to emerging market economy (EME) currencies.
As a result, major currencies generally enjoy higher market liquidity — making them most attractive to transact internationally with.
Still, as the world becomes ever more connected and digitized, the prevalence of EMEs within international transactions has increased, creating illiquid cross-border currency pairs that continue to face limitations, such as high costs, slow settlement times, lack of access to market solutions, and limited transparency.
The project from the New York Fed and MAS was designed to understand and validate potential solutions for this opportunity space by using CBDC vehicles to bridge exchange currency pairs that are not widely traded.
By establishing interoperable connectivity across heterogeneous simulated currency ledgers, the study found it was possible to both reduce settlement risk and decrease settlement time.
“Experimentation across the central banking community is vital to leverage the full potential of digital assets and CBDCs in particular” said NY Fed’s Neal.
With 11 central banks around the world having launched a CBDC, 18 more piloting one and a combined 72 central banks either developing or researching their own CBDC, it very well may be that a future state-financial system could involve countries designing and deploying new technologies in distinct ways.
Within this envisioned future scenario, facilitating cross-border transactions that don’t get hung up in the foreign exchange (FX) settlement process offers an attractive and efficient modern way of facilitating global transactions.
The NY Fed and MAS study devised a way to leverage wholesale CBDCs to bridge nation-specific heterogeneous networks and enable cross-border, multi-currency payments while at the same time maintaining the independence of the respective central bank infrastructures and models.
“[The project] advances global efforts to evaluate the benefits of wholesale CBDCs and help build capabilities for a future financial infrastructure that is open and interoperable,” said Leong Sing Chiong of MAS.
Overcoming differences in technologies across systems if often among one of the more pressing challenges facing interlinking initiatives. By using a particular form of smart contract called a hashed timelock contract, the project was able to successfully bridge distinct DLT systems to demonstrate interoperability across various technical designs.
Settlement was achieved in under 30 seconds for all of the hypothetical test scenarios the project ran, including those requiring multiple cross-ledger currency exchanges.
Still, as Catherine Gu, head of CBDC and protocols at Visa, told PYMNTS earlier this month (May 9) about her own firm’s CBDC pilot in Brazil, real-world deployment of any CBDC system remains “at least five-plus years away from where we are today.”
Both the NY Fed and MAS emphasized that their research was not intended to “advance any specific policy outcome, nor is it intended to signal that the Federal Reserve will make any imminent decisions about the appropriateness of issuing a retail or wholesale CBDC, nor how one would necessarily be designed.”