When talking about Central Bank Digital Currencies (CBDCs) most commentators focus on their lack of privacy and ability to be blocked or controlled. Although this dystopian narrative is highly dynamic, in reality that’s not the aspect that central banks are attracted to. They’re interested in CBDCs due to their ability to solve many of the latency issues around cross-border settlements.
During a recent discussion with a senior banker in Turkey, the topic of cryptocurrencies naturally arose. Their view was like many in the banking sector who aren’t directly involved with CBDCs. They didn’t understand the value of cryptocurrencies and felt that the existing system is fine, although it does need some improvements.
They confirmed that Turkey’s central bank is presently working on its own CBDC and that this confuses many people in the country’s current banking system who don’t see any need for digital currencies. Their belief is that money is already digitized and crypto is simply a passing fad.
Another view amongst bankers is that crypto would only have real value if it managed to become a worldwide currency that was used universally rather than the current system of multi-currencies. The banker we spoke to conceded that this creates additional problems for individual nations however as they would lose control over their own monetary policy.
The real reason that central banks are so interested in CBDCs is that they understand the outdated nature of the technology the present system is built upon. Aside from the cumbersome language that most banking systems are written in, COBOL, it’s also slowed down by the Swift payment system.
While COBOL accounts for just 43% of all banking systems it nevertheless handles over $3 trillion of daily transactions. That includes over 90% of all ATM transactions and approximately 75% of all credit and debit card payments. Swift meanwhile functions mainly as, ”the main messaging network through which international payments are initiated.”
Cross-border payments sent through the Swift network are anything but swift. They take days to settle and can be returned to the sender if one part of the network rejects the transaction. The problem inherent in cross-border payments that take days to settle is that the exchange rate between the currencies often changes during that time.
Many outsiders assume that central banks are taking their time to develop CBDCs because they are busy building the blockchains and protocols that will underlie them. This isn’t the case. Creating a CBDC is a relatively simple process and there are many experts already in the field that can make quick work of the heavy lifting involved.
The main area that central banks are developing with respect to CBDCs is their interoperability. They are looking at how they will be able to send a CBDC from one bank to another and have it automatically transfer into the target bank’s currency.
There are several ways to do this, but one may be as simple as creating a CBDC exchange system similar to DEXs like Uniswap. Imagine for example a version of Uniswap that only has liquidity pools for CBDCs. Furthermore, the only wallets that can connect to it would be the whitelisted ones of certain regulated banks.
In such a scenario you could ask your bank to transfer $10,000 from your US account to a UK account. The money would be moved from your account into the bank’s whitelisted wallet, connected to the CBDC swap protocol and they would select the UK bank’s whitelisted wallet as the output.
The protocol could take the price feed from the relevant markets, adjusting for slippage and fees. The entire transaction could be resolved within minutes rather than days and at an exchange rate that is highly predictable.
When this was explained to the senior banker in Turkey his jaw literally dropped and he described how revolutionary such a process would be for the industry. “Unbelievable. That would literally save billions every year. Unbelievable!”, he said.