The potential for CBDC and private/public chain collaboration is virtually limitless, particularly collaborations between central banks and smart contract platforms.
Smart contracts represent a revolutionary tool able to decentralize and disintermediate nearly every service imaginable. They allow the exchange of money, shares, property rights, or anything else of value in a transparent and conflict-free manner—all while eliminating the need for a third party.
From brokering insurance contracts to financial settlements, smart contracts could bring immense innovation to CBDCs that otherwise would act as little more than an augmented medium of exchange.
A perfect example of the potential of smart contracts is asserted within the Ethereum-based decentralized finance (DeFi) sector. DeFi essentially represents a decentralized twist on traditional finance—namely, the borrowing and lending markets. The sector has ballooned this year, with inflows climbing from $690 million in January to over $14 billion by current estimates. DeFi protocols run almost exclusively via smart contracts, enabling borrowing and lending to occur without the need for an intermediary.
By leveraging the DeFi model, central banks could endow CBDCs with the ability to become interest-bearing assets. Permitting borrowing and lending via smart contracts could enable qualified parties to issue digital assets backed by real-world assets, such as real estate and stocks—using them as collateral to secure loans in CBDCs— something that could bring enormous liquidity into the global economy.
In this way, the progress made toward open banking could be maintained under a CBDC model of finance, fostering innovation and supporting competition within the private sector that might be otherwise omitted.
But none of this will be possible without interoperability. As they stand, proposed CBDCs remain siloed with little in the way of global compatibility. Interoperability is critical to allow the multifunctionality that public chains could render. Without instilling cross-chain compatibility, CBDCs will be akin to an imperceptibly more practical digital cash option.
The benefits such as cross-border transfers will be limited as not all CBDCs will operate on the same infrastructure and therefore will require an intermediary such as the legacy interbank messaging service Swift or a CBDC foreign exchange to enact transactions. But, worst of all, CBDCs wouldn't be able to live up to their full potential.
Most central banks aren't concentrating enough on CBDC innovation. Instead, they're sticking to the same tired old rule book that's governed the financial system for decades—with an aim to duplicate the system, rather than reform it. In doing so, they stifle innovation before even giving it the chance to cultivate.
With over 80% of central banks moving toward production stages, the likelihood that every CBDC will be built with interoperability in mind is slim to none. But that needn't stop cross-chain compatibility.
Ironically what's required is a system similar to Swift, but instead of simply sending messages and notifications, it manages the transaction itself. An arbitrator connecting two separate CBDCs could verify cross-chain transfers via a common consensus mechanism, ensuring that transaction data is consistent with information on both sides of the trade—all while bypassing the double-spend problem. A system like this would also settle disparities in compliance with state transfer rules, including anti-money laundering regulations and sovereign monetary policies.
The system would also be responsible for linking public chains to CBDC infrastructure, enabling these instruments the innovation that is currently being overlooked.
