As the world grapples with high inflation, rising interest rates and the threat of recession, it would be easy to lose sight of the growing risk of deglobalisation. It is being fuelled by the spread of growing geopolitical tensions and the disruption Covid-19 has brought to the world’s supply chains.
Deglobalisation will have varied and complex effects on different economies, but it will hurt growth everywhere. Fortunately, central banks are developing a countervailing force, in the shape of central bank digital currencies. These will support global trade by making international payments simpler, cheaper, faster and more transparent.
The scope for efficiency gains is enormous. Global cross-border payment flows are expected to exceed $150tn in 2022, 96% of which will consist of business-to-business transactions. At the macro level, saving even a fraction of a percentage point of this sum would be worth more than most countries’ gross domestic product.
But the more life-changing effects will be at the micro level, given small businesses and low-income earners face disproportionately higher charges when sending and receiving money. For them, the advent of a cheaper, faster and more accessible cross-border payments system supported by CBDCs will open new opportunities to trade and transform livelihoods.
The potential to boost economic efficiency and financial inclusion by solving the cross-border payments problem is a major motivator for the 105 countries now exploring CBDCs. These countries, rich and poor, represent more than 95% of global GDP.
But in order to achieve seamless cross-border payments, the various CBDCs in development need to be interoperable. The Bank for International Settlements has outlined three ways this can be achieved. First, compatibility, where individual CBDC systems use common standards. Second, interlinking, which allows participants to transact with each other without participating in the same system by means of technical links. And third, through a single system on a common infrastructure hosting multiple CBDCs.
Of the three, a consensus is emerging that sees interlinking as the primary model for allowing payment systems, including CBDCs, to work together. Interlinking CBDCs could be achieved in different ways, such as by using a single access point, bilateral links or a ‘hub and spoke’ model.
The likes of Swift and Visa’s universal payments channel are pursuing ‘hub and spoke’ solutions, which are not much of a departure from the current system that relies on an ‘archaic network of correspondent banks,’ as described by Ravi Menon, the Monetary Authority of Singapore’s managing director. However, a cross-border payments system fit for the 21st century cannot be dominated by any single entity, country or interest. The European Central Bank warns this would give such an entity undue market power across international borders. In any case, regulators are likely to push back vigorously on any emerging platform with monopoly potential.
That is why a decentralised approach is needed. One such project underway is the Universal Digital Payments Network, an alliance made up of leading financial institutions, technology firms and other specialists from across the world. The UDPN achieves decentralisation by not giving any of the parties a majority share of influence on the governing council. UDPN partners are testing a minimum viable product consisting of a standardised common messaging backbone for cross-border, cross-chain digital currency transactions that delivers universal interoperability between both centralised and decentralised protocols.
Though CBDCs are the best bet for achieving the ‘holy grail’ – as the ECB puts it – of immediate, cheap and universal transactions executed in a secure settlement medium, developing them will take time. In the near term, regulated, fiat-backed stablecoins can streamline cross-border payments.
The ECB acknowledges that stablecoins occupy an intermediary place and could contribute to immediate improvements over the next few years. As such, the proposed UDPN solution would also serve to provide interoperability to support the current multi-coin, multi-chain stablecoin system – Circle’s regulated, fiat-backed USD Coin, for example, operates on no less than 14 different chains.
The lessons from improving cross-border transactions using stablecoins will inform CBDC design and the infrastructure that supports and connects them, providing the ultimate solution to the cross-border payments problem. One thing is clear: the boundless opportunities from empowering international trade can only be fully unleashed through the creation of a co-operative framework that serves the entire global economic network, not just individual entities seeking to dominate the cross-border payments landscape.