Wholesale CBDC and How Does it Work?

Why Cross Border Payment with Wholesale CBDC (w-CBDC)?

Cross-border payment at the moment is quite time-consuming, inefficient, and costly. There are several intermediaries or correspondent banks involved (while doing a cross-border payment). These banks operate from 9 am to 5 pm as per their time zone. This constrains the availability of the intermediary bank to process cross border payments 24X7. Further, these banks charge a hefty transfer fee for processing the transfer. These two factors add a lot of friction in the cross border payment ecosystem.

Because of the operational challenges, and restricted banking hours, a transaction between Bank A to Bank B, can take up to 10 days, to complete. This means that a business, waiting for the payment to be released by Bank B, needs an extra 10 days of working capital, which currently is a huge problem.

With Central Banks adopting Wholesale CBDCs, present on the blockchain ledger, it shall become a lot easier to transact.

Multi CBDC (m-CBDC) Experiment

To address the problem of friction in cross-border payment, a multi-CBDC experiment, named as ‘Project Dunbar’, was conducted by the Bank of International Settlement along with the Central Bank of the UAE, Bank of Thailand, People’s Bank of China, Hong Kong Monetary Authority. The prototype experiment used m-CBDC bridge, which is a multicurrency CBDC platform, used by central and commercial banks to streamline economic, financial, and regulatory activities.

Another m-CBDC experiment was conducted by JP Morgan4 where Singapore Dollar CBDC and EURO CBDC were transacted on a private ledger based on Quorum

How Will Cross-Border Payment Work with w-CBDC and m-CBDC Platform?

The m-CBDC platform is a platform where Central Banks and commercial banks of various countries can transact cross-border payment, 24X7, without the correspondent banks, at fraction of the current transaction cost.

Let’s say, you as an individual want to transfer $ 10,000 to a business owner in Europe to buy goods. Following are the steps that you will need to complete to execute the transaction successfully:-

1) Add Beneficiary Details

To initiate the transaction, you shall log in to your bank’s website and add the beneficiary’s details (of the merchant), present in Europe.

2) Transaction Initiation and Validation

After the beneficiary is added, you shall initiate the transaction. The transaction cost including the cost of converting Dollar to Euro by the liquidity pool shall be presented to the user for 30 seconds

Once accepted, the transactions shall undergo validation on the private ledger network. Various aspects of the transaction are validated such as:-

a) Validity of the identity of the individual initiating the transaction and beneficiary

b) Availably and Authenticity of funds

c) KYC and AMF/CFT validation

Since the transaction occurs in ISO 20022 format, carrying out validation becomes quicker and easier. It shall be possible with ISO 20222 format, to tell at source, to the payer, based on the validation result of the transaction, if the bank shall be able to proceed with the cross-border transaction or not.

After the validation is successful, w-CBDC (wholesale CBDC) from the payer’s bank ($ in this case) is released and is presented to the liquidity pool.

3) Liquidity Pool

m-CBDC bridge replaces Nostro, Vostro Accounts, and correspondent banks, with liquidity pools.

The liquidity pool is defined as a hub of pre-collateralized currency. Payment made in one currency with wholesale CBDC, shall be exchanged here as per the existing FX rate and thereby the converted currency shall be released to the beneficiary bank. In the example shared, payment made in wholesale CBDC dollars shall be converted to its equivalent Euro wholesale CBDC via a liquidity pool.

Who will maintain Liquidity Pool?

a) Financial institutions chosen by SWIFT or Bank of International Settlements shall fund liquidity pools with the currencies required for an exchange. In return, these financial institutions can charge a transaction amount to the bank. For example in the m-CBDC experiment, the Bank of France was charged 10 basis points, by the liquidity pool, on the amount that was to be transferred5.

b) The second way to maintain the liquidity pool is by bringing the m-CBDC bridge on Ripple’s On Demand Liquidity Platform6.

4) Ledger Update

Once the w-CBDC ($) is converted into w-CBDC (€) with the help of a liquidity pool, the ledger is updated and the amount in Euros is credited to the beneficiary’s account.

Since, the smart contracts are deployed in the m-CBDC bridge platform, Validation of transaction, payment debit from payer’s account, conversion of the currency in liquidity pool and credit of the beneficiary account happen automatically without any human intervention. This makes cross border transaction using w-CBDC almost instantaneous, cheaper, and available 24X7.