Just over a week ago, one action by payment giants Visa and PayPal moved cryptocurrencies out of a mere “speculative asset” zone into clear “currency” realm. While much has been said about this development, the future potential of these players is even more significant in the central bank digital currency (CBDC) world than with cryptocurrencies.
When Bitcoin was launched, no cryptocurrency project focused deeply on interoperability. Fast forward 12 years and a vast array of interoperability plays have developed – Cosmos, Polkadot, Chainlink and others. Similarly, CBDCs are at their nascent phase currently, with very few live projects and pilots. Fast forward a few years and interoperability is poised to become perhaps the most major bottleneck for CBDCs.
CBDCs face a challenge of interoperability
With the coronavirus pandemic pushing the use of contactless payments, central banks all over the world are rushing to experiment with CBDCs. The domestic capabilities required for CBDCs are already complex, but globally bridging the gap between various CBDC initiatives and existing financial infrastructure is a mammoth challenge.
CDBCs will need to share compatible technology, code languages, and standards, to achieve full functionality. Standardizing legislative structures, harmonizing regulatory discrepancies between jurisdictions, and ensuring CBDC's legal tender status is another major dimension of interoperability challenge.
Recent research by the Bank of International Settlements (BIS) and other bodies proposes various models such as a multi-CBDC bridge between different central banks using wholesale CBDCs. A common theme in central bank experiments involves the use of “corridor” networks for real-time, cross-border settlement between CBDC transactions.
One conclusion has been that there is a requirement for a modern SWIFT-like system – a consensus process by a third-party mediator between two distinct CBDCs that can verify cross-chain transactions, ensuring transaction information is compatible with data on both sides of the transfer. This will ensure that state transfer laws, such as anti-money laundering (AML) regulations, are followed while avoiding the problem of double-spending. CBDCs may require a common technical interface or even a shared clearing system between local systems. Enter payment players.
Payment players provide real interoperability
In the internet era, as businesses, merchants and governments moved to digital payments, Visa already cracked the infrastructure and interoperability requirements to process payments between them. Its flagship solution, VisaNet, interoperates between the layers of government in 200 countries, 15,000-plus financial institutions, 46 million-plus merchants and businesses and over 3 billion card holders.
Today it is the world’s largest electronic payment network, with robust capabilities in both domestic processing as well as cross-border processing. All of these become essential when it comes to the CBDC landscape.
PayPal is a different sort of payment company but in its own way performs an interoperability function. While Visa is primarily a payments processor, PayPal runs one of the world's largest e-commerce payments networks with over 377 million active users and merchants. With a focus on online and mobile payment wallets for consumers, it is offering more products and an omni-channel experience. PayPal acts as a gateway for a variety of merchants and payment processors to plug in, including card players such as Visa and Mastercard. In recent years PayPal has also been focused on creating interoperability among digital wallets, physical stores, online stores and other products such as discount finders.
CBDC interoperability is a harder challenge to solve than blockchain interoperability because it requires tackling both complex engineering and complex regulations. Apart from adoption, speed and scale, the real advantage for these players is not their systems, but that they are legally-compliant in every jurisdiction they operate in. This already gives them a near Herculean advantage compared to blockchain players when it comes to the realm of CBDCs. And they are actively capitalizing on it.
They are already innovating around CBDCs
Most major payment players are actively innovating for the CBDC and digital currency space. For example, Mastercard recently launched a proprietary virtual testing environment for evaluating CBDCs, which has already aided a number of banks in their evaluation and exploration of national digital currencies.
The new platform will enable banks, financial service providers and consumers to simulate the issuance, delivery and exchange of CBDCs. Central banks, commercial banks, technology and consulting firms have been invited to assess CBDC tech designs, validate use cases and assess interoperability with existing payment rails. Although there are a number of possible operational models, the most common one involves central banks issuing and distributing digital currencies, through commercial banks and other approved payment providers.
Additionally, users of a multi-currency Mastercard debit card will be able to purchase, carry, swap and sell up to eighteen conventional and digital currencies, as well as make free international ATM withdrawals up to a certain number.
Visa has already built and launched its solution to settle USDC transactions on Visa cards on the Ethereum blockchain. Its pilot allowed Crypto.com to settle a portion of its obligations for the Crypto.com Visa card program in USDC. This was enabled by Anchorage, the first federally chartered digital asset bank and an exclusive Visa digital currency settlement partner. These exact capabilities and their treasury improvements and integration with Anchorage will help with CBDC processing in the future.
PayPal enabled payments barely a week ago with bitcoin, ether, bitcoin cash and litecoin in their digital wallets. Its cryptocurrency offering last year enabled customers to convert their cryptocurrency holdings into fiat currency at checkouts. If a user has "sufficient cryptocurrency balance to support a qualified transaction," the crypto-payment function would automatically appear in their PayPal wallet. Although PayPal has not made public its CBDC strategy as yet, it is actively working on the space with an in-house team.
As CBDCs emerge as a major disruptor to existing infrastructure, interoperability remains one of the most significant roadblocks to their functionality. Although most financial institutions remained wary of digital currencies, payment players like Visa, Mastercard and PayPal have not only accepted the concept of cryptocurrencies and CBDCs but are constantly innovating on both fronts. The future could see them carving out a new niche for themselves – as the interoperability layer for the upcoming CBDC world.
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