The interoperability of CBDCs across networks and currencies

HSBC in partnership with IBM for the delivery of the Banque de France CBDC experiment wanted to show how central bank digital currencies (CBDCs) could cross every divide – cross-border, cross-digital and real-world currency, cross-asset and cross ledger.

Since the pandemic significantly reduced cash usage and boosted digital payments, the buzz around cryptocurrencies and digital assets has increased. But how these currencies will evolve is still an open question.

Big name cryptocurrencies like Bitcoin are proving to be more of a store of value, and a volatile one, than a means of payments. Stablecoins, those cryptocurrencies that are linked to real-world currencies like the dollar or the euro, have emerged to address the issue of price volatility. They are particularly useful for overseas payments as they require no foreign exchange fees and remove currency volatility from the transaction. However, there’s still uncertainty over how stable they really are, as issuers need to hold sufficient reserves of the real-world currency to back up the tokens that they’ve issued.

Increasingly, central banks are exploring the idea of their own digital currency, a CBDC that could ensure safety, robustness and efficiency of payments for developed nations and promote financial inclusion in emerging economies.

The success of the whole lifecycle experiment

There are key questions about how CBDCs could work that central banks need to address. HSBC has been pioneering the use of blockchain technology. Its Digital Vault service, launched in 2019, can hold securities and process and manage delivery versus payment (DvP) and payment versus payment (PvP) settlements. As a leading foreign exchange expert, HSBC also uses blockchain for its FX Everywhere service, a distributed ledger technology (DLT) solution for the netting and settlement of FX transactions and payments.

That’s why in May 2020, HSBC partnered with IBM to respond to an invitation from France’s central bank, the Banque de France (BdF), to propose a series of experiments aligned to their wholesale CBDC program. Several previous experiments have demonstrated how CBDCs, digital securities or foreign exchange could work on DLT, but this experiment was different. It was a full end-to-end transactional lifecyle, covering CBDCs, eBonds and foreign exchange, conducted in a hybrid cloud environment of public and private clouds and on-premise data sources.

The success of this experiment is a milestone in showing interoperability across different DLTs and technologies, and how CBDCs could save time, reduce market risk and improve security for transactions between central banks, commercial banks and clients all over the world.

Imagining the needs of customers

In setting up the experiment, HSBC invented a customer named Startmint, which has local manufacturing capabilities but international consumers. Startmint needs to use the fictional real-world currency XXX in its operating country, but it sells its products into the Eurozone. Because of that, they keep significant cash reserves in euro, because this currency is central to their daily banking operations.

For the purposes of the experiment, we know Startmint wants to grow, but has a conservative risk appetite. As a result, HSBC offers it an ultra-low risk bond investment opportunity that will take place digitally. It will have a rapid and fully transparenet execution cycle, minimising additional admin by Startmint, because its going to use CBDCs and HSBC’s integrated DLT infrastructure alongside the interoperability capabilities of IBM’s Weaver solution.

Right now, Startmint needs the coupon interest to be automatically converted into their operating currency XXX, to comply with local reporting reulgations. Startmint also wants to be able to monitor both bond purchases and the coupon conversion process, controlling the final target currency using standing settlement instructions executed through smart contracts. HSBC provides these custodial services, because it is able to track not just their currency balances, but also their bond holdings – in real-time.

The transaction

In real life, HSBC, IBM and BdF took four months to set up the testing environment for this use case to take the following steps:

• Issue and distribute a digital euro CBDC from the Banque de France.
• Issue and distribute a euro eBond from a fictious central securities depository to HSBC, paid for in digital euros.
• HSBC to acknowledge receipt of the eBond, then to sell and custody the eBond on behalf of its customer Startmint.
• Pay an eBond coupon in digital euro to HSBC, which would then transfer the coupon payment to Startmint in the XXX CBDC with a FX payment.
• Have the experiment take place over several business days and BdF reconcile the digital euro balances during the process.

Even though BdF and HSBC run separate DLT infrastructures, they can be connected via bridging software that enables interoperable transactions and cross-network DLT consistency. Distributed ledgers based on IBM’s Hyperledger Fabric and R3’s Corda were integrated using IBM Research’s Weaver interoperability tool.

The complex transaction requires HSBC to take ownership of the eBond, then transfer some of it to Startmint under its custody, issue Startmint its coupon payment in XXX and then execute an FX hedge transaction for euro/XXX.

Powering the currencies of the future

The success of the experiment is a significant achievement. Not only does it show how CBDC and DLT can be useful to businesses in the real world that resemble the fictitious business Startmint, but it also showcased partnership and collaboration between central banks, commercial banks, and technology providers in a challenging timeframe.

Experiments like these will provide the framework that allows central banks all over the world to confidentally issue CBDCs, something that we at HSBC anticipate is likely to happen within the next 15 years. The most likely solution at the moment is that they will be indirect, with the CBDCs being distributed via commercial banks like HSBC. This makes it all the more important for commercial banks to be part of designing and testing these new currencies.

To learn more about the details of the experiment conducted by HSBC, IBM and Banque de France download the experiment report below.