There’s a reason why decentralized currencies are more than just a buzzword. With the shift toward a fully interoperable global digital economy, financial institutions have the opportunity to become more competitive in today’s modern landscape and to better serve their customers. One exciting example of this is Central Bank Digital Currencies (CBDCs), where central banks can create digital alternatives of their own fiat currency by partnering with crypto service providers. CBDCs can drive more efficient, lower-cost payments, stimulate economic growth, and provide financial services to historically underserved demographics.

As with any emerging technology, there are uncertainties associated with digital assets. Many of these uncertainties can be alleviated with the help of regulatory guidance from policymakers, and cooperation with fintechs and crypto service providers at the international level. Not only will this pave the way to full interoperability of global digital currencies, but it will also support the digitization of global economies, streamline cross-border payments, and improve financial inclusion. 

Research from global universities has helped inspire CBDC solutions for the world’s largest financial institutions looking to integrate digital assets into their business models. With funding from Ripple’s University Blockchain Research Initiative (UBRI), leading campuses and scholars were able to spend the last few years researching engineering, policy, and business solutions for CBDCs, which are based on blockchain technology.

Geopolitical Implications of CBDCs

In October of 2021, we hosted our third annual UBRI Connect conference. The conference brings together the world’s foremost researchers and scholars from across the UBRI network to highlight findings in the blockchain space.

Digital currencies — like that of CBDCs and stablecoins — were a key topic at the conference. Darrell Duffie from Stanford Graduate School of Business sat down with James Wallis, Ripple’s VP of Central Bank Engagements, to discuss this topic further, including present and future sentiment around digital currency alternatives.

It is reported that as of 2021, the 87 countries which make up more than 90 percent of global GDP have begun exploring a CBDC solution. Recently, the Republic of Palau and the Royal Monetary Authority of Bhutan partnered with Ripple to develop a national digital currency utilizing the XRP Ledger (XRPL).

Of central banks that choose not to adopt a CBDC, Duffie said, “There’s going to be a vacuum for an international CBDC that starts to displace [the] local currency.” Although this statement leapfrogs over the many steps needed to optimize CBDC potential, the sentiment remains true: central banks have an opportunity to interoperate within this modern digital economy by offering consumers a digital currency option.

In terms of innovations through technology, Duffie explained how progress can be made in balancing privacy and security of payments alongside technological and economic advancements. To drive progress, Duffie believes the solution will come from central banks engaging the private sector by taking an international approach to CBDC solutions. This includes interactions and interoperability opportunities between commercial banks and central banks in the global economy. 

Duffie highlights the importance and likelihood of interoperability of digital assets in the future, but only if policymakers engage with leading firms in the crypto space to provide a clear regulatory structure. 

A Customizable Policy Approach

In a letter to the Bank of Thailand in June of 2021, our team highlights the belief that interoperability with a focus on international standard protocols will ensure the success of CBDCs. Like Duffie, we agree that a two-tiered public-private payments approach is an effective model. More specifically, the letter proposes private sector firms create and distribute CBDCs so that central banks can issue the digital currency to better serve their nation’s consumers.

Later on in the year, we announced that Ripple is joining the Digital Pound Foundation, cementing our efforts to work with players in the space to develop and implement a digital Pound in the United Kingdom. With the growing number of central banks implementing CBDCs, privacy, interoperability, and complete sovereignty will be the key factors in ensuring the UK maintains competitiveness in financial innovation. 

Ripple’s CBDC solution provides the opportunity for central banks to customize their own policy and privacy requirements. This is especially important for Governments during a crisis, for example, when issuing COVID-19 stimulus payments. Because Ripple’s CBDC solution is based on the same technology that powers the XRP Ledger, it’s inherently less energy-intensive, more efficient, and less expensive than alternative ledgers.

A Distributed, Private Design Framework

Three researchers from University College London (UCL) — Geoffrey Goodell, Hazem Danny Al-Nakib and Paolo Tasca — all of whom are supported through UBRI, proposed a design framework that could accommodate Central Banks issuing digital currencies.

The proposed solution is a “value container,” which is much broader than a simple digital currency issued by a central bank. They compare it to a connected railway system that programs a diverse set of assets in new ways, supporting the deployment of the digital currency and ensuring the privacy of users without altering existing market structures, such as the competitive fintech landscape.

The “value container” has two key features that could accommodate CBDCs. First, they recommend a distributed ledger technology (DLT) settlement system operated entirely by private entities yet overseen by the state government; and second, optimizing ​​privacy by design to amplify the welfare and safety of users. Privacy by design stresses the need for organizations to develop secure infrastructure models from the beginning in conjunction with evolving regulatory security measures.

Within this “value container,” they argue that a DLT system supplies a variety of operational and economic benefits and encourages transparency within the design itself, while also being able to closely collaborate with private sector firms. With the DLT infrastructure, the researchers also emphasize that this approach can support central bank collaborations with the private sector, enabling an interoperable system between central banks, digital assets, and government regulation.

The ongoing global inequality crisis, catalyzed by the COVID-19 pandemic, has raised concerns about economic holes caused by the current financial system, e.g. months-long delays in essential stimulus checks. The researchers from UCL make the case that their proposal can bolster economic stimulus policies, such as issuing social assistance checks using digital currencies the same way we use direct payments — made to individuals or non-financial businesses.

The Future is Bright for CBDCs

The University Blockchain Research Initiative’s global network is currently researching CBDC solutions, and some of the academic contribution highlights made in 2020 – 2021 have been released by researchers at universities supported through the initiative.

The widespread adoption of innovative CBDC solutions promises exciting potential and far-reaching benefits. Not only for financial institutions, central banks, and governments but also for countless global citizens to have access to secure, reliable and affordable financial resources.