Interoperability will determine CBDC winners and losers

China has opened testing for its digital yuan. The excitement surrounding this project has electrified several major Chinese cities, as well as onlookers throughout the world.

Most recently, Shenzhen launched its “iShenzhen” lottery, wherein the city government will distribute 20 million digital yuan among 100,000 central bank digital currency, or CBDC, wallet holders.

This comes on the back of a similar lottery held in the city of Suzhou, one of China’s major “special economic zones.” Suzhou has already engaged with several blockchain projects in an effort to deepen the municipality’s understanding and use of decentralized technology, smart contracts and the general learning curve the local population may face.

As China continues to cement itself in the international economy, it is proving to be a leader in the race toward CBDC adoption, an initiative that would make Chinese goods and services more accessible within the global marketplace.

Many experts in the fields of fiscal policy and financial technology have argued that the digitization of public money is an inevitable consequence of distributed ledger technology.

The particular political and economic ramifications of this switch to digital currency will depend on the specific decisions of governments regarding their approaches to these new technologies. China, for example, has adopted an approach that has seen repeated success throughout contemporary business culture.

A number of other nations, with economies of all sizes, are more or less waiting in the wings as the People’s Bank of China demonstrates its leadership. In the Suzhou and Shenzhen experiments, citizens are allotted digital yuan and encouraged to link their digital wallets to their existing PBoC accounts, and if they do not use the digital currency within a few weeks, it disappears.

Nations are especially eager to see how this program unfolds and how adoption looks at the grassroots level. Businesses and governments have a natural incentive to embrace this technology, as it reduces overhead and friction, which enhances their bottom line.

 However, for citizens whose motives might not be tied to financial gain, which other incentives will prompt them to start using an entirely different system of money and banking? These aforementioned adoption trends will be a key driver that determines how quickly other nations will begin developing their own CBDCs.

This experiment has excited economic participation within China and roused interest from public banks across the world. Which countries have positioned themselves to follow China into the digital future? Certainly, China’s influence, as well as a long-standing pro-technology culture throughout the continent, suggests that many East Asian countries may follow suit.

The Bank of Thailand launched a CBDC pilot program back in June 2020. Moreover, just last fall, the Bank of Korea announced plans for a 2021 CBDC issuance, while Japanese banking officials have articulated a more cautious, passive course of interest following China’s CBDC.

Smaller nations, of course, have a different set of obstacles in their financial experimentation. Recently, the Bahamas introduced its “Sand Dollar” and Cambodia its “Bakong,” following China’s example.

This is made possible, however, by the smaller size of these national banking systems that allow them to move with greater agility as well as a degree of autonomy.

This becomes an advantage for smaller nations, as the global dependence on their currency is also smaller, so the interoperability issues are of a lesser priority than for global economies like the United States and China where it becomes a highly critical aspect.

However, larger nations are also showing greater interest. A year-long research report published recently by the central banks of Saudi Arabia and the United Arab Emirates shows that the early adoption of digital currencies is favorable particularly for major economies that have operated with relatively higher degrees of autonomy, unlike those in the eurozone or a part of the North American Free Trade Association, for example.

 Like China, the Saudi and Emirati governments, given their manufacturing and natural resources, do not accrue as much debt as is standard in other major economies in the West.

This brings to light an interesting aspect of CBDC adoption, one that may influence the process of digitization across the world’s public banks. While a huge number of factors determine how and when a particular economy may adopt digital currency such as its size, the preexisting economic landscape, its gross domestic product, etc. an important aspect seems to be a strong national (as opposed to global) economic program.

This is interesting not only because it flags particular nations as being predisposed to CBDCs but also because it highlights the importance of interoperability after a currency has been instituted.

These digitization programs, in other words, will be brought about through strong national economic policy control, but in order to uphold the global systems that we live in, these technologies will need to interact through intermediary programs.

With a push to all the global CBDC initiatives, the Bank of International Settlements’ Innovation Hub, or BISIH, announced that CBDC research is a top priority for it in 2021. It plans to gauge the feasibility of faster, cheaper cross-border payments.

This initiative is going to be highly beneficial for global economies exploring the interoperability of their own CBDC projects using BISIH research and pilot tests to facilitate their own CBDC program and by working with them for all settlements and cross-border payment concerns.

While focusing on domestic use cases is understandable for individual countries, CBDCs will only ever operate in local sandboxes unless there is some type of interoperable protocol.

It is critical to bridge the gaps between the various CBDC initiatives and existing payments systems as well as other digital currencies to ensure their success on a global scale.

While governments exploring the use of CBDCs is undoubtedly a step in the right direction, truly borderless, global commerce will be powered with the help of an interoperable protocol, as our economic system is too multifaceted to be replaced by a singular currency.