Many of the world’s central banks are years into developing central bank digital currencies (CBDCs). Per the Bank of International Settlements (BIS), 94% of the world’s central banks are actively working on CBDCs, while 19 of the G20 nations were in advanced stages of CBDC development prior to this month.
However, recent government decisions suggest changing sentiment around CBDCs. On September 23, Canada announced it was shifting its focus away from a retail CBDC to a focus on “broader payments.” This announcement closely follows Australia’s pivot to a wholesale CBDC over a retail currency.
Decisions regarding CBDC development impact more than an individual country’s citizens and financial system. They have serious implications for a problem facing the broader Web3 ecosystem – a lack of interoperability.
CBDCs are more than just government-controlled digital money. They are a complex ecosystem that must account for different participants, use cases, tech stacks, data formats, and governance models. Not to mention, they must also be compatible with foreign CBDCs and legacy systems. Rolling out a functional CBDC is a tall order. However, it is not without parallel.
Read more: Fiorenzo Manganiello – Why We Won’t See CBDCs Everywhere
The world’s central banks are well aware of the formidable task ahead of them and have rightly been considering interoperability from the start. If anything, creating an interoperable CBDC ecosystem is even more daunting than Web3 interoperability. International cross-border payments, just one use case for CBDCs, are a complex and fragmented web of pre-existing, independent domestic payment systems and currency exchange challenges.
As such, central banks face enormous constraints when designing CBDCs. The pressure is on to be interoperable with legacy, contemporary, and, ideally, future financial systems. Beyond the obvious technical challenges, CBDCs must also comply with multiple legal and regulatory frameworks. Sound familiar?
These kinds of interoperability challenges have existed since Web3’s inception. Look no further than the two most prominent public blockchains: Bitcoin and Ethereum. On the surface, connecting these two networks seems obvious. Yet, the result of the industry’s best efforts is a collection of distinct stop-gap solutions, each requiring concessions in security, scalability, decentralization, or scope. As the CEO of the industry’s longest-running interoperability solution, Wanchain, I’ve witnessed all the progress we’ve made as an industry. Yet, I also recognize just how far we still are from true interoperability.
The widespread adoption of CBDCs provides a solution to the interoperability challenges holding back Web3. This is what makes Canada’s decision so significant – and frustrating. If too many governments abandon CBDCs, the CBDC landscape may end up looking like Web3 does today: a fractured ecosystem plagued by fragmented liquidity. With more than 100 L2s, 140+ active Layer 1s and countless private or consortium chains, the blockchain space already faces an existential threat. If we then add 75+ incompatible national CBDC networks… Let’s just say the outlook is bleak.
But there may be a silver lining. Nations that remain steadfast in their pursuit of CBDCs will have a more prominent voice in setting the standards for CBDC interoperability. Such an advantage could be a game-changer for smaller nations with Web3-friendly landscapes. While this will likely not disrupt the current world order, it offers countries an avenue to ameliorate their standing on the global stage.
Unlike the public blockchains that preceded them, CBDCs have the opportunity to be inherently interoperable. There are a number of options available to central banks, some of which have already been tested in Web3.
Individual CBDCs can leverage universal messaging formats, cryptographic algorithms, and data structures. This mirrors ongoing efforts in Web3 interoperability, where universal standards are being developed. While intermediary relayers would still be necessary, operational complexity would be reduced. However, this approach may pose challenges for countries already employing standardized domestic technical interfaces.
Alternatively, CBDCs could operate on a single platform, allowing jurisdictions to set their own rules for transaction limits and participation. The IMF suggested a similar approach in 2023. Here, the challenge lies in determining who should run this platform, as reliance on contentious international powers could prove problematic in any global setting. There is also the option to link CBDCs directly via singular gateway entities or a hub-and-spoke model, though these present scalability and concentration risks. A reciprocal link model where participants in one system can directly transact with another likely offers better outcomes, though this model lacks clear parallels in Web3 and is, therefore, unproven.
Finally, a more realistic option might be a hybrid solution that blends elements to address specific use cases and the unique needs of different jurisdictions.
While the precise technical configuration is yet to be determined, CBDCs have a leg-up on existing Web3 interoperability solutions as they are a blank slate. CBDC design can be informed by the difficulties public blockchains have encountered trying to make already deployed systems interoperable after the fact. There is a rare opportunity for central banks to work closely with experienced developers to (finally) get interoperability right.
A lack of interoperability remains one of the primary obstacles to developing CBDCs, and this echoes similar issues found in scaling Web3. In its current state, interoperability poses an existential threat to the mainstream adoption of both.
Yet, CBDCs have the potential to lay the groundwork for resolving these industry-wide interoperability challenges. To some, CBDCs elicit fears of pervasive government surveillance and control. To others, they are unnecessary in the age of stablecoins. But we should not ignore the contributions CBDCs can make for the long-term health of Web3 as a whole. It’s time for a unified and decentralized network of blockchains built on industry-wide interoperability standards.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.