Last week, the Reserve Bank of Australia (RBA) and the Digital Finance Cooperative Research Center (DFCRC) outlined their retail and wholesale central bank digital currency (CBDC) pilot projects. One of the selected partners for the 14 CBDC use cases is Mastercard, which is working with Cuscal on an interoperable CBDC for trusted Web3 commerce. The goal is to allow the use of an eAUD on public blockchains.

The pilot proposal will use the CBDC to pay for an NFT on Ethereum. Since the CBDC itself is not issued on a public blockchain, the proof will “lock” the required amount on the CBDC platform and issue an equivalent sum of Ethereum-wrapped tokens. However, for the transaction to take place, the buyer’s and seller’s Ethereum wallets and the smart contract itself must first be whitelisted. This will illustrate the possibility of implementing controls on public blockchains, such as know-your-customer (KYC) rules.

However, swaddling is not without its risks. Essentially, a wrapped token is a tokenized copy of a coin that exists on a different blockchain, tied to the value of the other asset, and backed on a 1:1 basis. Thus, the wrapper makes it possible to build bridges between different chains, bypassing the limitation of non-native assets on public blockchains like Ethereum or BNB Smart Chain.

The risks of wrapping CBDCs

However, the process must be transparent. Earlier this year, it came to light that the stablecoin Binance USD (BUSD), which is issued by New York-regulated trust company Paxos on Ethereum, was not always backed 1:1 on other chains, despite being rock solid on Ethereum. As it turned out, Paxos was not involved in managing or supporting wrapped versions of BUSD, which he was candid about on his website. Instead, other players were issuing BUSD wrapped or tied in other chains.

Just as important is who wraps a CBDC, not specific to this particular use case. Locking the currency on one blockchain and issuing it on another means that the code runs the process. Numerous smart contract vulnerabilities have resulted in the loss of significant sums of crypto across blockchain bridges. It is one thing for a vulnerability to damage the reputation of a cryptocurrency company, but another thing for it to damage an institutional reputation or be connected to a central bank.

Also, a group of people will be responsible for the keys that control the wallets. It is not uncommon for protocol creators to run out of funds. Therefore, they must be reliable.

Other than that, the central bank will be more finicky about anti-money laundering than a stablecoin issuer. So they will want to influence who wraps their CBDC. But on public permissionless blockchains, in theory, anyone can wrap whatever they want if someone is willing to use it.

Central banks around the world are taking different approaches to the public blockchain. Public blockchains are completely ignored by many, such as Europe, which until now has focused on paying for retail sales and P2P transfers. Others are more receptive, including Brazil, which has tested its digital real for a couple of retail applications using public blockchains. But CBDCs will inevitably be involved, so some regulations on what is allowed are likely to be put in place.

Mastercard’s solution will allow CBDCs to be tokenized on other chains with controls to ensure only authorized parties can hold, use and redeem them. According to the project team, this will allow consumers to “participate in crypto ecosystems using trusted and trusted forms of money.” More generally, it will increase the utility of the CBDC and exploit many of the benefits offered by cryptocurrencies and Web3 trading.