MBridge multi-CBDC for cross-border payments is on its way to production – Ledger Insights

The BIS Innovation Hub Hong Kong published its report on MBridge Pilot, a multi-CBDC initiative for cross-border payments involving the central banks of China, Hong Kong, Thailand and the United Arab Emirates. Twenty commercial banks participated and six other central banks participated as observers to the central bank digital currency (CBDC) project.

During the pilot test, which lasted five weeks until September 23, $12 million in currency was issued and $22 million in trade transactions were executed.

Two of the highlights are the use of a custom, permissioned blockchain and privacy.

The cross-border logic

It is widely known that there are considerable frictions in cross-border payments estimated to cost $120 billion in transaction fees annually, in addition to the indirect costs of delayed payments.

Emerging markets tend to bear the brunt of the friction. The correspondent banking system has contracted since the last financial crisis, reducing the choice of intermediaries to make payments. Additionally, emerging market countries often transact in foreign currency, increasing the need for intermediaries.

MBridge is on its way to production

Coming back to MBridge, after the pilot, it is now being developed into a minimum viable product before a production deployment.

During the pilot test, more transactions were made through the People’s Bank of China, in part because Hong and China started the pilot test before the other central banks. And also because China was the only bank that automated the integration of CBDC issuance and redemption with its national CBDC system.

How does it work

The solution uses a custom shared permissioned blockchain, which boasts of being developed by central banks for central banks. At the core are the four central banks that provide for the issuance and redemption of CBDCs.

Commercial banks can apply for CBDC issuance against reserves in their local currency at their local central bank and also redemption. Also, they may have foreign CBDCs. Commercial banks can initiate peer-to-peer push payments for trade in any platform digital currency. And they could also run FX PvP with other commercial banks.

FX trading proved less popular for a couple of reasons. Partly because some central banks required them to offload foreign CBDCs by the close of the day. Additionally, there was a discrepancy in RTGS hours, exchange rates determined outside the bridge, and the need for more liquidity. These are all factors that will be addressed during the next phase.

Custom blockchain and privacy

The report contrasts the custom distributed ledger (DLT) with “other multi-CBDC projects, in which the underlying technology was built by entities other than the central bank.” To be fair, the MBridge team did not build a blockchain entirely from scratch. It uses the Ethereum Solidity smart contract language, the Ethereum virtual machine, and HotStuff+ for consensus. In a bit of irony, Hotstuff’s main claim to fame was as the consensus mechanism of choice for the Libra/Diem stablecoin project that was rejected following rejection by regulators.

In terms of privacy, a central bank can see all commercial banking transactions in which its local bank is involved. For some central banks, this is a significant expansion in day-to-day transaction visibility with potential privacy issues not mentioned in the report.

The authoritative nature of the ledger means that each commercial bank can only see its own transactions. And sensitive data is stored outside of the ledger. For the next phase, zero-knowledge proofs are being explored “to enforce stronger privacy against arbitrary central bank validators.”

Other participants

Of the 20 commercial banks, several were foreign branches of the same banks. Thus, the high-profile banks involved were the five largest Chinese state-owned banks and HSBC and Standard Chartered.

Observer central banks included those of the Philippines, Malaysia, Indonesia, Korea, Sweden and Israel. Staff from the London BIS Innovation Hub also looked on, as did representatives from the Federal Reserve Bank of New York’s innovation hub.

Notably, Malaysia is involved in another multi-CBDC initiative, the Dunbar Project, which is run from Singapore. And the Philippines is also considering joining Dunbar.

Both multi-CBDC projects highlighted the political challenges of allowing foreign banks to hold a CBDC when central bank money is typically only available to locally supervised banks.

One key issue MBridge has yet to address is how to back a foreign currency not represented by participating central banks. The US dollar is the most obvious.