Facilitating cross network CBDC interoperability

June 25, 2021

Central Bank Digital Currency (CBDC) is a unique asset class that is created and controlled by sovereign entities, who have sole jurisdiction over the use, control and evolution of the currency.

In the technical debate around CBDC, interoperability is sometimes portrayed as a straight binary trade-off against network sovereignty, with issuers expected to sacrifice control of their network and its consensus systems to be able to interact with other issuers.

We are excited to report that this is no longer the case. We have developed a solution to enable interoperability between two sovereign networks, without requiring the network operators to trust each other, or give up control over their assets. Utilising Corda’s design, our blockchain-based protocol allows cross network transactions to be performed in a cryptographically provable safe fashion in a trustless environment, giving transacting participants the confidence that their assets will be safe from counterparty risk or potential breaks, which would have previously resulted in painful reconciliation processes or potential fraud.

This ability for two networks to interoperate not only maintains — but may also increase — the current level of control that participants, such as central banks can exercise over their respective currencies. It is now possible to perform a truly peer to peer transfer of value, without the requirement of a third party to facilitate. By removing the third party, central banks could deploy CBDCs in an environment with greater efficiency, lower risk and with greater systemic resiliency than were they to rely upon centralised systems.

In the past, one central bank may have had to grant power to another to finalise transactions in its currency, or a new centralised intermediary would have had to be created. Today, however, we can envisage a better solution, one which works with the grain of the existing financial system, which is inherently decentralised already. And it is the combination of cryptographically secure APIs at the level of the individual central banks and ‘atomic swap’ protocols coordinated by a battle tested blockchain platform that provides the answer.

Description of the protocol — “Happy Path”

Starting with the simplest network setup:

We have two issuers, each with their own network and consensus systems (notaries in Corda), and two commercial banks.

Issuer One only trusts its network, and Issuer two only trusts its network. Between these two networks, the commercial banks wish to exchange $100 for £80. In the classical method, this would occur as one bank posting $100 and the other returning £80 at some time later using an existing correspondent banking relationship or through an FX exchange.

classical correspondent banking exchange

By leveraging blockchain and smart contract technology, it is possible to improve on this by removing the counterparty risk of the second £80 not being posted.

This starts off with Bank 1 building a transaction which will move $100 from itself to Bank 2

Bank1 proposing TX to move $100 to Bank2

Bank2 inspects TX and extracts lock parameters

Having calculated these pieces of information, Bank 2 is now able to start the process to encumber the £80 it would be sending in exchange by creating a “Lock”. Encumbrances in Corda enforce the rule that any two states which are encumbered on each other, must be spent in the same transaction.

The “Lock” is comprised of notary public key, and expected TX hash

In this case, the locking state has very simple rules, it can only be “spent” by a transaction which includes a signature from the USD notary, over the previously determined transaction hash. Because Corda provides finality when the notary signature is provided, Bank 2 can be certain that if this signature is available, the USD has been spent and now owned by itself.

Bank2 building encumbered transaction for the £80

Bank1 inspecting encumbered TX obeys sensible rules before committing it’s $100 to the ledger

Bank1 submits the $100 TX to the ledger

Bank1 is now able to use the signature for the USD TX to unlock the GBP

Conclusion

We are excited at to continue to work with our ecosystem and with the industry to progress CBDC initiatives worldwide. The introduction of cross atomic swaps paves the way for scaling and interoperability between multiple networks without the need for establishing one-to-one integration or relying on the existing financial infrastructure and is another step on the path to making such cross-border settlement a reality. Please reach out to us to learn more about this work and about the many exciting things happening with digital currencies at R3