New York Fed advances tests of CBDCs for cross-border payments

Even as the high-profile FTX crash sent the cryptocurrency world scrambling once again, the Federal Reserve Bank of New York embarked on projects that could inform an expanded government role in digital currencies. 

The New York Fed's innovation center and the Monetary Authority of Singapore have commenced work on an experiment that will investigate how wholesale central bank digital currencies can improve cross-border payments. In a separate project, the New York Fed's innovation lab is participating in a proof-of-concept test that will determine the feasibility of digital currencies operating in an interoperable network of financial institutions. 

The work comes amid political disagreements over whether the U.S. should have a CBDC, and the introduction of China's digital yuan, which could threaten the dollar's position as the world's reserve currency. 

"CBDCs have been creeping ever closer as the world has been watching China's digital yuan roll out, and it's likely that recent events will only accelerate the CBDC narrative," Stefan Rust, CEO of Laguna Labs, said in a research note. 

Scott Eells/Bloomberg

The New York Fed, which did not provide comment, did not link its CBDC work to any development in the private stablecoin market or volatility in the crypto market. The New York Fed also did not take a position on the necessity of a CBDC, a contentious subject among politicians and within the Fed system itself. But the New York Fed's work is also not happening in a vacuum. 

"Central banks and regulators will use the collapse of FTX as a way to promote CBDCs as a 'safer crypto environment for users,' " Rust said. 

The Singapore partnership, called Project Cedar Phase II x Ubin+, will use wholesale CBDCs as a settlement asset for cross-currency transactions. The effort involves establishing a connection between multiple simulated currency ledgers and is designed to reduce settlement risk, which the New York Fed and MAS view as a major pain point in cross-border payments.  

An earlier test of the New York Fed's Project Ceder, which used a prototype CBDC and a blockchain, reported payments cleared simultaneously, usually within 10 seconds. 

CBDC testing is essential for modernizing cross-border payments with blockchain technology, and to showcase one of the benefits for central banks to issue their own digital currency, said Anthony Welfare, senior advisor for CBDC and Global Partnerships at Ripple. Ripple has used the technology supporting the XRP token for years to speed cross-border payments, and Welfare has worked with the U.K.'s government on building use cases for a potential digital pound. 

 "Countries solely focused on building CBDCs for internal requirements miss the opportunities outside the country," Welfare said. "This means, for a digital currency to have any utility to people and businesses, it needs to coexist and interact with other payment schemes in that domestic market."

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The trials with MAS and the New York Fed, along with the many other CBDC projects taking place, will help to find ways to exchange one CBDC with another CBDC on a different ledger or platform, Welfare said, adding the Bank for International Settlements is also involved in many of the projects.   

"The next level of interoperability for CBDCs is the ability to work for global transactions. Without seamless cross-border functionality, most CBDC projects will significantly underachieve their potential," Welfare said. 

MAS did not provide comment. The Singapore banking regulator has several other CBDC projects in the works to test interoperability between nations and currencies, including work with France's central bank and other MAS Project Ubin participants. 

"[MAS] has a lot of experience in this area and has done a lot of research, so it is appropriate for the New York Fed to work with them," said Enrico Camerinelli, a strategic advisor at Aite-Noverica.  

BNY Mellon, Citigroup, PNC Bank, TD Bank, Truist, U.S. Bank and Wells Fargo are among the banks participating in the New York Fed's test of CBDCs within a group of financial institutions. Mastercard and SWIFT are also participating. The project will last 12 weeks and will use a technology sandbox and simulated data. 

The New York Fed is focusing mostly on wholesale CBDCs, which are designed mainly for large commercial banks or regulated parties that move large volumes of funds, often between countries. A wholesale CBDC uses a token to transfer value much faster than the traditional system in which central banks debit and credit accounts for cross-border interbank payments, but don't execute transfers in real time. An example of a wholesale CBDC is Project Jura, a test that includes central banks in France and Switzerland and commercial banks such as UBS and Credit Suisse.  

Wholesale CBDC projects are seen as less difficult to execute on both technological and political grounds than the consumer-oriented retail CBDCs, which are subject to the same risks and regulatory concerns as other digital payments, governing scale and money-laundering risks. There are also claims that a retail CBDC will lead consumers to pull large amounts of funds out of commercial banks, along with uncertainty over what role commercial banks will play in retail CBDCs. 

A recent report from the Biden administration, which has not taken a formal stance on CBDCs, suggests there are potential use cases for consumers, such as financial inclusion. Some U.S. politicians, such as Rep. Jim Hines, D-Conn., are in favor of CBDCs, while Republicans have pushed back on the administration's authority to create a CBDC without congressional approval. The Trump Administration was opposed to a CBDC. 

The fluctuations in the broader crypto market will likely draw more attention to CBDCs, Camerinelli said. 

"Crypto has had a negative connotation," Camerinelli said. "A CBDC provides the instant settlement but also avoids the fluctuations that you could have with crypto."