The SWIFT Experiment for Central Bank Digital Currencies - ‘Connecting Digital Islands’

Introduction

SWIFT have claimed that after successful testing in a sandbox setting with the participation of central and commercial banks, the company claims that its clients are starting to see "obvious promise and value" in Swift's innovative CBDC interoperability solution. It is evident that central bank digital currencies (CBDCs) are gaining popularity. So how can we guarantee that the expanding global payments ecosystem can continue to easily interoperate, regardless of the form value takes, as central banks throughout the world continue to investigate the possible use of central bank-backed digital money in their local markets? We try to unpack this further in this latest article on SWIFTs proposed solution.

As the use of digital currencies grows, enabling interoperability with new innovations is a core emphasis for Swift and a major problem for the financial sector [SWIFT].

Background

The CBDC (Central Bank Digital Currency) solution concept for SWIFT (Society for Worldwide Interbank Financial Telecommunication) connector refers to a potential strategy for central banks to use SWIFT's global messaging network as a means of facilitating CBDC transfers and exchanges between various financial institutions and central banks.

Swift's goal is quick and hassle-free cross-border transactions, and in that light, they have been studying CBDCs for a while. With a focus on the use case for cross-border payments, we established an innovation project in 2020 to comprehend the effects of CBDCs and digital currencies on Swift and their members.

This research attempted to comprehend, for instance, how a company in a nation with a CBDC may conduct business with another company in a country where the currency is not a CBDC. For these kinds of transactions, CBDCs present a variety of issues, posing both possibilities and obstacles.

According to SWIFT, their solution proposes to offer a standardized messaging protocol for CBDC? transactions, enabling participating institutions to make and receive CBDC payments in a safe and quick way. This would make it possible for financial institutions affiliated with various central banks to trade in CBDC across borders, as well as speed up and make domestic CBDC transactions more transparent.

SWIFT have stated that they are collaborating closely with the financial sector to find a solution to this problem so that as CBDCs advance, cross-border use will be possible as well. They recently declared in October of last year that they had created a successful method for CBDCs to switch between fiat-based and DLT-based systems utilizing already-existing financial infrastructure.

They now claim they have now put that approach to the test with 18 central and commercial banks in a sandbox setting. Participants enthusiastically endorsed the solution's further development, pointing out that it allowed for the easy interchange of CBDCs, even those created on other platforms.

The Testing Specifications

The testing and development of the solution have in fact included international cooperation. The Monetary Authority of Singapore, the Banque de France, the German Bundesbank, BNP Paribas, HSBC, Intesa Sanpaolo, NatWest, Royal Bank of Canada, SMBC, Société Générale, Standard Chartered, and UBS were among the institutions that took part in the sandbox. Four other central banks were spectators, offering suggestions and criticism but not taking part in the sandbox.

During the 12-week collaborative testing period, participants processed a total of 4,736 transactions between the Quorum and Corda blockchain networks, and between Corda and a fiat currency.

SWIFT have stated they will be creating a beta version of the payment solution in the upcoming months so that central banks may test it out further. Also, a second round of sandbox testing will be conducted, allowing the Swift community to work together more closely while concentrating on fresh use cases such as conditional payments, trade finance, and cross-asset exchange in the settlement of securities.

Solving the Interlinking Challenge?

The SWIFT approach aims to demonstrate the possibility of seamless cross-border interlinking between multiple CBDC and RTGS networks. While individual CBDC network operators will develop CBDC networks, we built a sample implementation based on the following elements to illustrate the concept:

1. CBDC Networks: Two simulated CBDC networks are used in the solution, one running on R3 Corda and the other on Quorum. CBDC network administrators will control and manage a "trusted DLT node" Swift's solution will construct.
2. RTGS Simulator: As the adoption of CBDCs is expected to be slow, we presume that it would be essential to conduct transactions between a traditional RTGS and CBDC network. As a result, they simulated an RTGS environment in this situation.
3. Swift CBDC Connector Gateway: Using the Swift platform emulator, a Swift CBDC Connector Gateway was created to enable smooth connections between diverse networks. Being a single point of entry and exit for cross-border payments into and out of the CBDC network, this gateway serves as a standardized interface for all communication between the Swift platform simulator and the CBDC network. The gateway, which is operated on a regulator node, gives network operators the freedom to implement their connection to the gateway in accordance with the specific network design of their organization. This freedom includes the freedom to use any smart contract protocol, conditional payment protocol, messaging format, etc.
4. Swift Platform Simulator: The key tenet of Swift's transaction management philosophy is that it permits interoperability across various standards, channels, protocols, and monetary systems while including ancillary services to ensure that the payment is safe, secure, and complete. A platform simulator was employed in order to take advantage of these features, adding the possibility for expansion of value-added services like KYC, AML, security, integrity, transparency, sanctions screening, etc.

In addition to these high level IT components the following specifications were included in the design of the proposed solution including: the use of:

• ISO 20022: To be effective, cross-border payments have a complicated procedure that involves several parties. In contrast to MT format and other native formats, ISO 20022 has a large amount of data and supports a wide variety of characters. This data message may be used by the IT system for procedures like AML, fraud checks, etc. because it is in the XML format.
• PKI: This solution leverages PKI based identity. The identity is used by participating banks to sign ISO 20022 messages sent over the DLT network.?

There are many possible design choices currently being explored by various central banks for the purpose of creating CBDCs. As such, in our experiments, we implemented two different DLT networks, Corda and Quorum, to show the interlinking between different networks. In addition to these simulated CBDC DLT networks, a third mock-RTGS network was also created to demonstrate a hybrid cross-border flow. This experiment showcases two high-level use cases: CBDC to CBDC (both Corda to Quorum, and Quorum to Corda) and RTGS to CBDC (RTGS to Corda). In addition to these standard flows, exception scenarios were implemented

The Payment Flow for the SWIFT CBDC Connector

Here are the steps involved in the operation and functioning of the SWIFT CBDC connectors:

1. Issuance of CBDCs: The central bank of a country issues CBDCs as a digital version of its currency. These CBDCs are then made available for purchase or exchange by financial institutions that have access to the SWIFT CBDC Connectors.
2. Access to SWIFT CBDC Connectors: Financial institutions that wish to exchange CBDCs need to have access to the SWIFT CBDC Connectors. To do so, they need to be a member of the SWIFT network and also need to be connected to the CBDC platform of their respective central banks.
3. Transaction Initiation: A financial institution initiates a CBDC transaction by sending a message through the SWIFT network to the recipient financial institution. The message includes details such as the amount of CBDCs to be transferred, the sender's account details, and the recipient's account details.
4. Authentication and Authorization: The SWIFT CBDC Connectors authenticate the transaction message and check if the sender has sufficient funds to complete the transaction. If the transaction is authorized, the SWIFT CBDC Connectors communicate with the central bank's CBDC platform to verify and authorize the transaction.
5. CBDC Transfer: Once the transaction is authorized, the CBDCs are transferred from the sender's account to the recipient's account. The SWIFT CBDC Connectors update the transaction status and send a confirmation message to both financial institutions.
6. Settlement: The final step involves settlement of the transaction. The central bank updates the CBDC accounts of both financial institutions to reflect the transfer of CBDCs. The SWIFT CBDC Connectors also update their records to reflect the completion of the transaction.

Pilot Testing Outcomes

SWIFT have now stated that they have now tested that solution in a sandbox environment with 18 central and commercial banks. Participants expressed strong support for the solution’s continued development, noting that it enabled seamless exchange of CBDCs, even those built on different platforms.

In addition, SWIFT noted that participants' expectations about how CBDCs would probably operate in the future are "strongly aligned" to one another. SWIFT intends to run a second phase of its CBDC sandbox and create a beta version of its "CBDC interlinking solution for payments with increased atomicity" as its next steps.

“Our solution has been successfully tested across almost 5,000 transactions between two different blockchain networks and a traditional fiat currency, and we’re delighted to have the support of our community in developing it further. Many participants have made clear their desire for continued collaboration on interoperability, and this is particularly pleasing,” says Tom Zschach, Chief Innovation Officer at Swift.

SWIFT have also claimed that ‘almost 5,000 transactions across two separate blockchain networks and a conventional fiat currency have successfully proven their solution, and they are buoyed to have the community's support in further expanding it’. SWIFT is also encouraged that so many participants have expressed a willingness for further cooperation on interoperability, the author notes.

As a result of the latest tests' success, SWIFT have shown the technological viability of our CBDC interlinking solution, which substantially simplifies connecting CBDCs to other financial networks by utilizing standards and a gateway in each network. It may offer a highly scalable solution to the "one-to-many" problem that bilateral connectivity is unable to handle, while more accurately simulating the flows that commercial banks are accustomed to from established cross-border transfers.

Summary

It can be observed that SWIFT has highlighted the need for an environment that enables us to interact, test, and cooperate with consumers in a creative and open manner as part of their continuous CBDC experiments and research. In order to investigate prospective use cases and greater CBDC operability, they have created a CBDC sandbox and visual interface that are now being utilised by more than 10 institutions, including central banks, market infrastructures, and commercial banks from across the world.

The SWIFT connector CBDC solution idea may be a viable strategy for making it easier to transmit and trade CBDCs securely and effectively on a worldwide scale, while simultaneously fostering standardization and interoperability within the CBDC ecosystem. It is crucial to keep in mind that this idea is still in the development stage and that a variety of circumstances, such as legislative requirements, technology limitations, and stakeholder preferences, will affect how it is implemented.

The sandbox, which incorporates different blockchain technologies, not only enables bilateral testing but also gives consumers the chance to provide Swift real-time feedback and share their problems with the company.