New technology is offering us some exciting opportunities to overhaul and improve the ways in which we pay, borrow, lend and earn. However, actually realising this potential requires systems to be designed with interoperability at the centre.
Introducing new systems is a constructive step. But when fragmentation is a key issue at hand – specifically, a surplus of competing standards and overlapping protocols — ushering in a new system can often worsen the problem.
But there are broadly three dimensions to interoperability: backwards compatibility, horizontal compatibility and regulatory compatibility.
As tempting as introducing a flashy new system to replace an old one can be, it isn’t always the answer. No matter how speedy and safe the new rails are, if the old stock can’t run on them, you’ll have to keep the old ones operating just the same – at least until the old stock can be replaced with shiny new stock, which often takes a long time.
As we assess these possibilities, it’s important to remember two things. First, the savings offered by such systems, even when they appear transformational to our way of doing business, often only materialise when they reach a critical mass of use. Second, past processes will not disappear overnight. When assessing the cost of introducing a new system, we must bear in mind that, whatever savings it promises, it will likely operate as well as, not instead of, the incumbent system it is intending to replace.
Both objections can be fatal to the development and introduction of new systems, and this inertia will lead to unsatisfactory outcomes. The only way to mitigate their effect is to ensure backwards compatibility. For capital markets in particular, as new blockchain-based securities begin to emerge, it is vital that they be freely exchangeable with conventional instruments or the investor base for both will be reduced and their value compromised.
Unless newly introduced systems allow money and assets to flow freely between different rails and mediums of exchange, they risk creating walled gardens.
Blockchain – though often touted as a solution to interoperability challenges faced by incumbent systems – is vulnerable to this kind of risk. Tokens issued on one blockchain protocol are not necessarily usable on another. Building interoperability bridges and ensuring that they are both safe and efficient is not just complex but also technically challenging.
Even if all the complexities of different banking system structures and different data protocols are managed with technical solutions, the flow of payments and business across borders still depends on regulatory harmonisation.
Delivering interoperability across these three dimensions is vital to delivering on the potential that new technologies offer. All too often, new systems for payment or asset settlement are conceived as if for Plato’s Republic — a vacuum where we can deploy our ideal systems from the ground up.
Sadly, this is not the case. Any new technology will be deployed into our messy and complex world of overlapping platforms and legacy systems. Cleaning this up, consolidating and making progress can only come from acknowledging the realities of our present ecosystem and building to fit them.
Fortunately, these lessons are well understood by the Digital Monetary Institute community. This year’s 2024 annual features contributions from members from a variety of sectors, all on the theme of interoperability — its value and the challenges of delivering it.
For the 2024 DMI annual, Wolfram Seidemann, chief executive officer of Giesecke+Devrient Currency Technology emphasises the need for a central bank digital currency to serve as an open infrastructure ‘that not only allows interlinkages, but interfaces with other systems’. While interoperability is thought of as being able to connect the wider payments ecosystem, Charles Kerrigan, partner, CMS, advocates for a blockchain-enabled interoperability solution to enhance the adaptability of financial systems overall.
On the role of interoperability in improving global growth and scalability, Jonathan Ehrenfeld, head of securities strategy, Swift, underscores the importance of ‘a global mindset’ and seamless connectivity across diverse networks and systems. However, looking more closely, Ezechiel Copic, director of digital currency policy, Visa, contends that interoperability has immense potential for small businesses. The feature will enable ‘more timely and greater access to global markets, thus allowing small- and medium-sized enterprises to grow their businesses’.
While there are key advantages to the technology, the concept is not without its challenge – namely ‘global and national regulatory frameworks, standardisation hurdles as well as security and privacy concerns’ as James Wallis, vice president, central bank engagements and central bank digital currencies at Ripple argues. But it will be essential to unlocking the potential of a fully digital financial ecosystem, says Steffen Schacher, Universal Digital Payments Network lead, GFT.
2024 is likely to be another year of rapid and dynamic evolution in the digital money space. As technical developments come into alignment with strategic objectives, it is worth highlighting a final, vital aspect of interoperability: institutional collaboration. Building flexible, interoperable systems in isolation is much more difficult than building them as part of a vibrant and collaborative community. But real potential lies in how we can transform the world of money, especially how we transact, as Dirk Cavens, chief product officer and Victoria Cumings, chief legal and regulatory officer at RTGS.global.
With fierce competition within the private sector to develop interoperable solutions, it’s becoming increasingly important to create a standardised framework that facilitates smooth interaction between financial technologies. Between its challenges and its potentialities, OMFIF looks forward to another year facilitating productive discussions within the digital money community.
Lewis McLellan is Editor, Digital Monetary Institute, OMFIF.
Read the 2024 DMI annual here.