Home Cryptocurrency How do Digital RMB smart contracts work? First supply chain finance use cases – Ledger Insights

How do Digital RMB smart contracts work? First supply chain finance use cases – Ledger Insights

by Harry Garcia

ICBC, China’s largest bank, and e-commerce giant JD.com have collaborated to develop a supply chain finance solution based on digital RMB smart contracts. This is one of the first business applications of smart contracts in the broader ecosystem of central bank digital currencies (CBDCs), which raises interesting questions about the future of banking.

Earlier this month, JD.com participated in the first automated supply chain finance credit using digital RMB. Typically, supply chain finance solutions involve a large company working with its bank to provide credit to its suppliers. In this case, large companies pay the funds directly and instantly to the suppliers using CBDC, eliminating bank settlement delays. By combining CBDC and smart contracts, JD.com showcased the possibility of working directly with multiple financiers without the need for a third-party provider.

Smart contracts are pieces of programming code that add payment conditionality and programmability to transactions. They are separate from the CBDC system but are used to facilitate and execute transactions. The smart contract platform allows organizations to develop contracts based on central bank rules and standards with the help of big banks. The contracts are then submitted to the central platform for review and approval. Once approved, the contracts become open source templates that can be reused by others.

It is unclear whether the smart contracts run on the banks’ infrastructure or the central bank’s infrastructure. Given the added layer of security provided by banks in CBDC transactions, it is logical for them to host the smart contracts. The framework for smart contracts outlined by the head of the central bank’s Digital Currency Research Institute emphasizes the need for secure and convenient development and interoperability with external systems.

While the digital RMB itself is not programmable money, it can work in conjunction with smart contracts to achieve similar functionality. For example, programmable smart contracts were used in China’s digital RMB ‘red envelope’ giveaways to promote adoption and implement restrictions on where the CBDC could be spent. Smart contracts also enforced expiry dates on the red envelopes, reclaiming unused currency after the validity period.

The impact of CBDC smart contracts on commercial bank money is a critical consideration. In the UK, Barclays highlighted the importance of functional consistency between bank deposit tokens and CBDC to ensure interoperability. It remains to be seen to what extent banks in China can integrate their own payments with the digital RMB smart contract platform. If the functionality is restricted to CBDC, it could put commercial bank money at a disadvantage, limiting the capabilities of smaller banks.

The concept of open source in the context of CBDCs and smart contracts raises questions about the commoditization of banking services and how banks in the West will respond. Open source accelerates innovation but can also benefit those with brands and scale. Legacy systems may slow down the adoption of open source in existing banks, giving new entrants an advantage. If higher-value activities become open source and automated, it could impact competitive advantage in the banking industry.

The supply chain finance example demonstrates the potential for CBDCs to disintermediate banks, not just for payments but for other functions as well. Traditionally, a single bank acts as the main conduit for supply chain finance, but with digital RMB, multiple financiers can compete. This may result in the disintermediation of trade finance platforms. In a distant future, banks could compete for lending opportunities on centralized smart contract platforms, similar to the concept of narrow banking where lending is the primary role of commercial banks. This has significant implications for commercial banks and existing platforms for trade finance and other banking services, raising questions about the role of central banks in the broader banking landscape.

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