The widespread adoption of cryptocurrencies remains a question for the future to answer, but there are clear signs of banks and other financial institutions moving ahead with specific use cases.
Institutions are focused on three primary forms of digital money: stablecoins, tokenized bank deposits, and central bank digital currencies (CBDCs). In countries where central banks opt not to issue CBDCs directly, commercial banks will have a role in issuing and managing CBDCs for the public.
A recurring theme in the recent Fintech Connect conference in London was the growing use of wholesale CBDCs to move money across borders — something that TradFi looks to be deeply focused on.
Here is our recap of what we felt were the major talking points across the conference.
Rita Martins, a financial services executive and former Head of FinTech Partnerships for Global Functions at HSBC, explained the focus on institutions:
“With retail, there’s a lot of risks, because you have a wide spectrum of people, and you don’t know how much they understand all the risks they are taking.
“So until there is real regulation, I don’t think we’ll see banks coming into retail. And that’s why they have started with the institutional clients.”
For these various institutional solutions to work with CBDCs, public stablecoins, and other forms of digital assets, interoperability with the broader financial infrastructure will be critical.
Citi Token Services tokenizes the dollar and allows the bank to move money 24/7 between its branches, starting with Singapore and New York, with plans to expand from there.
David Cunningham, Head of Strategy & Partnerships for Digital Assets, Treasury and Trade Solutions at Citibank, said:
“We move about $6 trillion a day. The total market cap of stablecoins is about $150 billion. We would need about 40 times that amount just to move money on behalf of our clients today.
And we need credit, and we need more liquidity into the ecosystem, so that’s the role commercial banks can play.
But some of the big challenges we have are how is that tokenized money going to interact with the regular financial market infrastructure?”
“The main difference is, for these tokens, they’re a promise to pay by somebody,”, he added. “So, if it’s a central bank, they promise to pay from a sovereign currency. If it’s a commercial bank, we promise to pay from a regulated institution.
“But it doesn’t need to be backed one-to-one in the same way that stablecoins are because, in the same way that we create commercial bank money today, it’s up to us to honor it.”
The Interaction Between WCBDCs and Bank Stablecoins
Wholesale CBDCs are digital currencies issued by a country’s central bank. They are distinct from retail CBDCs as they are not designed to be used by the general public but specifically for use by financial institutions such as banks and other wholesale participants in large-scale financial transactions.
One of the primary uses for wholesale CBDCs is to facilitate high-value and time-sensitive interbank transactions and settlements.
They can be used alone or interact with private bank-issued stablecoins to transfer funds securely between financial institutions and across borders in real-time, increasing the efficiency of the payment and settlement systems.
Several banks worldwide have launched digital tokens in some form, such as JP Morgan’s stablecoin JPM Coin, on the Onyx bank-led blockchain platform.
On December 6, Societe Generale-Forge (SG-Forge), the French bank’s cryptoasset subsidiary, launched a euro stablecoin on the Ethereum blockchain EUR CoinVertible (EURCV) on the Bitstamp exchange.
It is the first EUR stablecoin to be issued on an exchange by a fully regulated subsidiary of a global bank.
The bank stated that the launch aims to meet growing customer demand for a settlement and store-of-value asset for on-chain transactions, a solution for cash management and cash pooling activities, and enhanced collateral management. The move came after the bank on November 30 issued its first digital green bond as a security token directly registered on Ethereum (ETH).
In September, Citibank’s Treasury and Trade Solutions (TTS) business unit announced creating and piloting Citi Token Services for cash management and trade finance, integrating tokenized deposits and smart contracts to provide digital asset solutions for institutional clients.
And in November, a pilot between Citibank, T. Rowe Price Associates, and Fidelity International joined the Monetary Authority of Singapore’s Project Guardian asset tokenization trial to test institutional-grade mechanisms to price and execute bilateral digital asset trades and explore real-time post-trade reporting and analytics.
So How Will Asset-Backed Currencies Reach Institutions?
While there is some debate as to whether stablecoins, tokenized assets, or CBDCs will reach widespread public adoption, there are ways in which they can interact at the institutional level.
Emma Landriault, Vice President of Product Management at JPM Morgan’s Onyx Coin Systems, said:
“We’re seeing adoption where there are use cases where funds need to be moved across complex webs of intermediaries. And it requires the synchronization and harmonization of multiple different systems that sit in different silos.
“One example of this would be in the payment space. For both cross-border and domestic payments, we rely on the synchronized clearing and settlement of payments across a variety of systems.
“I think what’s important is that one innovation is not going to exist at the detriment of another.
“Looking specifically at the commercial bank money token relationship with potentially a wholesale CBDC, the answer is simple — it’s interconnectivity, in the same way that commercial bank money is interconnected with central bank money today,” Landriault added.
“And this is important because we may have environments or ledgers that we want to issue commercial bank money tokens onto and allow those commercial bank money tokens throughout a given trading period, or a given daily period or to the specific net tab, we want to allow them to move a little bit more freely and to be transferred freely within these kinds of trust environments so that they can work in the same way that cash works today.
“One example of this is that you might use a deposit token to do delivery versus payment with a tokenized security and then use that same token to post it as margin for a collateral call. And today, we don’t need to take our money out of an ecosystem to do that.
“And if we have commercial bank money tokens, we have the flexibility to enable that transferability in a more fluid fashion. But to maintain financial stability and the singleness of money, they still need to have that end finality where you can net positions in a central bank, in central bank money.”
A Question of Interconnectivity
Landriault continued: “This is interesting because we could implement it in a couple of different ways. There are different solutions for central bank money — central bank digital currencies, some more native token-based solutions, and some more like a trigger solution where you’re triggering API calls to move those balances.
“And the beauty of having that flexibility is that when you have a private sector, commercial bank money token that has a little bit more flexibility in the design and in the programmability, then you can integrate with a variety of these different systems in a significantly easier fashion.
“So, it’s going to be a question of interconnectivity; we believe that deposit tokens will connect with central bank money, a central bank digital currency so that we can maintain financial stability but also exploit some of the benefits that a token format of commercial bank money could bring.
“The other key use case looking forward is certainly settlement functions and specifically settlement in capital markets, or securities settlement, where right now we have intermediaries who are managing the process flow all day long, and then have to go and settlement with central banks have to align all of the different parties within the value chain.
“But by bringing in solutions like deposit tokens that can be issued natively onto blockchain ledgers where tokenized securities can also say we can bring in atomic delivery versus payment and create frictionless real-time final settlement on the solution,” Landriault said.
German commercial institution DZ Bank has developed a smart derivative contract (SDC) to enable real-time settlement of over-the-counter derivatives trades using a digital token. The trading of derivative products has become increasingly centralized since the 2008 financial crisis with the collapse of Lehman Brothers, and traders remain exposed to counterparty risk.
To address this, the SDC runs on distributed ledger technology (DLT) and digitizes the trading process, including all the documentation in the contract. By incorporating pre-funding from decentralized finance (DeFi), the process is executed automatically, and there is less chance of default or dispute.
“There’s no settlement risk anymore because there’s no collateral process, and the counterparty credit risk is economically zero because of the pre-funding mechanism,” said Peter Kohl-Landgraf, Senior Business Analyst at DZ Bank.
In essence, the contract is settled at the end of the day, reducing processing times and costs. The SDC can be a digital escrow, with funds locked in the contract. If the settlement fails, the SDC automatically transfers the termination fee from its own balance to the receiving party’s balance.
The German central bank — the Bundesbank — is working with the European Central Bank (ECB) and other euro-area central banks on potentially introducing a digital euro CBDC. DZ Bank’s open-source SDC could run directly on the Bundesbank blockchain, “then it could show its full potential because it would be fully decentralized, and it would directly settle against target systems against central bank money,” Kohl-Landgraf said.
The Challenge of Interoperability
There is a danger of disparate projects emerging that are unable to interoperate or expand at scale, according to John Ho, Head of Legal, Financial Markets, at Standard Chartered.
“One of the big challenges we’re seeing right now is because the number of initiatives — notwithstanding they’re well-intentioned — they’re built within a private permissioned network, and as a result, the different networks create a walled garden,” Ho said.
“The key point is to make sure that there’s some form of harmonized network standards, messaging standards… for a wider adoption because otherwise you’re going to create silos. And that would not be able to scale.
“When this technology matures, and we see more probability at scale, with parties able to connect to each other, perhaps you could see this momentum growing,” Ho said.
The current emergence of public permissioned, public permissionless ledgers and private ledgers will require standardization.
For instance, SG Forge is operating its digital assets on public blockchains. In contrast, US bank Goldman Sachs has used a HyperLedger private blockchain for its recent digital bonds issuances, said Laurent Marochini, Head of Innovation at Societe Generale.
“We have done everything on the public blockchain, however we have to look at the interoperability because I don’t believe that we will have a lot of CBDCs on the public blockchain.”
Each bank or financial institution is likely to have its own blockchain, of which some will be public and some will be private, depending on their risk tolerance, according to Martins. As regulated institutions, banks and other financial services providers will need to adhere to anti-money laundering (AML) and other regulations, which will present challenges to operating on public blockchains.
“Some of the public blockchains are already trying to work with different techniques to try and bring some of that privacy component to public blockchains. So we are also going to see the evolution of what a public and private blockchain are,” Martins said. “The public blockchains in the future are going to be different than today.”
The Swift network, which facilitates communication and transaction processing between the world’s banks, will have a central role in supporting digital asset interoperability.
“Swift was formed 50 years ago precisely to solve the problem of interoperability,” said Pallavi Thakur, Director of CBDC and Interoperability at Swift.
“Today, again, we are at the same inflection point where you have multiple digital networks coming that don’t talk to each other. And how do we move values because there will be people making payments from one network to another… we have to enable instant frictionless payments, irrespective of digital topology.”
But there are not only the technical challenges of interoperability; there are also regulatory challenges, Thakur noted. There are many countries in the world where capital controls are in place, and any new international digital payment networks will need to comply.
The Question of Regulation
Swift’s CBDC Working Group and beta testing connector are developing a standard layer of functionality, enabling CBDC networks, tokenized asset networks, commercial bank money networks, and stablecoins that can operate across jurisdictions and types of institutions while complying with local regulations.
“The risk is because we have different approaches from the Fed versus other regulators around the world, we end up with a fragmented system of blockchains, and that feeds into the need for interoperability between blockchain networks because private permissioned are mandated by some institutions and public permissionless among others, so we have this kind of fragmented environment which is one of the inhibitors,” said Keith Bear, a fellow at the Cambridge Centre for Alternative Finance.
Ho noted that regulations in most countries would need to change, as existing laws do not allow central banks to issue money in digital form. There are also questions as to whether they will embed the ability to programmability, which raises concerns about privacy and civil liberties that must be addressed before CBDCs can reach large-scale adoption at scale.
If there are some CBDCs that are programmable while others are not, there will be even more of a need for alternative forms of digital assets, Landriault said.
“It’s not necessarily going to be one solution to rule them all — we’ll likely have the connectivity of commercial bank deposit tokens and CBDCs in specific use cases… we’ll start to see how many of these transaction processing controls will be moved to a native environment where commercial bank money tokens are issued versus how many will stay off-chain.”
While financial institutions wait for clarity on what the future of retail cryptocurrencies and CBDCs might look like, they are increasingly moving ahead with wholesale CBDCs and tokenized deposits as a way to modernize, automate, and enhance the efficiency of the financial infrastructure.
Commercial bank tokens can work with CBDCs to facilitate faster and cheaper cross-border payments and reduce settlement times and counterparty risks in large-value transactions.
How these assets interoperate in the future will depend on developing international standards enabling connectivity and supportive regulatory frameworks.