In most of the countries, final financial settlement of any sort, either securities or payment settlement is done in central bank money.
The exchanges house, the clearing houses, all work with the central bank payment system to achieve the finality of their transactions.
Most financial assets are now digital but the process of their issuance and settlement remains highly centralized.
Listing, issuing, trading, clearing and settlement, custody services, for digital assets all are centralized on systems owned by private or government entities.
This is changing, courtesy “tokenization of everything”.
Tokenization of assets is a revolution on its own, (heard of #NFTs !). Anything can be represented into a token; real estate, art, watches, tweets !, random images, anything.
Fractional ownership usually is part of the story, along with capability of programming actions on top of tokens using smart contracts.
DLT platforms (distributed ledger technology) are the foundation on which tokens are issued and these transactions are settled. These are peer to peer, permissioned or permission less DLT networks, where transactions are immutable, irrevocable and settled instantly.
All this combined with traditional securities is creating a very diverse, multi asset type ecosystems, where settlement is done in digital currencies (which can be issued on these DLT platforms) and NOT in traditional central bank money.
“Settlement of tokenized assets in central bank money”, this is one of the biggest problems that the central banks and governments have to solve for and wholesale CBDC might just be the solution.
Wholesale CBDC is a variation of central bank digital currency issued to financial institutions and intermediaries in the country. These can be issued on a DLT platform and be used for settlement of tokenized digital assets in central bank money.
Central banks across the world are indulged in research to find the feasibility and impact of CBDC’s. Swiss national bank is working on one as well.
Project Helvetia is a multi phase experiment being conducted by BIS Innovation hub in Switzerland, SIX digital exchange(SDX), and Swiss national bank(SNB) along with a bunch of commercial banks. They conducted two POCs to evaluate the settlement of tokenized assets :
i. Issuance and redemption of wCBDC on DLT platform for settlement.
ii. RTGS link with the digital exchange (SDX) : Even though creating a link with the RTGS system (SIC) was fairly easy, it lacked the flexibility to add programming on top of the tokens.
The original concept was to use SDX coin, a Swiss Franc stablecoin with the liability on SDX exchange and not on the Swiss national bank, as a mean of settlement of the platform.
As part of this experiment, SDX coin was replaced by a novel wCBDC issued by the Swiss national bank.
The platform supports something called as atomic settlement (instantaneous and simultaneous) of tokenized assets and eliminates the step of clearing in the process entirely.
wCBDC are issued to the commercial banks and are part of the central bank balance sheet. These could be either part of the reserve balances that these banks hold with central banks or separate balances. The overall balance sheet of the SNB remained unaltered in this case.
The process is not very complicated technically, a commercial bank can issue an instruction for use of the wCBDC from its vault at the central bank and introduce it into the DLT platform, SDX in this case.
As soon as the wCBDC is issued in the exchange, commercial banks can exchange tokenized assets in a “Delivery vs Payment” model.
Commercial bank that receives a wCBDC in exchange can redeem it with central bank and update the ledger in its favor. The settlement is immutable, instantaneously, simultaneous and irrevocable.
In the economy though, wCBDC will have to be introduced into multiple DLT platforms to maintain an even playing field for all players, and interoperability between these platforms will be essential. A wCBDC in platform A has to be valid in platform, in the cryptocurrency realm, something like a wrap token.
Cross border payments settlement is a key use case that wCBDC can be used to target. Multi- CBDC bridges as a concept are being evaluated as well. It is a framework where CBDCs of multiple central banks are exchanged against payment to achieve international payment settlement instantly.
Wholesale CBDC is a concept that exists to counter the cryptocurrency adoption across the globe, which challenges everything that the central banks stand for. wCBDC will be an important tool for central banks to stay relevant, but I believe it will not be enough. Some sort of democratization will make a huge difference.
If one or more decentralized digital currencies are to take over a major share of settlements in the world economy, the relevance of the governments, central banks and the money issued by them will diminish and may be even become obsolete. This scenario is not too farfetched anymore.
Central banks have to adapt, collaborate or build, what ever it takes, they will have to come into the new world order and stay relevant. Just regulations against the decentralized ecosystem will not be enough.
Image credit : @InvestaX Tokenized Bored Ape.