As developments in digital finance gain traction, the future of our financial systems stands to look radically different. To discuss these developments and more, experts on central bank digital currencies, payments, tokenisation and artificial intelligence gathered in Knightsbridge for OMFIF’s 2024 Digital money summit.
Against a lively atmosphere – with frank views and differing opinions exchanged between the public and private sectors – participants gained some immensely valuable insights into the trajectory of technological innovation in finance and payments.
Momentum builds for tokenisation in 2024’s zeitgeist
Tokenisation – representing ownership of an asset on a digital ledger (usually a blockchain) – has found a level of momentum that it has never had before, with the Bank of England’s former deputy governor for financial stability, Jon Cunliffe examining its potential in his keynote speech. The technology itself is not new. The first blockchain bonds were issued around seven years ago, but a confluence of factors has spurred interest in the concept.
First, Bank for International Settlements governor AgustÃn Carstens has made it a central tenet of the BIS’ vision for the future of financial markets with his ‘Finternet’ paper. The paper calls for a completely interconnected network of financial ecosystems, on which a broad range of financial and non-financial assets would be represented in tokenised format and able to be atomically swapped for tokenised versions of cash in various currencies.
The vision is, to put it charitably, ambitious – one panellist at the summit referred to it more bluntly as ‘utopian’. The challenges involved in agreeing shared standards and principles for such a platform would be enormous. Not to mention, the added technical challenge of ensuring that a system of such immensely concentrated systemic importance remains secure and operationally resilient will likely be dwarfed by the problems involved in determining the governance of such a platform.
Reflecting this, a poll revealed that 34% of the audience felt that governance would be the biggest challenge in building such a system (Figure 1), beating out legal and regulatory compliance with 26% and interoperability with 22%.
Figure 1. Audience finds governance to be the most important consideration
Which of the following is likely to be the most difficult challenge when trying to build a unified ledger system?
Source: OMFIF analysis
The work is beginning, however. The Regulated Liability Network – a partnership between several banks, Swift and others – is among the most exciting projects exploring this aim.
As ambitious as the eventual vision appears, incremental changes, such as building tokenisation-powered issuance and trading platforms, asset class by asset class, might move us gradually towards a reality that looks more like the vision of the Finternet.
Projects making these changes are another reason why interest in tokenisation is accelerating. From the World Bank’s seven-year digital bond in Swiss francs launched this week, to the Hong Kong Monetary Authority’s four tranche digital green bonds in February 2024, digital bonds are moving from proof-of-concept to legitimate funding instrument.
Cash remains among missing links
Realising the potential of tokenised assets requires the tokenisation of a means of payment. While possible contenders for this already exist – such as stablecoins, experimental wholesale CBDCs and synthetic versions like Fnality – the question of how to provide tokenised cash already has technical answers. What the market is waiting for is monetary authorities to provide a policy answer, around which they can coalesce and on which, they can start to build.
Cash is a key missing link, but it is not the only one. Many of the technical questions on tokenised capital markets have already been solved, but building the full infrastructure, allowing clients to be seamlessly onboarded and interact with a new form of asset, is not yet complete.
Perhaps more fundamentally, policy-makers and market participants have yet to come to a conclusion on the roles of infrastructure providers. The UK’s Digital Securities Sandbox and the European Union’s DLT Pilot Regime are exploring the ability of distributed ledger technology-powered infrastructure to fulfil the roles of central securities depositories.
While the technology might be able to deliver a robust enough system to provide a satisfactory approximation of settlement finality, it is not yet clear that this will entirely remove the need for a central financial market infrastructure to deal with edge cases, failed trades, enforcement and supervision.
No matter who is operating the infrastructure, most of the audience was confident that DLT would underpin settlement systems in the future. In a session about the future infrastructure of capital markets, 43% of the audience felt that settlement would take place on DLTs operated by CSDs, while 30% felt that DLT settlement systems would make CSDs redundant. Only 10% felt sure that DLT will not provide settlement infrastructure.
CBDCs not the only option for retail payment developments
Market participants are eagerly awaiting the arrival of wholesale CBDCs to address their cash settlement needs, but retail CBDC projects are still in progress in many jurisdictions.
For some central banks, the rationale for retail CBDC issuance is less obvious than for wholesale. Domestic payments have been improving steadily and, with the advent of instant payment systems and projects to interlink across borders, CBDC may prove to be just one of a suite of options for the continued advancement of payments technology. In a session at the summit, 51% of the audience believed that interlinking fast payment systems was the most promising avenue for improving cross-border payments, beating multi CBDC platforms with 30%.
Delivering offline payments and privacy will likely prove to be key functions of CBDCs. However, the policy decisions as much as technology, will be key to preventing abuse, either by individuals for the purpose of crime or states for the purpose of surveillance and control.
In any case, while provision of tokenised money may be the missing link for tokenisation, there was broad agreement that a robust digital identity system is the missing link for retail CBDC.
States might also be asked to make another decision regarding the provision of payments services. In his speech, Jon Cunliffe also suggested that the possibility of new entrants to the business of transaction services and money provision might mean greater competition and innovation. Opening access to central bank accounts for non-banks, perhaps including stablecoin providers, might be an avenue to deliver this competition, but it will require policy decisions and frameworks to be introduced to ensure they are sufficiently robust.
Some jurisdictions might provide new payment provision services regulation that enables this activity without permitting a full banking balance sheet. By broadening the potential universe of payment services providers, this might deliver a more competitive and innovative payments sector.
Lewis McLellan is Editor, Digital Monetary Institute, OMFIF.Â
