The current monthly report from the Bundesbank explores the options available to the financial industry for payment processing as digital transaction technologies become increasingly prevalent. It is expected that the combination of Distributed Ledger Technology (DLT), digital asset tokenization, and digital money could generate significant efficiency gains for the financial industry. “Through the use of DLT, various companies can share the same database, and through automated processes known as smart contracts, coordination costs and ultimately back-office costs can be eliminated,” says Martin Diehl, payment expert and co-author of the report.
CBDC, Stablecoins, or Tokenized Deposits
For larger financial market transactions, digital central bank money (CBDC), tokenized deposits, or stablecoins are being considered. However, the acceptance of stablecoins in the financial sector may be questionable due to their governance structure and the quality of the underlying collateral, according to Diehl. Some banks are working on tokenized deposits, which would represent a further development of current commercial bank money based on DLT. However, numerous legal and practical questions remain unresolved, and there is a high coordination effort required between banks. Additionally, like any commercial bank money, there is a risk of failure with tokenized deposits, Diehl warns.
Wholesale CBDC as a Solution?
For these reasons, many central banks worldwide are exploring wholesale CBDC, which refers to digital central bank money for a restricted user group within the financial sector to facilitate DLT-based transactions. If new technologies like DLT reach maturity and market penetration, it must be ensured that central bank money can be used for these new types of transactions, according to the authors. While innovation and functional advancements should not compromise the stability and security of central bank money, it is essential to prevent a decline in the significance of central bank money due to outdated settlement structures.
Martin Diehl emphasizes that central bank money should always be the first choice for settling large-value transactions for financial stability reasons. To ensure this, central banks need to consider new digital settlement options. While it is possible for third parties to operate a DLT infrastructure for the settlement of digital central bank money, Diehl states that control over central bank money must be guaranteed from the central bank’s perspective. If the DLT network is operated on a different network, the central bank would need intervention rights. “We cannot outsource the material risk,” says Diehl. Therefore, it seems unlikely that central banks will utilize public DLT networks. Even if the arguments might suggest outsourcing central bank money to networks operated by others, reputational risks for the central bank would remain in case of problems, as stated in the monthly report.
In this context, the Eurosystem is focusing on so-called interoperability solutions. This could involve tokenized central bank money on its own DLT or providing interfaces between external DLT networks and existing settlement systems such as T2, explains Diehl. The advantage of these interfaces or trigger solutions would be the ability to leverage the capabilities of DLT-based settlement without compromising on security and stability. This would avoid negative implications for monetary policy implementation or liquidity management of banks that could arise from the introduction of wholesale CBDC.
The Future of DLT and Tokenized Deposits Remains Uncertain
The authors, led by Martin Diehl, conclude in their report that the further development of DLT and tokenized money is hardly predictable. While a large part of the financial industry is exploring DLT as a settlement technology and expecting increased usability, many initiatives have not progressed beyond the prototype stage. If DLT applications gain acceptance and market penetration, solutions to settle these applications using central bank money are likely to be developed, the authors argue. Close coordination and cooperation between market participants, banks, and central banks are essential to prevent fragmentation and isolated solutions in the future system of digital money forms. “We also need to consider how to make the central bank fit for the future,” says Diehl.
Distributed Ledger Technology (DLT)
DLT has been gaining importance in recent years. With DLT-based settlement, values and money can be represented in the form of tokens. Transaction data is recorded and stored in a distributed ledger, enabling the transfer of digital or digitally represented assets.
https://www.bundesbank.de/de/aufgaben/themen/digitales-geld-optionen-fuer-die-finanzindustrie-913154