Crypto tech can improve payments

CRYPTO assets have been more of a disappointment than a revolution for many users, and global bodies like the IMF and the Financial Stability Board urge tighter regulation.

Some of the rapidly evolving technology behind crypto, however, may ultimately hold greater promise. The private sector keeps innovating and customizing financial services.

But the public sector too should leverage technology to upgrade its payment infrastructure and ensure interoperability, safety, and efficiency in digital finance, as we noted in a recent working paper: “A Multi-Currency Exchange and Contracting Platform”. Others too are advancing similar views.

Technology has jumped ahead

New payment technologies include tokenisation, encryption, and programmability:

Tokenisation means representing property rights to an asset, such as money, on an electronic ledger — a database held by all market participants, optimised to be widely accessible, synchronised, easily updatable, and tamper-proof. Anonymity of token balances and transactions is not required (and in fact undermines financial integrity).

Encryption helps decouple compliance checks from transactions so only authorised parties access sensitive information. This facilitates transparency while promoting trust.

Programmability allows financial contracts to be more easily written and automatically executed, such as with “smart contracts,” without relying on a trusted third party.

Private-sector innovation

With these new tools in hand, the private sector is innovating in ways that may be more transformative than the initial wave of crypto assets: tokenisation of financial assets, tokenisation of money, and automation.

The tokenisation of stocks, bonds, and other assets may cut trading costs, integrate markets, and enlarge access. But paying for such assets will require money on a compatible ledger. One example is stablecoins, are one example to the extent they comply with regulation. More importantly, banks are testing tokenized checking accounts. And automation is widespread, allowing third parties to program functionality much as developers build smartphone apps.

While the private sector pushes the boundaries of innovation and customization, it will not ensure that transactions are safe, efficient, and interoperable, even if well regulated. Rather, the private sector is likely to create client-only networks for trading assets and making payments. Open ledgers may emerge in an attempt to bridge private networks, but are likely to lack standardization and sufficient investment given limited profit potential. And using private forms of money to settle transactions would put counterparties at risk.

Central bank role

Central bank digital currencies can help because of their dual nature as both a monetary instrument — a store of value and means of payment — but also as infrastructure essential to clear and settle transactions. Policy discussions have mostly focused on the first aspect, but we believe the second should receive just as much attention.

As a monetary instrument, CBDC provides safety; it alleviates counterparty risks and provides liquidity in payments. But as infrastructure, CBDC could bring interoperability and efficiency among private networks for digital money and even assets.

Payments could be made from one private money to another, through the CBDC ledger or platform. Money could be escrowed on the CBDC platform, then released when certain conditions are met, such as when a tokenised asset is received. And the CBDC platform could offer a basic programming language to ensure smart contracts are trusted and compatible with one another. That too will become a public good in tomorrow's digital world.

Cross-border payments

The same vision applies to cross-border payments, although governance gets more complicated (an important topic we leave for another time).

A public platform could allow banks and other regulated financial institutions to trade digital representations of domestic central bank reserves across borders, as suggested in our working paper.

Participants could trade safe central bank reserves without being formally regulated by each central bank, nor requiring major changes to national payment systems.

Again, transactions require more than the movement of funds. Risk-sharing, currency exchange, liquidity management—all are part of the package.

Thanks to the single ledger and programmability, currencies could be exchanged simultaneously, so one party does not bear the risk of the other walking away. More generally, risk-sharing contracts can be written, auctions can support thinly traded currency markets, and limits on capital flows (which exist in many countries) can be automated.

Importantly, the platform would minimise risks inherent in such contracts. It would ensure that contracts be fully backed with escrowed money, automatically executed to avoid failed trades, and consistent with one another. For instance, a contract to receive a payment tomorrow could be pledged as collateral today, lowering costs of idle funds.

Beyond the transfer of value, encryption can help manage the transfer of information. For instance, the platform could check that participants comply with anti-money laundering requirements, but allow them to bid anonymously on the platform for, say, foreign exchange, while still seeing the aggregate balance between bids and asks.

Technology can thus support key public policy objectives:

◆ Interoperability among national cur

rencies;

◆ Safety thanks to escrowed central bank reserves, settlement finality, and automatic contract execution;

◆ Efficiency from low transaction costs, open participation, contract consistency, and transparency.

Much remains to be explored, and this vision is still taking shape. Crypto was fueled by an attempt to circumvent intermediaries and public oversight. Ironically, its real value may come from the technology that the public sector can leverage to upgrade payments and financial infrastructure for the public good — to inject interoperability, safety, and efficiency into private sector innovation and customisation. - IMF News