Disrupting the payments stack

COVID-19 has prompted a fair amount of reassessment in the financial sector. But, in truth, digital disruption to the global monetary system was underway long before the pandemic emerged.

Cash usage has been steadily falling – albeit accelerated over the past few months by a huge swing towards online shopping, while ‘bricks and mortar’ merchants have been reluctant to handle coins and bills, and encouraged by governments raising contactless card payment limits to make the digital switch. Meanwhile, digitally distributed stimulus payments to citizens and businesses, to protect them from the economic ravages of the pandemic, have, unsurprisingly, been seen as quicker and more efficient than simply sending out cheques. And alongside all this is the emergent parallel world of cryptocurrencies and stable coins.

The change in how we pay and what we choose to pay with has far-reaching consequences – not least for central banks who preside over the world’s monetary systems. Many of them are now questioning whether the token of value on which they’ve built centuries of thinking and systems – cash – is really up to the job or whether they should now commit to issuing central bank digital currencies (CBDCs). It’s a huge step. Central banks are being forced to respond to changes that challenge the foundation of monetary systems. R3’s Daniel Eidan says blockchain-enabled CBDCs could be one solution

Daniel Eidan, a solutions architect for enterprise blockchain technology company R3, which has been working with at least two central banks on Corda blockchain-facilitated CBDC projects, says the emergence of Libra – Facebook’s proposed stable coin – was a watershed moment.

“Libra has awoken central banks to the fact there are technology providers out there that actually have the network and technical capacity to potentially challenge some of our assumptions around how we use money,” he says.

As the Institute and Faculty of Actuaries noted in March 2019 in its paper Understanding Central Bank Digital Currencies: “A switch from public fiat towards private electronic money challenges the definition of money, the access to legal tender, the role of central banks, the financial intermediation model and the transmission of monetary policy.”

It added that central banks are now under pressure to respond to these challenges. And one way they might do that is with CBDCs.

As far back as 2015, Bank of England chief economist Andy Haldane floated the idea of using a blockchain-based central bank currency as a tool that would allow for negative interest rates to be sanctioned, if required. Fast forward five years and the bank’s March 2020 discussion paper, Central Bank Digital Currency: Opportunities, Challenges And Design, fleshes out a sterling-based CBDC in significantly greater detail. Of the many paths the BoE could take, building a fast, highly secure and resilient technology platform to sit alongside its real time gross settlement service with the necessary functionality for retail CBDC payments, would, it suggests, be easiest. 

Disrupting the payments s t a c k

 This would allow private sector payment interface providers (PIPs) to connect to the bank’s systems, in order to offer customer-facing CBDC payment services.

Even if all central banks recognise the same existential threats to the global financial ecosystem, their motivations for issuing CBDCs are much more nuanced, given payment systems vary globally, as do geopolitical considerations.

The People’s Bank of China has a long-stated aim of actively promoting the development of a state digital currency. Even if no formal timetable for any roll-out is in place yet, the country’s major state-run commercial banks are presently conducting large-scale internal testing of a digital wallet application.

In Sweden, the Riksbank began testing its e-krone earlier this year, taking the country one step closer to creating world’s first CBDC. It followed news that the

The fall of cash?

Central banks are responding to fundamental changes

country had also joined forces with the UK, Japan, Switzerland and the Eurozone to assess the case for issuing CBDCs.

Sweden’s e-Krone is driven mainly by a desire that no one should be left behind as the country heads towards total cashlessness in 2024/5. It’s an example of the inclusion agenda that Eidan has seen playing out.

“Central banks are coming in and saying ‘we want to provide central bank money to every citizen in society’, which in turn enables inclusivity by offering an alternative to cash payments that aren’t run by the private sector,” he says.

R3, meanwhile, is working with central banks, including in Canada and Thailand, to implement wholesale CBDCs.

NO CENTRAL POINT OF FAILURE On the assumption that CBDCs are eventually issued, portability is likely to be a major benefit, since such currencies won’t necessarily need to stay within the geographical confines of the country in which they’re issued.

“It’s actually a lot easier to export CBDC to other jurisdictions. So you see a competitive nature to the instrument itself that maybe doesn’t exist as much in cash,” says Eidan.

In its April 2020 White Paper Central Bank Digital Currency: An Innovation In Payments, R3 separates its analysis of CBDC projects into wholesale and retail categories, arguing that end users invariably have different requirements/preferences.

The R3 paper makes clear that central bank-run experiments so far have shown how core existing features of RTGS systems can be improved using blockchain. In one example, according to R3, decentralised liquidity savings mechanisms may be more effective in reducing gridlock than existing approaches. In addition, decentralised systems may enable banks to have more flexibility than they currently have using centralised liquidity savings mechanisms, meaning each bank could have more control and real-time visibility of how their payments are netting, network-wide, according to the paper. This would reduce reliance on the central operator for that netting calculation. And mean greater control and flexibility with liquidity that would benefit all market participants.

Looking at the potential benefits of CBDC, Eidan says: “CBDC enables a distributed system, so it would enable counterparties to interact, each running their own piece of software and ensuring there’s no centralised point of failure, which in turn would lead to a more secure and resilient environment.”

The Bank of England is still weighing up the best technology rail to use for retail CBDC, although it is being courted by at least one blockchain provider, L3COS, to run its operating system. In the meantime R3’s enterprise blockchain platform Corda continues to evolve.

“What’s unique about this operating system is that it’s able to run applications – and synchronise between those applications – on many different systems,” says Eidan. “In effect, entire industries/ multiple countries can be optimised simultaneously, rather than simply optimising an individual firm.”

And that significantly expands the number of use cases being made available.

“What’s likely to happen is all of these different systems that were so used to being decoupled from one another, are going to be able to interact, because platforms like Corda and other distributed ledger technology (DLT) will become ubiquitous within the industry,” says Eidan.

Taking a five-year view, he sees a variety of CBDCs offering different use cases, depending on the country of issue. But convergence is likely over the longer term.

“As a retail user, I can see a future where I could potentially carry as many currencies as I want with me and pay automatically, based on how I live my life, and what types

As a retail user, I can see a future where

I could potentially carry as many currencies as I want with me and pay automatically

of goods and services I consume,” says Eidan. A FUNDAMENTAL CHANGE So far, innovation in the payments space has largely involved the building of a payments stack of services and products on top of fiat currencies that haven’t fundamentally changed their character. Now, central banks are being forced to acknowledge the fundamental disruption to monetary systems posed by the seemingly inexorable move away from that historic token of value – cash – that underpins them.

As Eidan says: “What’s fundamentally different about CBDC is that we’re not talking about adding another layer of innovation (to the payments stack), but adding another element to the base that will substantially change what this kind of payment stack looks like.” ■