A new multilateral platform that leverages technological innovations can enhance cross-border payments. This platform aims to optimize word choice, structure, readability, and eloquence while maintaining the original meaning.
For users, crypto assets have proven to be more of a letdown rather than an anticipated revolution. Notably, international entities such as the IMF and the Financial Stability Board are emphasizing the need for stricter regulations in this domain.
Certain aspects of the swiftly advancing crypto technology might offer even more substantial potential. The private sector continuously pioneers and tailors financial services to pave the way for innovation.
The public sector should also embrace technology to enhance its payment infrastructure and guarantee interoperability, safety, and efficiency in digital finance. This was highlighted in our recent working paper titled “A Multi-Currency Exchange and Contracting Platform”. It is worth mentioning that others are expressing similar perspectives.
How Crypto Tech Can Enhance Cross-Border Payments
Technology has jumped ahead
The realm of payment technology has witnessed advancements like tokenization, encryption, and programmability. These innovative solutions not only enhance security but also pave the way for seamless transactions and unmatched versatility.
- Tokenization refers to the representation of property rights to assets, like money, on an electronic ledger. This ledger is a database accessible to all market participants, designed to be easily updated, tamper-proof, and widely accessible. While token balances and transactions don’t necessitate anonymity (in fact, it undermines financial integrity), they offer a secure and efficient way to manage and transfer ownership.
- Encryption serves to separate compliance verification from transactions, ensuring that only authorized entities gain access to sensitive information. This not only fosters transparency but also cultivates trust among parties involved, while upholding utmost confidentiality.
- The capability of programmability enables the creation and automatic execution of financial contracts, including “smart contracts,” without the need for a trusted third party. This facilitates easier contract composition while maintaining the core integrity of the process.
Private-sector innovation
Empowered by these newfound tools, the private sector embarks on an innovative journey that holds transformative potential surpassing the initial crypto asset surge. This entails the tokenization of financial assets and money, coupled with the seamless integration of automation.
Tokenizing stocks, bonds, and other assets has the potential to reduce trading costs, unify markets, and broaden access. However, acquiring such assets necessitates funds within a compatible ledger, such as stablecoins that meet regulatory requirements. Notably, banks are exploring tokenized checking accounts, and automation is prevalent, enabling third parties to program functionality akin to developers crafting smartphone apps.
While the private sector continues to drive innovation and customize solutions, it is not capable of guaranteeing safe, efficient, and interoperable transactions, even with proper regulation. Instead, the private sector is more inclined to establish exclusive networks for asset trading and payment processing. Although open ledgers may arise to bridge these private networks, they are likely to lack standardization and significant investment due to limited profit potential. Moreover, settling transactions using private forms of currency would expose counterparties to risks.
Also, Read- The 5 Best Crypto Hardware Wallets of 2023
Central bank role
Central bank digital currencies are valuable on two fronts: as a monetary instrument, serving as a store of value and facilitating payments, and as indispensable infrastructure for transaction clearance and settlement. While much of the policy discourse has centered around the former aspect, we contend that equal attention should be devoted to the latter.
Central Bank Digital Currency (CBDC) serves as a secure monetary instrument, mitigating counterparty risks and enhancing payment liquidity. Furthermore, CBDC possesses the potential to greatly enhance interoperability and efficiency among private networks, facilitating seamless digital transactions and asset transfers.
Payments can be made between private currencies using the CBDC ledger or platform. Funds can be held in escrow on the CBDC platform and released upon meeting specific conditions, like receiving a tokenized asset. Moreover, the CBDC platform can provide a fundamental programming language to ensure trust and compatibility among smart contracts. This aspect will also emerge as a valuable public resource in the digital landscape of tomorrow.
Cross-border payments
The same mindset holds true for cross-border payments, albeit with more complex governance (a significant topic we will delve into another time).
Our working paper proposes the idea of a public platform that would enable regulated financial institutions, including banks, to trade digital representations of domestic central bank reserves globally. This innovation has the potential to revolutionize cross-border transactions in the financial industry.
Participants can engage in the trading of secure central bank reserves without the need for formal regulation from individual central banks or significant alterations to national payment systems. This allows for a seamless and efficient exchange while maintaining the integrity and stability of the financial ecosystem.
Again, transactions require more than the movement of funds. Risk-sharing, currency exchange, liquidity management—all are part of the package.
With the advantage of a single ledger and programmability, currencies can be exchanged simultaneously, eliminating the risk of one party walking away. Furthermore, this opens up possibilities for creating risk-sharing contracts, supporting thinly traded currency markets through auctions, and automating limits on capital flows – a feature relevant in many countries.
The platform plays a crucial role in mitigating risks associated with such contracts. It guarantees full backing of contracts with escrowed funds, automates execution to prevent failed trades, and ensures consistency among contracts. As an example, a contract to receive a payment tomorrow could be pledged as collateral today, reducing idle fund costs. This not only enhances the overall quality and structure of the contracts but also improves readability and eloquence while preserving their original intent.
In addition to facilitating the transfer of value, encryption plays a crucial role in managing the exchange of information. As an example, the platform has the capability to verify participants’ compliance with anti-money laundering regulations, while providing them the option to bid anonymously on the platform for foreign exchange. Meanwhile, participants can still access the combined balance of bids and offers.
Technology can thus support key public policy objectives:
- Promoting seamless exchange between national currencies.
- Ensure safety through the use of escrowed central bank reserves, settlement finality, and automatic contract execution.
- By minimizing transaction costs, encouraging broad participation, ensuring contract consistency, and fostering transparency, efficiency can be achieved.
There is still much to be discovered as this vision continues to evolve. The rise of crypto was driven by a desire to bypass intermediaries and public regulation. Interestingly, its true potential lies in the technology that the public sector can utilize to enhance public good through improved payment systems and financial infrastructure. This presents an opportunity to integrate interoperability, safety, and efficiency into private sector innovations and customization.
This blog is based on joint research work with Federico Grinberg, Robert M. Townsend, and Nicolas Zhang.