Three issues have in recent years, dominated the payment space. The cryptocurrency which many central banks have rejected as endangering financial ecosystems; cross-border payments which came with several settlement risks and the newly energised Central Bank Digital Currency (CBDC), which is still struggling for acceptance across many economies.
Still, a new kind of multilateral platform could improve cross-border payments, leveraging technological innovations for public policy objectives.
Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department of the International Monetary Fund (IMF) and Tommaso Mancini-Griffoli, Deputy Division Chief in the Monetary and Capital Markets Department at the IMF explained how that could happen.
Both IMF chiefs said that 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 they noted in a recent working paper: A Multi-Currency Exchange and Exchange Contracting Platform.
Technology has jumped ahead
Adrian and Mancini-Griffoli listed the new payment technologies as tokenization, encryption, and programmability.
Tokenization means representing property rights to an asset, such as money, on an electronic ledger—a database held by all market participants, optimized to be widely accessible, synchronized, 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 authorized 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.
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: tokenization of financial assets, tokenization of money, and automation.
The tokenization 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.
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.
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.
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 minimize 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.
Still, 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 Adrian and Mancini-Griffoli believe the second should receive just as much attention.
As a monetary instrument, Central Bank Digital Currency (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 tokenized 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.
Very significantly, the IMF recently called on the Central Bank of Nigeria (CBN) to strengthen Nigeria’s national identification systems and make Know-Your-Customer (KYC) requirements easily enforced as the Central Bank Digital Currency (CBDC)-e-Naira integration into the payment ecosystem continues.
The multilateral institution, said the CBN and other central banks in Africa, will need to develop the expertise and technical capacity to manage the risks to data privacy, including from potential cyber-attacks, and financial integrity as Central Bank Digital Currency (CBDC) gains ground.
The Fund said the CBDC could trigger risks of citizens pulling too much money out of banks to purchase digital currencies, affecting banks’ ability to lend.
This is especially a problem for countries with unstable financial systems. Central banks will also need to consider how CBDCs affect the private industry for digital payment services, which has made important strides in promoting financial inclusion through mobile money.
The IMF also said South Africa and Ghana central banks are exploring or in the pilot phase of a digital currency, following Nigeria’s introduction of e-Naira.
The IMF said Nigeria was the second country after the Bahamas to roll out a Central Bank Digital Currency (CBDC), adding that South Africa and Ghana are running pilots while other countries are in the research phase.
The Bank of Ghana, by contrast, is testing a general purpose or retail CBDC, the e-Cedi, which can be used by anyone with either a digital wallet app or a contactless smart card that can be used offline.
While African countries continue look at the CBDCs and its benefits, the IMF team insists that technology for crypto currency can also support payments.
For Nigeria, the introduction of e-Naira to Nigeria’s payment space will continue to boost trade, investments and other economic activities in the country.