Fintech Daily Digest

The European Central Bank (ECB) concluded its tests of the use of distributed ledger technology (DLT) for wholesale settlement in central bank money. Between May and November 2024, the Eurosystem processed over 200 transactions and a total value of €1.59 billion. In total, 64 participants comprising central banks, financial market participants and DLT operators completed over 40 trials and experiments. Trials included actual settlement in central bank money, while experiments were tests with mock settlement. In January 2025, participants involved in the exploratory work will be invited to discuss lessons learned from the trials and experiments. The outcome of the analysis will inform the Eurosystem's decision on its next steps.

The foreign exchange market is subject to significant credit and settlement risks. While there are risk mitigation mechanisms, about one third of foreign exchange settlements are estimated to take place without them. Ousmène Mandeng writes that the adoption of central bank and other digital currencies can give rise to an entirely new settlement approach, collapsing the foreign exchange life cycle and freeing transactions from credit and settlement risks.

Vitalik Buterin gives views of some of the properties that an ideal Ethereum wallet would have. This is not intended to be a complete list; reflecting his cypherpunk leanings, it focuses on security and privacy, and it is almost certainly incomplete on the user experience front. However, he argues that wishlists are less effective for optimizing user experience than simply deploying and iterating based on feedback, and so he thinks it is most valuable to focus on the security and privacy properties.

The federal government is a massive bureaucracy with many, many departments-each with a different mandate and agenda. Yet the federal government's overall resistance to payment alternatives has been such that when any federal agency claims to be defending fintech innovation, the appropriate rejoinder is "Yeah, if only." Hauling leading private payment providers like Visa into court may garner headlines. But if the government is serious about payment alternatives it should first get to work removing all of the stumbling blocks-from regulation by enforcement to discretionary pressure campaigns-that Washington places in their way.

David Marcus, the former head of Diem (formerly Libra) at Meta, posted the chain of events that led to the death of the Diem blockchain-based payment network that was announced in 2019. According to his timeline, after two years of negotiations with regulators, they got to the cusp of approval by the U.S. Federal Reserve (Fed) of a limited rollout. However, the Fed got "cold feet" about the project, allegedly on warnings from Treasury Secretary Janet Yellen that it would be "political suicide" to approve it. Shortly thereafter, letters went out from U.S. government authorities to all the regulated Diem's partners to expect a high level of scrutiny on all payment activities. At that point, partners started to dropped their support and Diem eventually folded in 2022. Marcus's statements come after allegations of tech founders being debanked as part of the U.S. authorities' "Operation Chokepoint 2.0". https://decrypt.co/293947/operation-chokepoint-2-0-crypto-founders-silenced-by-secret-debanking

The European Central Bank (ECB) published its 2nd progress report on the preparation phase of a digital euro, which was launched on November 1, 2023. Since the publication of the 1st progress report, the ECB has updated its digital euro scheme rulebook, aimed at harmonizing digital euro payments across the euro area. Also, the ECB has concluded a call for applications for selecting potential providers of digital euro components and related services, and started user research and experimentation activities, to gather insights into users' preferences and to inform design decision-making. In addition, along with with key stakeholders, the ECB will be exploring innovative use cases for the digital euro, including conditional payments. In parallel, the ECB is working with Eurosystem national central banks and other competent authorities to develop a methodology for setting digital euro holding limits.

The New York Fed published an article that presents an overview of financial stability risks associated with digital assets, adapting the Federal Reserve's framework for monitoring financial stability in the traditional financial system. The overview reveals that the observed fragility of digital assets is associated with several financial vulnerabilities: valuation pressures of crypto assets, funding risk in most crypto sectors, the widespread use of leverage, and a highly interconnected crypto ecosystem. However, to date, these vulnerabilities have made a limited contribution to systemic risk given that the digital ecosystem is relatively small, is not a major provider of financial services, and exhibits limited interconnections with the traditional financial system.

Citibank's Tony McLaughlin posted an article that isolates a potentially compliant form of the tokenization thesis. This can be tested to determine whether there is a case for the industry to move beyond the current 'messaging' paradigm. The analysis suggests that the 'messaging' paradigm might be augmented by a general purpose 'state machine'. The messaging paradigm generally does not provide participants with unambiguous, authoritative knowledge of the status of a financial transaction throughout its lifecycle. A tokenized system might provide that capability as well as support multi-asset and programmable operations.

[October 31, 2024] During the Digital Shekel Challenge that concluded in October 2024, Kima, an asset-agnostic, peer-to-peer money transfer and payment protocol, successfully facilitated the transfer of a tokenized stock via digital shekel, demonstrating a successful use case of its cross-ecosystem interoperable delivery-vs-payment (DvP) solution. To demonstrate the utility of its transfer protocol, Kima built an imaginary trading platform called PeerTrade which facilitated an atomic swap of the tokenized share. Kima's secure decentralized settlement layer orchestrated the transaction instead of an intermediary, directly linking the buyer interested in purchasing the stock using her digital shekels with the seller, who held a tokenized share in their wallet to receive the payment into their bank account in the form of regular shekels. https://www.boi.org.il/en/communication-and-publications/press-releases/the-bank-of-israel-held-a-concluding-conference-for-the-digital-shekel-challenge-today-and-announced-the-winners-of-the-challenge/

Michael Salmony posted a paper that explores the challenges and opportunities related to the adoption of central bank digital currencies (CBDCs) with a particular focus on the Digital Euro. It critically addresses the often unclear problems CBDCs are intended to solve, and emphasizes the necessity of motivating key stakeholders, especially commercial banks, consumers, and merchants, to support and use them. It argues that simply mandating adoption is insufficient for success; instead, intrinsic motivation and clear business cases for each stakeholder group are essential. Additionally, the article proposes that an offline CBDC, resembling a modern form of cash, might offer a viable path forward, providing benefits such as increased financial inclusion and enhanced privacy. https://payments-innovation.com/

The Official Monetary and Financial Institutions Forum (OMFIF) Digital Monetary Institute (DMI) published its annual Future of Payments report, based on a survey of 34 central banks, 13 from advanced and 21 from emerging market economies. It found that platforms based on multi-currency central bank digital currencies (CBDCs) are emerging as alternatives to existing cross-border payments systems, with Project mBridge being the most advanced, although liquidity issues and governance concerns still pose limitations for widespread adoption. CBDC interoperability will be a key consideration for global payments going forward, with a hub-and-spoke model being favored by survey respondents. Standardization (e.g., migrating to ISO 20022 standards) is helping to reduce the costs and frictions in cross-border payments, but implementation is patchy. However, instant payments systems are rapidly growing in importance, with 47% of survey respondents selecting it as the most promising avenue for improving cross-border payments.

European Digital Identity Framework implementing acts The European Commission (EC) published for consultation the European Digital Identity Framework implementing acts, published in August 2024, which have now been adopted by the EC. The Framework seeks to give citizens and businesses a trusted and secure means of digital identification that works across all Member States via the means of European Union (EU) Digital Identity Wallets. It entered into force in May 2024. Each Member State will offer at least one version of the EU Digital Identity Wallet, built to the same common specifications, by 2026.

The European Central Bank (ECB) is inviting leading experts in branding and communication with advanced knowledge of payments and digital money to contribute to the brand rules workstream. This workstream is the part of the Rulebook Development Group that is to develop a proposal for brand rules that participants in the digital euro scheme, i.e. supervised payment service providers (PSPs), will adopt for their end-user solutions. This excludes brand strategy, expression and the visual identity of the digital euro.

The European Central Bank (ECB) and Norges Bank signed an agreement for Norway to join the Eurosystem's TARGET Instant Payment Settlement (TIPS) service. This will make the Norwegian krone the fourth currency available for settlement in TIPS, in addition to the euro, the Swedish krona and the Danish krone, which is scheduled to join in April 2025. The inclusion of the Norwegian krone in TIPS, which is part of the Eurosystem's TARGET Services, is planned for the first half of 2028 and will enable market participants in Norway to settle payments instantly, around the clock and in central bank money.

The Bank of Japan (BOJ) published an English version of slides presented at the October 17, 2024 meeting of its CBDC Forum. The BOJ provided an update on the development of the prototype system details of the system, and updates on progress made by different working groups. Since April 2023, the BOJ has been conducting technical evaluations not explored in the earlier proof of concept phase, while leveraging the skills and insights of private businesses. https://www.boj.or.jp/en/paym/digital/dig240531a.pdf

The European Commission (EC) published a report that examines the potential of public permissionless blockchains to enhance traditional financial services. It highlights the key advantages of utilizing an open base layer, including transparency, inclusivity, and increased competition, while addressing critical challenges such as scalability, privacy, transaction sequencing, finality, and governance. The report concludes that public permissionless blockchains represent a promising alternative to permissioned platforms, with the potential to reduce dependencies and mitigate monopolistic market structures on a platform level. It emphasizes that compliance does not necessarily require a platform-wide gatekeeper or other forms of base layer regulation, but can instead be implemented higher up on the technology stack. This allows for more flexible approaches, based on asset- and application-types.

Sveriges Riksbank published an independent assessment of the Swedish payments system, aiming to gaps in available services and to suggest some possible directions/opportunities for the system's evolution. It concluded that enabling a wider range of instant (or real-time) account-to-account payments should be a high priority for banks and the payments industry, in addition to the work underway to modernize Swedish bulk/batch payments. Also, the report recommends that, "although the case for a retail central bank digital currency (CBDC) is probably stronger in Sweden than in most other advanced economies", the best strategy for the Riksbank is to step back but be ready to be a "fast follower" of a digital euro launch, "possibly either using the European Central Bank's infrastructure or borrowing heavily from its design".

The Yidindji Reserve Bank acts as the sovereign monetary authority for the Yidindji Nation. It may issue its own currency or develop alternative systems of exchange that reflect Indigenous values and economic priorities under instruction from the Office of Chief Minister & the Department of the Treasury.

A U.S. appeals court ruled that the U.S. Treasury Department's Office of Foreign Assets Control (OFAC) acted outside its authority when it sanctioned crypto-asset mixer Tornado Cash in 2022 and accused it of helping launder over $7 billion for North Korean hackers and other malicious cyber actors. Crypto-asset mixers are anonymized software tools that allow users to conceal the source or owner of digital assets. OFAC blacklisted Tornado Cash after concluding it was helping launder proceeds of cyber crimes, including more than $455 million stolen by the Lazarus Group, a North Korean government-backed hacking group. The ruling said that federal law only gave OFAC the authority to regulate property, which Tornado Cash's immutable crypto-mixing smart contracts did not constitute. https://drive.google.com/file/d/1x3im8DdYdItlP6Hw4VF5JiBV1ccuKE6X/view

"Last week the Financial Services Agency (FSA) presented some ideas relating to cryptocurrency and stablecoins to the Financial System Council Working Group on Payment Services. The FSA is reluctant to allow banks to issue stablecoins other than trust banks. For trust bank issued stablecoins, it wants to relax the reserve requirements which currently require all assets to be held in bank demand deposits. However, it also wants to impose the travel rule, requiring KYC for trust bank issued stablecoin transfers."