Fintech Daily Digest

Worldline has published a white paper to serve as a resource to guide stakeholders through the multifaceted CBDC landscape. It provides insights and guidance to navigate the complexities and opportunities of this transformative financial technology.

The Italian Banking Association (ABI) published the results of its Project Leonidas (Liquidation Effective ONchaIn Dlt Asset on Check) distributed ledger technology (DLT) based wholesale central bank digital currency (CBDC) proof of concept (POC) work. The project, which concluded at the end of 2023, was carried out under the Banca d'Italia Milano Hub innovation center. It investigated the benefits of using DLT-based wholesale CBDC for interbank transactions, so that the capacity, efficiency and robustness requirements of central bank systems are met.

Banca d'Italia published a paper in July 2003 that uses a theoretical model to study how the introduction of a central bank digital currency (CBDC) by a systemic economy can affect the choices of residents in a small open economy. It finds that an increase in the preference for the foreign CBDC induces a banking crisis and has a negative impact on GDP, the greater the more the foreign CBDC is perceived as deposit-like. Public authorities can mitigate these effects with multiple tools: by taxing the CBDC, by easing macroprudential requirements, or through FX interventions. A higher stock of foreign CBDC held by households can shield the small economy from an increase in the interest rate on external debt, if the remuneration of the CBDC remains constant.

The English version of the Interim Report on Japan's "Design Outline of central bank digital currency (CBDC)", initially published in Japanese only in April 2024, has been published. The joint work by the Bank of Japan (BoJ), Ministry of Finance (MoF) and other relevant ministries identifies the basic considerations on main design issues and possible options for CBDC introduction. The report does not prejudge whether or not to introduce CBDC in Japan, but this preparation will help Japan introduce CBDC in the future without delay if the decision were made after discussions with the Japanese public.

The Bank of Ghana (BOG) confirmed the completion of the Project Digital Economy Semi-Fungible Token (DESFT), a joint project with the Monetary Authority of Singapore (MAS) and the United Nations Development Programme (UNDP). The first phase saw the development of the blockchain-based Universal Trusted Credentials (UTC) system that enables micro, small and medium enterprises (MSMEs) to efficiently verify authenticity of key information, such as basic credentials, licenses, certificates, and trade records across borders. In the second phase, a cross-border payment was made using UTCs, the eCedi CBDC and a Singapore dollar stablecoin, using the purpose-bound money (PBM) protocol.

The European Blockchain Sandbox announced the 20 participants in its second cohort. https://ec.europa.eu/digital-building-blocks/sites/display/EBSISANDCOLLAB/European+Blockchain+Sandbox+announces+the+selected+projects+for+the+second+cohort

The World Federation of Exchanges (WFE) published a paper on tokenization that concedes that that it has many benefits that may make it the natural next step for financial markets, but that it requires substantial upfront investment without clear gains in markets that are already highly efficient. It found that the primary benefit of tokenization is fractionalization. And by making fractional assets available to a larger pool of investors, there's potential to enhance liquidity. However, as highlighted by Ledger Insights, the paper seems to mix up the separate concepts of atomic settlement, one of tokenization's key benefits, with instant delivery versus payment (DVP) "atomic" settlement, ignoring the fact that batching and netting can still be achieved when settlement is atomic. https://www.world-exchanges.org/our-work/articles/demystifying-tokenisation-embracing-future

In April 2024 the European Central Bank (ECB) published a paper that shows the usefulness of digital euro safeguards, such as holding limits, that would limit the impact of the introduction of a digital euro on banks' liquidity and on their reliance on central bank funding. To this end, it assesses how banks might respond to the introduction of a digital euro while seeking to maximize profitability and manage their risks for a range of holding limit scenarios. The results of the simulated impact on key liquidity metrics show that, with safeguards in place and on aggregate, the liquidity metrics of euro area banks would decline but remain well above regulatory minimums. In addition, the central bank funding ratios of euro area banks would not increase materially on aggregate and would remain contained overall.

94% of the 86 central banks surveyed (between October 2023 and January 2024) by the Bank for International Settlements (BIS) are exploring central bank digital currency (CBDC). 54% are experimenting with proofs of concept and 31% are running a pilot. Around 30% of central banks focus on retail CBDCs only and 2% are working on wholesale CBDCs only, and it is more likely that central banks will issue a wholesale CBDC within the next six years than retail CBDC. More emerging market (EMDE) central banks are likely to issue a retail CBDC on a distributed ledger than advanced economy (AE) central banks, perhaps reflecting a willingness to leapfrog moving from legacy systems to cutting-edge technologies. Also, this year the survey also provides insight into the use of stablecoins for payments and regulatory approaches to crypto-assets across the globe.

The European Central Bank (ECB) published a blog post that explains what degrees of payments privacy future users of a digital euro can expect. It claims that it will promise better privacy and data protection than other current electronic means of payment, but not the same degree of privacy as cash although paying with an "offline digital euro" comes pretty close. Online digital euro payments will not be so private, because the commercial banks that run the user-facing parts of the platform will have full access to user identity and transaction information, just like they currently do on their own platforms. However, digital euro holder identities will be separated from the payment data, and the banks will pseudonymize user data so they are not visible to the Eurosystem.

"Wholesale CBDCs were considered useful for banks. However, some institutions are keener than others, often depending on the application of the wholesale CBDC. Executives in the securities services sector are usually the most enthusiastic. On the payments side, JP Morgan's Umar Farooq appeared to have reservations during last month's Consensus event... However, at a big picture level, the objective of wholesale CBDC is to reduce risk. Instant settlement in central bank money for a wider range of applications could take a significant amount of risk out of the banking and capital markets system. If banks are subject to less risk, it might allow them to be more expansive in other areas.

The Bank of Thailand (BoT) will test programmable payments in its Enhanced Regulatory Sandbox. Programmable payments automate transaction with predefined conditions for the payment of goods and services. This project will demonstrate the potential for applying technology to a wide variety of financial services, accompanied by appropriate risk management processes. The BOT will work in collaboration with the Securities and Exchange Commission, the Office of Insurance Commission, and the Fiscal Policy Office, Ministry of Finance, to evaluate the benefits and risks of financial innovations and to establish potential and suitable supervisory policies.

The International Working Group on Data Protection in Technology (the "Berlin Group"), chaired by the German Federal Commissioner for Data Protection and Freedom of Information (BfDI), published a working paper on central bank digital currency (CBDC) privacy-related risk factors. For example, the paper points out that the ECB must take a privacy and data protection by design and by default approach. In addition, it argues that a distributed ledger technology (DLT) architecture does not necessary entail a more privacy friendly solution, because data is immediately visible to all nodes in the network and immutability means that data can never be deleted or rectified (a right that is guaranteed in Europe's General Data Protection Regulation (GDPR). Also, some programmable features imply privacy and civil rights risks that may outweigh the potential benefits, due to legal and ethical concerns (for example automated decision-making without possibility of appeal and/or risk of censorship).

In 2016 the Australian Stock Exchange (ASX) engaged Digital Asset Holdings to replace its aging (launched in 1994) Clearing House Electronic Sub-register System (CHESS) securities settlement system. The replacement was to run with smart contract functionality written in DAML (Digital Assets Modeling Language). The whole project turned out to be a fiasco (check out David Gerard's timeline here) and it was shutdown in 2022 with ASX writing off AUD$250 million. Plus ASX users effectively wrote off the tens of millions of dollars spent on building interfaces to the failed system. In April 2024, a parliamentary enquiry concluded that the ASX and its regulators should have identified and monitored strategic technical risks such as scalability for the CHESS replacement project more carefully, and enhance their technology skills and experience at the most senior levels, and place less reliance on outsourcing their responsibility to contractors and consultants.

The Philippine Government's Department of Information and Communications Technology (DICT) has reportedly introduced eGOVchain, a government blockchain aimed at enhancing transparency, security, and efficiency in public transactions. DICT's efforts to streamline government services are encapsulated in its five-pillar strategy under the e-Gov office. These include developing e-government platforms, assisting local and national government agencies, innovating at the grassroots level, building cloud services and aligning government information systems.

The Ethiopian government's Council of Ministers approved a draft proclamation that would establish a legal framework for the introduction of a central bank digital currency (CBDC). The proposed National Bank of Ethiopia Establishment Proclamation revisions will soon be referred to the House of People's Representatives for review, comment, and final ratification. https://www.linkedin.com/feed/update/urn:li:activity:7207410991230320641/

The Bank for International Settlements (BIS) Innovation Hub and Bank of England have launched Project Meridian FX to experiment with FX transaction synchronization concepts. This will be achieved via a "synchronization operator" (SO) that uses distributed ledger technology (DLT) to interlink central bank settlement (RTGS) systems, and orchestrate the settlement of a payment versus payment (PvP) FX transactions. The experiments, which will take place towards the end of 2024, will connect Meridian FX's SO to the three solutions being explored as part of the Eurosystem's broader exploratory work on wholesale settlement.

Tether is launched Alloy (aUSD₮), a stablecoin pegged to the U.S. dollar overcollateralized by Tether Gold (XAU₮). Users can mint aUSD₮ by depositing XAU₮ as collateral through a process managed by Ethereum-compatible smart contracts. The aUSD₮ smart contract ensures transparency by keeping track of all collateral and minted tokens, using price oracles to constantly evaluate the Mint to Value (MTV) ratio.

Central banks need to realise that it is impossible to prevent distribution of counterfeit coins that are transacted in an offline mode when a cryptographic dialogue is carried out between payer and payee. This vulnerability relates to most known secure elements/devices, stored-value cards, universal access devices and Tamper Resistant Elements (TRE), such as smart cards, SIM cards, embedded secure elements and so on, that are already being tested for offline clearing and final settlement capabilities. It derives from realizing that any cryptographic dialogue that convinces a payee offline may be emulated by a resourceful counterfeiter. If you wish to execute payments between two parties in offline mode when there is no internet connection, with no risk of counterfeit money to be distributed by adversaries, you need to have a physical procedure (not cryptographic) that enables a fast, instant, simple and secure (up to being quantum-safe) validation process and payment transaction, with finality of payment.

Fnality and HQLAᵡ have completed end-to-end testing to enable intraday sterling repo settlement on the Eurex Repo F7 platform via their two blockchain networks. They plan to go live in Q4 2024 subject to UK regulatory approvals. Fnality is a UK-regulated systemic payment system and HQLAᵡ operates a digital collateral registry to enable intraday collateral movement. Fnality's settlement instrument is effectively a "synthetic" wholesale central bank digital currency (CBDC) - i..e., a sterling-denominated stablecoin backed by deposits in a Bank of England omnibus account. In conventional repo transactions, the collateral settlement takes two days, but on the Fnality/HQLAᵡ platform, trades can be settled on a atomically intra-day delivery-versus-payment (DvP) basis. https://www.linkedin.com/posts/eurex_eurex-repo-dlt-activity-7208755407740137472-g29d/