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The Green Sheet Online Edition

May 27, 2024 • Issue 24:05:02

The great payments race – will competition or collaboration win?

By Edvards Margevics

Cross-border payments have become the lynchpin of trade in today's financial world. And now an ongoing digital revolution promises to reshape the landscape further, with stablecoins, central bank digital currencies (CBDCs), and tokenized deposits at the forefront. The April 3, 2024, launch of Project Agorá from the Bank for International Settlements (BIS – www.bis.org/about/bisih/topics/fmis/agora.htm) marks a significant step forward in cross-border payments collaboration between central banks and the private sector, but it also shows that the race between traditional finance (tradfi) and decentralized finance (defi) is still to be won.

Project Agorá, led by seven central banks, including the Bank of France, Bank of Japan and Bank of England, will explore how tokenization of wholesale central bank money and commercial bank deposits on programmable platforms can improve the monetary system and reshape global transactions.

This project's launch follows the successful conclusion of BIS’ Project Mariana (www.bis.org/about/bisih/topics/cbdc/mariana.htm) in late 2023, which explored the cross-border settlement capabilities of wholesale CBDCs. Project Agorá also builds on BIS’ “unified ledger” model, disclosed in 2023, which proposes a structure where tokenized deposits, central bank money and other tokenized assets are available in one decentralized ledger. This would produce functionality as yet unavailable today due to the current structure of the monetary system and its controls.

Project Agorá (Greek for ‘marketplace’) reaffirms the shift taking place in the broader financial and payment spaces, where established incumbents and nimble challengers have battled for market share, and competition is gradually giving way to collaboration. What’s remarkable about this latest initiative is the giant leap forward in public-private partnerships. This unprecedented level of cooperation recognizes that working together is the fastest way to produce the greatest benefits for all. How tokenization can enhance the monetary system's functionality

This project promises significant transformations, with innovative technologies like DLT and tokenization sweeping away many pain points, like high fees and slow settlement, that have typically afflicted cross-border payments. It’s clear the incumbent cross-border payment network Swift is not just under scrutiny, but now also faces credible challenges to its dominance in this evolving landscape. It's widely recognized that although the current monetary system has functioned adequately, it also contains many design flaws causing frictions that slow efficiencies and force higher costs on businesses, such as the reliance on commercial correspondent banks, compliance expenses, regulatory differences and varying operating hours in different time zones that can delay settlements.

These frictions are due to design flaws where digital money and transaction elements reside in siloed, proprietary databases located at the edges of communication networks. These databases also must be connected through third-party messaging systems that send messages back and forth. Thus, transactions must be reconciled separately before eventually being settled with finality. During this fraught back-and-forth process, bank and business participants can’t get a complete view over their transactions, and uncertainties and misaligned incentives preclude some transactions that have clear economic rationale. While workarounds such as collateral or escrow can mitigate such frictions, these solutions have limits and create their own inefficiencies. Tokenization is a more fundamental route toward addressing the shortcomings of the current system.

Working with private financial firms, the seven central banks seek to integrate tokenized commercial bank deposits with wholesale central bank money in a programmable core financial platform. By leveraging blockchain-based smart contracts and programmability, Agorá holds the potential to revolutionize the monetary system while maintaining its essential two-tier structure.

The broader implications of Project Agorá for the financial industry

Here’s why Project Agorá is exciting and what it could mean for cross-border payments:

  • Faster, atomic settlements: With instant, programmable transactions using smart contracts, settlement delays can be eliminated, and money can get where it needs to be much faster and more securely, aiding business cash flows and instilling confidence in trading.
  • Programmable money: Smart contracts enable new ways of settlement, such as automated escrow releases or interest rate adjustments based on predefined conditions. This is a major leap forward in business efficiencies and ensures finances can be more accurately tracked and calculated, enabling better forecasting and business agility.
  • CBDCs for stability: Central bank digital currencies provide a trusted foundation for tokenized transactions. Because the central bank is the issuer of the CBDC, businesses can depend on built-in safeguards and the assurance that money will always be available. Plus, there’s no need to worry about bank failure as has happened in the commercial bank sector.
  • Unified ledgers for seamless integration: By breaking down silos and segregated ledgers, transactions can be enabled across different asset classes on a single platform, while tokenized deposits within the existing system preserve the "singleness of money" and add flexibility for banks.
  • Enhanced security: Tokenized assets reside on secure, tamper-proof ledgers, reducing the risk of fraud and unauthorized access. Blockchain-based transactions also guarantee full traceability so each party in the transaction can see where their money is at any time. There are also potential compliance cost reductions with shared infrastructure, as processes like know-your-customer and anti-money laundering checks could be streamlined.
  • Easier regulatory compliance: Tokenization will enable streamlined compliance, as compliance measures are embedded within smart contracts. This not only automates adherence to regulations, but also creates auditable compliance trails, providing transparency in regulatory processes.

Interest in using defi to solve old tradfi problems is growing

Project Agorá is an exciting development and is indicative of how multifaceted the digital payments world is. What I’m really encouraged by is witnessing the growing institutional participation in such projects. This project, with firm commitments between the public and private sectors, indicates that there is growing appetite for defi explorations to solve old tradfi problems.

While central banks navigate the complexities of CBDCs, the private sector, driven by fintech expertise, is arguably racing ahead in reinventing traditional payment methods and rails. The success of some stablecoins like USDT is proof of that. Now it’s the traditional payment rails for those assets to enable their use in cross-border payments that are ripe for reinvention.

Project Agora isn't just theory. It paves the way for a more efficient, secure and user-friendly financial future. In this dynamic environment, those adept at navigating technological advancements, regulatory frameworks and customer demands will shape the future of finance. It's not merely a race; it's a digital transformation defining the future of payments. end of article

Edvards Margevics is co-partner at Concryt, a game-changer in finance that brings reliability to every challenge, be it payments, technology or risk management, https://concryt.io. Contact Edvards at linkedin.com/in/edvards-margevics.

The Green Sheet Inc. is now a proud affiliate of Bankcard Life, a premier community that provides industry-leading training and resources for payment professionals. Click here for more information.

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