Industry expert Amit Ghosh reviews the dynamic restructuring of Asia Pacific’s financial ecosystem in the wake of digitalisation.
As digitisation increases across many industries, governments and businesses alike are looking at new and innovative ways to embrace technology. Central banks are no exception and APAC’s success with digital currencies is a prime example. Countries that have historically been at the forefront of currency developments, such as the US and the UK are no longer leading the charge. The desire to protect longstanding currencies has led to a “regulation first” not “innovation first” approach for many.
The U.S. Fed, the Bank of England, the Bank of Japan and the European Central Bank are all currently exploring the technology. Meanwhile, the Bank for International Settlements (BIS), the so-called “central banks’ central bank” has been discussing Central Bank Digital Currencies (CBDCs) at length.
So why are central banks, the heart of the economic establishment, so interested in a technology with such radical and revolutionary roots?
In part, they are responding to challenges from private sector initiatives, such as Facebook’s Diem. However, CBDCs also suggest substantial benefits for general purpose use, which make them highly attractive in their own right. Specifically, central banks’ motivations include:
- Providing a cash alternative
- Promoting financial inclusion
- Increasing seigniorage profit (difference between a currency’s face value and the cost of its production and distribution)
- Implementing monetary policy
- Linking payments to identity
- Modernising payments for a digital economy.
What’s interesting about the recent models is the collaborative approach many are taking with a supporting cast from the private sector. For example, the Bank of England has been researching what it calls the “platform model,” in which the bank is the only entity allowed to create or destroy a token, while leaving ‘payment interface providers’ (PIPs) to interact with end-users.
Others have gone a step further. Researchers at the International Monetary Fund have coined the term “synthetic CBDC” (sCBDC) to describe a model in which a non-central bank entity, such as a commercial bank, can issue a stablecoin backed by central bank reserves.
Ultimately, it is likely that a variety of uses for CBDCs in the retail space and a number ofdifferent implementations will develop. These will have important benefits for a wide variety of institutions, from corporate treasury departments to payment networks open to the general public.
The distinction is quickly blurring between the currently evolving retail CBDC models and previous projects with wholesale CBDCs. A CBDC is a great tool at the wholesale level, and its applications teach us a lot about the prospects for retail CBDCs. For example:
Project Ubin with the Monetary Authority of Singapore (MAS) taught us that a blockchain-enabled CBDC supports more efficient complex payment workflows, including a decentralised liquidity savings mechanism. Now the MAS is partnering with the BIS Innovation Hub and the central banking community on Project Dunbar, an initiative to design, develop and test new multi-CBDC models.
Project Inthanon with the Bank of Thailand and Hong Kong Monetary Authority taught us that a blockchain CBDC allows for a cross-border corridor, enabled FX price discovery, and facilitated atomic PvP.
Blockchain is crucial in enabling the tokenisation of these payment assets, allowing for peer-to-peer transactions and distributed custody. Additionally, blockchain enables atomic transactions which means that any DvP (delivery vs. payment) or PvP (payment vs. payment) scenarios can occur, in real-time, without risk that one leg of the transaction will execute before the other.
Blockchain also sets the architecture for a more secure payment system in which there is no centralised point of failure nor honeypot for hackers to attack. Finally, it allows connectivity into a growing tokenised financial ecosystem with global integrity.
Looking to the future, it is possible to envisage an entirely new payment structure. The way banks, businesses and individuals handle, exchange and process money will be reimagined.
This architecture is empowered by blockchain as a means of keeping record, but relies on central banks’ diligence in providing robust governance frameworks for these new assets.
Increased adoption and wider access to CBDCs will be the next step for central banks to fulfil their mandate of offering modern and digital payment solutions. This will generate greater connectivity within the financial industry and encourage parallel innovations outside of the payments sphere too. Innovation is the key to unlocking this next generation of payments and Asian central banks are leading by example.