Payments - A new world in dawning

If you haven't yet stopped to notice that the payment industry is at the onset of a remarkable change - then this is just about time. If the hundreds of on-going experimental projects in various central and commercial banks are going to finish well - the face of the industry will not be the same as how we know it today.

The very concept of money and payments itself is changing. Currently we have ledgers, and then we have messages flowing between these ledgers indicating a change to them (known as payments). Ledgers act as store of value, and payments act as means of exchange (of value). In the new world, money is represented as 'tokens' - a digital mechanism which embed the characters of both store of value and medium of exchange. This is exactly how physical cash is in action today ('bearer instrument').

Tokens have a shattering impact to the whole banking industry. Just the way cash can move hands without the help of an intermediary (bank), tokens can as well move around disengaging the intermediaries, except for its creation (mint) and destruction (burn). Money in token form is way more useful to end customers because it possess almost all the functional features of cash, utility of electronic money, plus it allows customer to engage in many financial services that banks do not offer today (or at least, do not offer without friction). These are especially the services spawned by private crypto industry, one of the main ones being decentralised financing options (lending and borrowing). There are many more to come as the industry matures.

Retail CBDC is a classic case of tokenised money. As the liability of the CBDC token lies with the central bank, just as is cash, it can move around seamlessly across bank boundaries without bank mediation. Also thanks to tokenisation, retail CBDC breaths fresh air into the dying world of public money.

Meanwhile commercial banks, in the fear of missing out, have kicked off a counter-attack through 'tokenised deposits' - a token form of the customer deposits. Customer can opt to convert their classic bank deposits to token based money so they can keep them in wallets (mobile phone) for the purpose of using them in the new world. As deposits are commercial bank liability, tokenised deposits are not exactly seamless as retail CBDC is, i.e. payments transfer across banks require movement of reserves to happen within the central bank (via balance in RTGS, or via wholesale CBDC if available). While this is double work for commercial banks, they may very well, in the interest of not missing out, choose to offer this (trying to alleviate the interbank complexity by settling net / deferred).

Another tool in commercial bank kit is 'bank-issued' stable coins (not to be compared with non-bank issued stable coins - which are not quite authentic). J P Morgan is leading this space, who has offered JPM Coin to their customers already, and is now in the quest of building shared DLT based ledgers to move the coins across banks (Onyx). Such shared DLT means in reality - an alternative to todays national clearing & settlement infrastructures - which rely on quite messy messaging technology in comparison with atomic settlement feature of a DLT.

Retail CBDC, tokenised deposit and bank issued stable coins are likely to take center stage in modern finance - especially for domestic transfers, and re-vitalise decentralised finance (DeFi) space with its authenticity and integrity - compared to its originally envisaged private crypto money forms that weren't helping it to pick up.

Tokenised Assets & DvP

Now, the most impressive of all is the ability to exchange money tokens seamlessly with tokens that represent assets (securities converted to tokens just the way money is) as part of a DvP process. As money and assets are in tokensied form, they can be exchanged and settled in the same platform (digital exchange) -  atomically, compared to T+2 today that uses a technology that is light-years behind mankind. Atomic settlements for DvP transactions remove the century old problems that still prevails today in trade such as country party risk and painful manual operations.

In just matter of time, more securities will get onboarded into tokenised form, digital exchanges will proliferate, leading to slow disappearance of CSD and custodians. This will be another great leap in Securities trade industry for DvP in its steps towards disintermediation. Swiss Digital Exchange (SDX, part of SIX) who is leading this game is a Digital exchange that performs exchange of tokenised assets against cash (in tokenised commercial bank money, or wholesale CBDC in future when available).

BIS has many projects running currently with various central banks and commercial banks that experiments Delivery Verses Payment (DvP) platforms with cross border payments (wholesale CBDC). Just google and you will get lost in its expanse!

Tokenisation of Real World Assets

The game does not end anywhere here. Introduction of real-world assets (RWA) into tokens is a game changer for both institutional and retail customers. RWA's are assets in the real world such as real estate or farms or commodities, that I as a retail customer can (immobilise and) tokenise to be used in decentralised exchanges for financing needs. Personally, this use case is dear to me, as I, just as many of you reading this, have many traditional assets are the lying illiquid, and you know the pain of converting that to liquidity by going through banks.

The advent of RWA is real and big for the whole banking industry. Chainlink has so called 'Oracles' that helps link off-chain RWA to on-chain artefacts - which helps maintain the integrity and authenticity of the tokenised RWA asset. Chain link also has developed a protocol that helps transfer tokens across chains, so that no one needs to be stuck with their asset in a certain specific chain.

FX & Cross Border Payments

Cross border payments is in complete shambles with its technology and protocol failing to keep with up with time. It operates on a messaging protocol, every time trying to build a route for each payment - through a series of hops (correspondent banks). Unlike google maps that builds your travel route upfront, international payments more often builds the route "as it goes", leaving the end to end transfer so complex, unpredictable and expensive by time and money.  

Apart of the regular narratives that it is slow, opaque, and costly, there are massive untold drawbacks if one looks inside the hood - the complexity of building, maintaining the payment systems, and managing (payment operations) both for banks and system vendors. The annual upgrades are such a nightmare, year after year for both parties.

Central bank DLT bridges takes out the whole complexity mentioned above with a simple bank to bank transfer structure (through respective Central banks). Once again numerous projects are underway under BIS to establish a model that disintermediates correspondent banks (the "highway-toll banks" - if I may call it). 

Yet another use case where tokenisation is a game changer is global FX trade (PvP). Just as I mentioned for DvP, numerous projects are currently ongoing under BIS watch that facilitates FX trade in wholesale CBDC. (The only missing piece today is probably an automatic market maker).

Peer-to-Peer commerce

Yet another use case worth mentioning is about solving the age-old problem in peer to peer commerce of 'who goes first'. The buyer does not trust the seller with money before the goods are dispatched while the seller does not trust the buyer with goods before payment is made. It's a deadlock that gave rise to intermediaries such as PayPal. Retail CBDC and tokenised deposits solve this issue through smart contracts where buyer can place the money in an escrow and release it conditionally, all within the DLT platform.

Summary

I can go on, but in the interest of not losing the reader, I stop by re-instating the point that a new world is dawning for the banking and payments world - based on blockchain -  a technology that had the very original objective of disintermediation (removing intermediaries). All banks will need to get on the chain inevitably, if not imminently, and offer services based on tokens to avoid missing the wave.  

Last and least, my previous articles supporting case for CBDC can be found here (2023), here (2022) and here (2021).