Tokenisation is an area of great promise for capital markets. Many participants are working hard to create blockchain tokens that represent ownership of a broad spectrum of financial and tangible assets. But to deliver the benefits of tokenisation require a tokenised means of representing cash as well.
Of the many benefits that tokenising assets could deliver, the most important is that it enables transactions to take place on a delivery-versus-payment basis. This ensures that one leg of a transaction cannot be sent without the other, thus eliminating counterparty risk.
This counterparty risk is a costly and inefficient feature of many markets, since it requires participants to hold collateral against the possibility of a failed settlement. However, this can only exist if both legs of the transaction – the asset and the cash – are both represented on chain.
Overhauling market infrastructure
Stablecoins – cryptoassets that maintain a stable peg to a given currency – are emerging as one potential solution from the private sector that delivers a representation of on-ledger cash.
However, the Bank for International Settlements’ principles for financial market infrastructures stipulates that, where available, settlement should be carried out in central bank money. At present, most central banks do not offer a tokenised form of their currency for use in capital markets. This tokenised central bank cash, or wholesale central bank digital currency, may prove to be the key to overhauling capital markets infrastructure.
While much of the public debate around the digital euro has centred around retail CBDC – due to the political implications of the state providing a digital payments’ solution for individuals – some representatives of the Eurosystem of central banks believe that a wholesale version may arrive first.
Yet, it is important to note that blockchain systems are not monolithic. Tokenisation of both assets and cash will likely take place on a variety of different blockchain protocols. This might risk fragmenting market liquidity by limiting the ability of different investors to trade assets.
Capital markets bodies will have to establish a set of shared principles to ensure that this does not happen and that tokenisation does not lock assets into specific protocols.
Beyond domestic interoperability, one must also consider the fact that many capital markets operate internationally. If one central bank were to issue a wholesale CBDC, it would not be sufficient to fully deliver the improvements to market infrastructure that proponents of tokenisation hope for.
Central bank projects in development
But creating a global network of interoperable CBDCs is no easy task. Several consortia of central banks have projects in progress that are pursuing this goal. Among the most advanced of these is project mBridge: a collaborative endeavour between the People’s Bank of China, the Hong Kong Monetary Authority, the Bank of Thailand and the Central Bank of the United Arab Emirates.
The European Central Bank is also pursuing trials and experiments, including with the Swiss National Bank, looking to solve the same problems.
However, achieving this kind of system requires central banks from disparate regulatory regimes to come to agreement on a number of points – anti-money laundering, know-your-customer, liquidity arrangements – which will not be easy. The incentive to harmonise these standards has been present for many years, but agreement is difficult to come to, no matter the underlying plumbing.
Nevertheless, as we move towards a tokenised ecosystem, central banks face the possibility of the mechanics of payment and asset settlement moving out of their direct oversight. They will have to adapt to the changing realities to ensure they can continue to secure financial stability.
If the private sector leads the way on digital asset development, competition – though it spurs innovation – may harm adoption and risk the issues of fragmentation alluded to earlier. Central banks might be able to remove this risk by establishing new rails of capital markets on infrastructure designed and maintained by them.
Lewis McLellan is Editor, Digital Monetary Institute, OMFIF.
