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Central banks across the globe are considering blockchain technology for new global payment solutions.

National Banks Worldwide Explore Blockchain Payment SolutionsARTICLE

By Mike Faden

The central banks of some of the world’s largest countries are exploring blockchain technology for a wide range of potentially far-reaching applications, including national digital currencies1,2 and global payment solutions.3 Although the banks generally stress that the technology is at an early stage, they are also starting to identify potential technical hurdles and areas where additional regulations may be required.4

Blockchain, also known as distributed ledger technology (DLT), was originally invented to support the crypto-currency Bitcoin. It provides an immutable, secure record of transactions, potentially making transactions more efficient by eliminating the need for trusted intermediaries and cumbersome verification processes.

Central banks that are actively investigating and in some cases experimenting with blockchain include those of the United States, Canada, China, U.K., France, the Netherlands, Singapore, South Africa, and Sweden.5,6,7 Though they are generally positive about the technology’s potential for applications such as international payment solutions, they also note technical obstacles such as scalability and other concerns such as privacy, security and legal issues.

Accelerating International Payment Methods

In December 2016, the U.S. Federal Reserve published a long-awaited research paper titled Distributed ledger technology in payments, clearing, and settlement, which examined the use of blockchain for payment solutions and financial trading.8 The report cited several reasons for the Fed’s interest in blockchain, noting that its core objectives include promoting financial stability and the safety and efficiency of the U.S. payment system; its regulatory role; and that it already operates national payment solutions.

The Fed report highlighted blockchain’s potential to accelerate and simplify cross-border payments, saying current international payment methods are often described as “slow, indirect, and expensive.” The Fed noted that blockchain technology is at an early stage, with many observers suggesting mainstream adoption may be several years away.

Technical issues identified by the bank include scalability: the algorithms and cryptographic verification used by some blockchain technologies limit the number of concurrent transactions they can handle, and blockchains may challenge storage capacity over time as they continually add to the stored transactional history. There are also legal concerns: Businesses using the records stored on shared ledgers “must be assured of their reliability as an authoritative source of the underlying obligations and the enforceability of those obligations,” the Fed notes. “Shared ledgers should be designed to provide these assurances under existing laws, or, alternatively, statutes and rules may need to be adjusted to accommodate DLT enabled recordkeeping.”

The Fed cites legal concerns about using blockchain for smart contracts, which are computer programs that automatically execute contract terms and conditions. As the Fed put it, “Some classic contract doctrines, such as voiding unconscionable contracts, or amending contracts due to changed circumstances, conflict with the automatic execution of smart contracts. If smart contracts proliferate, judges and juries will have to review them to determine their legal basis and evidentiary status.”

Digital Currency and Blockchain

The Bank of England’s (BoE’s) involvement with blockchain includes both broad analysis and technical experimentation. The bank has been examining the implications of the technology not only for payments but also as a way to support a potential digital currency, which would be similar in some ways to a nationally issued version of Bitcoin or other existing virtual currencies. In a research paper, bank economists argued that issuing a digital currency could permanently boost GDP by as much as 3 percent due to reductions in real interest rates, distortionary taxes, and transaction costs, while also increasing economic stability.9

Centrally issued digital currency could have major implications for businesses, consumers, and financial institutions. If central banks issued digital currency, money could exist electronically outside of bank accounts in digital wallets. This means businesses might be able to bypass banks altogether when making payments to one another.10

The BoE is also directly exploring blockchain technology via a financial technology accelerator that it has established to work with innovative firms and new technologies. As part of this initiative, the BoE created a proof-of-concept to help better understand the technology; like the Fed, the BoE noted concerns such as scalability and reliability, as well as customer privacy.11 It also said that its next-generation real-time gross settlement payments solution, currently being defined, must be able to interface with blockchain systems as and when they mature.12

Central Banks in Australia, Canada, China and More also Experiment with Blockchain

In Australia, the federal Treasury department is reviewing the potential of blockchain for the public and private sectors, looking at legislative and regulatory implications as well as possible applications. The Australian Securities Exchange is also planning to implement new post-trade systems on the technology, and major retail banks are also testing blockchain applications.13

The Bank of Canada’s exploration of blockchain has included an experimental proof-of-concept interbank payment system based on a fictional national digital currency, CAD-Coin. The research project was conducted with major Canadian banks; the Bank of Canada stressed that the goal was solely to better understand the technology.14

Central banks of Asian countries, including China and Singapore, are also looking at blockchain technology for payment solutions and digital currency. The Monetary Authority of Singapore said in 2016 that it planned a proof-of-concept interbank payments system based on blockchain as a first step towards exploring the potential of central bank-issued digital currency.15 Any national initiatives in China could have global implications due to the size of China’s economy and exports. China’s central bank has discussed potential benefits of digital currency such as reduced circulation cost and the ability to curb money laundering, and in November 2016 said it is looking to recruit blockchain experts as part of a plan to establish a digital-currency research institute.16,17

The Takeaway

Central banks’ interest in blockchain represents further recognition of the technology’s potential to transform many aspects of financial systems worldwide, from international payments solutions to new digital currencies. Notably, though, central banks generally emphasize that the technology is at an early stage and may be years away from widespread use for such applications. They also identify potential hurdles, including technical and legal concerns, that would need to be overcome.

Mike Faden - The Author

The Author

Mike Faden

Mike Faden has covered business and technology issues for more than 30 years as a writer, consultant and analyst for media brands, market-research firms, startups and established corporations. Mike also is a principal at Content Marketing Partners.

Sources

1. "Singapore to Test Digital Currency in Latest Fintech Initiative", Bloomberg News; https://www.bloomberg.com/news/articles/2016-11-16/singapore-working-on-interbank-payments-blockchain-with-r3-dbs
2. The macroeconomics of central bank issued digital currencies, Bank of England; http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp605.pdf
3. Distributed ledger technology in payments, clearing, and settlement, US Federal Reserve; https://www.federalreserve.gov/econresdata/feds/2016/files/2016095pap.pdf
4. Ibid.
5. "How Blockchain Could Disrupt Cross-Border Payments", The Clearing House; https://www.theclearinghouse.org/research/2016/2016-q4-banking-perspectives/blockchain-cross-border-payments
6. "France's Central Bank Details its First Blockchain Test", CoinDesk; http://www.coindesk.com/frances-central-bank-first-blockchain-test/
7. "Sweden's Central Bank Considers Digital Currency Use", CoinDesk; http://www.coindesk.com/sweden-central-bank-digital-currency/
8. Distributed ledger technology in payments, clearing, and settlement, US Federal Reserve; https://www.federalreserve.gov/econresdata/feds/2016/files/2016095pap.pdf
9. The macroeconomics of central bank issued digital currencies, Bank of England; http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp605.pdf
10. "The Central Bankers’ Bold New Idea: Print Bitcoins", The Wall Street Journal; http://www.wsj.com/articles/the-central-bankers-bold-new-idea-print-bitcoins-1468936751
11. FinTech Accelerator Proof of Concept, Bank of England; http://www.bankofengland.co.uk/Documents/fintech/fintechpocdlt.pdf
12. "A new RTGS service for the United Kingdom: safeguarding stability, enabling innovation", Bank of England; http://www.bankofengland.co.uk/publications/Pages/news/2016/071.aspx
13. "Data61, Treasury to investigate blockchain", itnews; http://www.itnews.com.au/news/data61-treasury-to-investigate-blockchain-418997
14. "Canada Has Been Experimenting With A Digital Fiat Currency Called CAD-COIN", Forbes; http://www.forbes.com/sites/laurashin/2016/06/16/canada-has-been-experimenting-with-a-digital-fiat-currency-called-cad-coin/#30f70ef71b0c
15. "Singapore to Test Digital Currency in Latest Fintech Initiative", Bloomberg News; https://www.bloomberg.com/news/articles/2016-11-16/singapore-working-on-interbank-payments-blockchain-with-r3-dbs
16. "Central Bank Plans Digital Currency Task Force", Research Institute; http://english.caixin.com/2016-11-17/101008590.html
17. "China’s central bank serious about developing digital currency", Shanghai Daily; http://www.shanghaidaily.com/business/finance/Chinas-central-bank-serious-about-developing-digital-currency/shdaily.shtml

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