Is the hype over distributed ledger technology (DLT) overblown? Not according to Yves Mersch, a member of the European Central Bank (ECB) executive board. Speaking to the Deutsche Bank Transaction Bankers’ Forum in Frankfurt yesterday, Mersch said in his prepared remarks that DLT might not be a panacea for the financial industry’s ailments, but it is certainly not just a flash in the pan.
DLT, according to Mersch, could be a game changer. The chance for market infrastructures and financial intermediaries to share a blockchain is unprecedented. DLT has the potential to help certain actors by reducing back office costs, capital requirements and collateral.
“At the same time, it may possibly disintermediate or even make redundant some market actors that do not provide core functions,” he said.
Central Banker’s Perspective
From a central banker’s perspective, it is important to provide safe and efficient services to settle payments and securities. To this end, it is necessary to assess available technical solutions.
Central bankers must consider the extent to which DLT affects their role as a trusted third party for settling payments and securities, or as the issuer of risk-free, base money as the anchor of monetary policy.
In their role as catalysts, central bankers facilitate market actors’ work on interoperability and standardization. The Eurosystem serves as supervisor of financial institutions and as an overseer of market infrastructure. A common understanding on how blockchain adoption could impact the supervised entities and their business models must be pursued, in addition to how accounting and reporting could be impacted.
The first consideration is the operation and development of the Eurosystem’s financial market infrastructure. The Eurosystem owns and operates TARGET2, the euro’s real-time gross settlement system, and also owns and operates TARGET2-Securities (T2S), an integrated platform that processes real-time settlement of securities against central bank money throughout Europe.
To address these financial market infrastructures’ needs, the Eurosystem has identified four action points to work on through 2020 and beyond.
One is to explore synergies between T2S and TARGET2 to provide a single gateway to the two platforms. Part of this goal is to enable TARGET2, a 1990s system, to benefit from features available for T2S, a system from the last 10 years.
The second point is to provide new TARTET2 services. A market consultation on business and functional opportunities of future real-time gross settlement has been conducted. Openness to new technologies has been identified as a key component. The bank is currently analyzing replies to the consultation.
The third point is preparing to enhance TARGET2 services with instant retail payments, at least in the settlement layer. The Euro Retail Payments Board in 2014 cited the need for at least one pan-European euro instant payment solution that is open to any EU payment provider.
Instant Euro Payments Ahead
End user solutions for instant euro payments are to be available at the pan-European level by payment service providers by November 2017. Present efforts address P2P schemes, but they would establish the foundation for more ambitious B2B instant payment solutions.
The fourth point concerns the harmonization of Eurosystem arrangements for collateralization. Progress is required in this area before a common Eurosystem collateral management system business case can be reconsidered.
The bank is currently in the design phase of the project. In assessing possible technical solutions, the bank regards blockchain tech as among several possibilities. It is being analyzed regarding lower costs and a more legally sound and resilient market infrastructure.
If DLT emerged as technically superior in the areas of safety and efficiency, the bank would also have to consider the wider implications of its use.
Who Can Access The Blockchain?
In regards to the use of DLT as a central bank financial market infrastructure, the key question would be how central bank money is applied into the blockchain. Which entities can access the bank money on the ledger?
Access to the blockchain for securities and payment settlements could be confined to banks or to market infrastructure providers like central securities depositories. It could also extend to central counterparties and automated clearing houses. These would be the only parties to have access to the central bank digital currency on the blockchain.
The concept could be broadened, however. PSPs and individuals could access the central bank digital currency on the blockchain via bank accounts. This would preserve the relationship model of banks and central banks. To some extent, it would preserve the existing organizational structure of the financial ecosystem.
Open To All Citizens?
Another scenario has the central bank offering a DLT network open to all citizens. The citizens could hold commercial bank deposits with banks or digital currency at the central bank. This raises the question as to what functions would be embedded in a central bank deposit account and how it would affect the bank’s ability to lend money. Another question is how the monetary transmission mechanism would work if many banks’ business models were impaired.
Banks would not be the only affected parties.
Also to be considered is the impact of central bank digital currency on physical cash, the impact on central bank seigniorage, how market participants change investment strategies, and business models. Implications on the integration of the European capital market, financial inclusion and economic growth also need to be considered.
Changes to the Eurosystem’s market infrastructure or the settlement of securities and payment systems are not the only considerations.
Mersch said he will steer an organizational structure to analyze the technological innovation in the financial sector.
“It will range from practical aspects, such as the possible usage of DLT for our Eurosystem market infrastructure, to more research-driven activities like the implications of the issuance of central bank digital money.”
Eurosystem Oversight Functions
Mersch ended with reflections on the Eurosystem’s catalyst and oversight functions. He said the bank strongly believes in creating an integrated European market for payments and securities in ways that will improve efficiency and contribute to economic growth.
The Eurosystem seeks to ensure that technological innovation does not disrupt or re-fragment the market.
It would be ironic to explore a consensus technology from a proprietary perspective and create silos, he noted. At the same time, one has to consider if a permission-less world without a trusted third party or supervised gatekeeper is a utopian approach that defies human history.
Mersch called it a positive signal that collaborative initiatives are taking place among banks, fintech companies, market infrastructures and technology companies.
As an overseer, the Eurosystem has to find a common understanding of how the DLT will affect the overseen parties and their business models. The effects of digitalization and new technologies like DLT have to be studied in the context of cyber resilience.
Access to the DLT network for the central bank’s oversight could cover data requirements of the overseer and ease the reporting burden of the overseen parties. The right level of data and access protection requirements need to be respected.
“DLT has a disruptive potential in the financial market. Like the hammer that shatters glass yet can forge steel, it may bring advantages to some actors and disintermediate others.”
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