No One Size Fits All: Unlocking the Future International Monetary System

Improving efficiencies, reducing risk, and enhancing equal access to global payments rests on an international monetary system that can combine the fundamentals of traditional finance, with the most innovative developments in blockchain-based finance, writes Yves Longchamp, Managing Director and Head of Research at SEBA Bank

In its recent Annual Economic Report, the Bank for International Settlements (BIS) proposed that the blueprint for the future international monetary system consists of a hybrid crypto-fiat model, one centered upon “improving the old, enabling the new.” Key to this are Central Bank Digital Currencies (CBDCs). With recent major developments in crypto taking place, from PayPal issuing its stablecoin to the launch of Sam Altman’s Worldcoin, real world asset tokenization is transforming asset ownership and enabling seamless borderless transactions to ‘enable the new’.

The report therefore comes at an appropriate time to consider what a world of blockchain-based finance might look like, and how those utilizing this technology are poised to improve access to international payments and iron out the inefficiencies in the international monetary system.

The Blueprint: A Unified Ledger

The crux of the proposed blueprint is what is termed “a Unified Ledger”. Based closely upon a blockchain ledger, the “Unified Ledger” purports to allow CBDCs, private tokenized monies, and digitized assets to coexist on the same programmable platform. The name is slightly misleading, however. The report stresses that it is not submitting the idea that a unique ledger contains everything, but instead that multiple ledgers can coexist depending on the services being provided. These ledgers would be flexible enough to evolve or adapt over time, branching out to absorb new functions or merging with one another.

Unified ledgers are made possible and made better if they combine key characteristics of traditional finance (TradFi) with the best in decentralized finance (DeFi) and blockchain. TradFi has served us well to date but services are restricted to the banked people only. DeFi on the other hand has democratized access and allows virtually anyone with the internet to access financial services.

A unified ledger potentially reconciles TradFi and DeFi. On the one hand TradFi has a long tradition of identifying clients (KYC: Know Your Client) and knowing the origin of funds (AML: Anti-Money Laundering), but is slow and costly. DeFi on the other hand is open to everyone as there is no KYC And AML, as it is built on blockchain, a technology designed to provide cheap and fast transactions. On blockchain, trade is settlement, meaning messaging and settlement are one, avoiding costly errors and reducing frictions.

The benefits of a unified ledger do not stop here. Customers from two different banks lack the ability to track their transactions live. Across borders, the complexities are amplified by differing messaging standards, time zones, and a lack of interoperability between systems. All this has the potential to increase investment risks and increase costs for resolutions. In this way a sender or receiver on a multi-billion dollar transaction (such as an aviation leasing deal) may lose to the tune of hundreds of thousands, owing to a sudden or dramatic change in foreign exchange overnight.

With the cross-border payment market projected to exceed $42.7 trillion by 2026, banks have sought to address these inefficiencies. In December of last year, Wells Fargo and HSBC expanded their blockchain-based bilateral foreign exchange (FX) settlements service, indicating the value of distributed ledger technology (DLT) in the settlement of payments and transactions. Through the use of DLT technology and smart contracts, problems of coordination could be overcome. Operating smart contracts could ensure the stability of the banking system, particularly in scenarios of contingent performances.

Blockchain ledgers can also provide the highest standards in data security and privacy. Smart contracts and seamless transactions require the processing of a considerable volume of data. How that data is stored, and who gets to see what information, are important questions to be addressed. Concerns regarding privacy can cause investors and consumers to become hesitant to share personal information. Worldcoin’s “proof of person” concept, scanning the irises of users for confirmation of identity, has given rise to concerns about the privacy standards of crypto asset providers.

With the discussion regarding blockchain technologies, particularly cryptocurrencies, revolving around data privacy and security, any concept of a unified ledger must place data privacy at its center. By utilizing good governance and security structures of existing TradFi institutions, a workable hybrid crypto-fiat framework can be created for the implementation of a Unified Ledger that enhances and upholds consumer protection standards.

Potential framework

An essential feature of a unified ledger is how centralized or decentralized it is as two views of the world are colliding. The BIS, as the central bank of central banks, is naturally inclined to keep the upper hand of the entire international monetary system. This would give this institution the right to reject transactions, with the risk of censoring some, which in the context of weaponization of finance, may lead to an even more fragmented system. At the other end of the spectrum, blockchain is a technology where potentially everyone can validate transactions, making it a censorship resistant financial infrastructure.

How a unified ledger will be set up and who controls it is not described in the blueprint. As a result, the whole governance and representativeness of the unified ledger idea is not discussed, despite its utmost importance. Only if the new financial system is built on strong governance and represents the participants fairly, the unified blockchain has a chance to emerge and to unify.

One way to solve the tensions between these antagonist views is to give each central bank and each bank across the globe the right to validate transactions. It would create a large and representative set of validators, decentralized enough to avoid censorship, and representative enough to take into account all the primary users of this infrastructure.

How exactly the framework is structured needs to be explored further. Acknowledging that the scope of the ledger may vary depending on the needs and constraints of the jurisdictions considering its implementation, the report suggests that the starting point for building solid principles would be the pre-existing Principles for Financial Market Infrastructures (PFMI). Governance of the ledger may follow existing rules, guiding Central Banks and private parties in their actions. 

For this framework to work, it needs to be inclusive. Examining the impacts this blueprint will have on the financial industry is critical. Competition must not be stifled, nor should innovation. In this regard, stakeholders should be consulted. States across the globe, particularly the UK, have begun or finished consultations regarding the potential of CBDCs and tokenization. Regulatory sandboxes have been formed to test these concepts too.

A workable digital asset “framework” requires incorporating the tried and tested of traditional finance, along with the innovation that comes with blockchain-based technology, including instant settlement, encryption and privacy. Such a combined model ensures the required regulatory oversight and a formal “digital asset” framework that encompasses the legal and regulatory aspects.

These considerations involve gaining a profound understanding of DeFi structures, establishing uniform regulatory standards, efficiently identifying and managing risks, ensuring transparent disclosures, and enforcing relevant laws. This comprehensive approach covers critical elements such as monetary policy, tax clarity, regulatory supervision, and measures to combat financial crimes.

The transformative potential of crypto-assets is evident, as they have the capability to challenge traditional monetary policies, bypass capital controls, present fiscal risks, and even threaten the stability of the global financial system.

Therefore international payments bodies and monetary authorities should be examining the key characteristics of traditional finance that work well with DeFi - only then will we be able to “improve the old, and enable the new” international monetary system.

Lastly, both regulators and crypto asset providers must work together and collaborate effectively if the benefits of a crypto-hybrid model are to be realized. Co-operation will reap its rewards by giving world citizens more equitable, and frequent access to payment solutions.

The launch of innovative crypto projects such as PayPal’s stablecoin, and the tokenization of real-world assets shows how this hybrid crypto-fiat model is gaining traction not only as a concept in enabling the new, but as a practicable, viable monetary solution. The next phase will be about building the financial infrastructure layers that support this model as a cornerstone of the international monetary system.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.