Written by:

Diane Cheung, Master of Accounting at the University of Sydney and MEM at Peking University, has been a FinTech product manager for ten years, focusing on payments and tokenization

Will Awang, Master of International Business Law from the United States, ten years of legal experience, serial entrepreneur in the technology industry, investment and financing lawyer

Spinach Spinach, RMIT Blockchain Master, Web3 Researcher, SFTLabs & Ample FinTech Buildler

Today, the global monetary system stands on the cusp of a historic leap forward. After digitization, tokenization (the digital expression of equity in an asset on a programmable platform) is the key to making the leap. Tokenization greatly enhances the capabilities of the monetary and financial systems by changing the way intermediaries serve users; opening up the barriers between information transmission, reconciliation and settlement. Tokenization will create new economic activities that are difficult to achieve in the current inherent monetary system.

Cryptocurrency or decentralized finance (as seen recently with DeFi greedily devouring RWA assets) only opens up one aspect of tokenization for us. They remain limited not only by difficulty in connecting to the real world, but also by the lack of monetary trust provided by a central bank, and even those stablecoins are unstable.

The Citi RWA research report we compiled previously: Money, Tokens and Games (Blockchain’s Next Billion Users and Ten Trillion Values) opened up a new $10 trillion tokenization market. So before embarking on the magnificent voyage, we still have to go back to the starting point and look at tokenization, RWA, and even token payment from the first principles of the blockchain, just like we carefully studied the Bitcoin white paper.

Therefore, we have compiled the passages on tokenization in the 2023 Annual Economic Report of the Bank for International Settlements (BIS) to provide reference for industry insiders to further understand the underlying logic of tokenization operations.

BIS deconstructs tokenization from the perspective of the monetary system and banking system, showing the future blueprint of the global monetary system. The key elements in building a future blueprint are CBDC, tokenized deposits and other tokenized rights and interests in financial and real assets. The blueprint envisions integrating these elements into a new type of financial market infrastructure called the “Unified Ledger”, in order to realize all the advantages of tokenization. This will improve the old system and build a new system.

Core ideas

1. Tokens and the tokenization of assets have huge potential, but the trust backing of central bank money and its ability to connect to the financial system is key to the success of tokenization;
2. “Unified Ledger” is a new type of financial market infrastructure that can combine CBDC, tokenized deposits and tokenized assets on a programmable platform to maximize the advantages of tokenization;
3. CBDC and tokenized deposits have certain advantages in maintaining currency unity, settlement finality, providing liquidity and risk avoidance;
4. The application of tokenization and unified ledgers can not only improve the existing financial market infrastructure by seamlessly integrating multiple systems, but also create new economic arrangements using programmable platforms, which has great commercial value;
5. Multiple use case-specific ledgers can co-exist simultaneously, interconnected via application programming interfaces to ensure interoperability while promoting financial inclusion and fair competition;
6. Governance arrangements are an important factor in promoting the application of new technologies such as unified ledgers and tokenization, and reasonable incentives are the key to attracting participants to join new references and ultimately form network effects.

Glossary

Token – Token refers to a digital identification representing a certain right or asset on the blockchain or distributed unified ledger.

Tokenisation – Tokenization is the process of recording rights to physical or financial assets that exist on traditional ledgers onto programmable platforms.

Private Tokenised Monies – privatized tokens refer to tokens issued by the private sector (non-central banks).

Singleness of Money – Singleness of currency means that in a specific monetary system, there is only one major currency, and different forms of currency or assets can be exchanged for this major currency at equal value, that is, the value of currency is not affected by different forms of currency. effects, whether they are privately issued currencies (such as deposits) or publicly issued currencies (such as cash).

Settlement Finality – Settlement finality means that after funds are transferred from one account to another, they officially become the legal property of the recipient and are irrevocable.

Unified Ledger – Distributed unified ledger, a new type of financial market infrastructure (FMI), refers to a system that integrates multiple data sources, platforms or system information (financial transactions, data records, contracts, digital assets, etc.) for All transactions and data are recorded without the intervention of a centralized organization.

Programmable Platform – A programmable platform refers to a platform that is not restricted by a specific technology, including a Turing machine with an execution environment, accounting and governance rules.

Ramp – Ramp smart contracts refer to contracts that connect non-programmable platforms with programmable platforms. Ramps lock assets on their original platform as collateral for tokens issued on programmable platforms.

Atomic Settlement – ​​Atomic settlement refers to linking the transfer of two assets to ensure that the asset can only be transferred if the other asset is transferred at the same time. That is, settlement is conditional, so there are only two settlement results, both parties succeed. The assets are traded or no transfer of assets occurs. Atomic settlement makes T+0 settlement possible.

Payment-versus-payment (PvP) – Synchronous settlement of foreign exchange transactions, a settlement mechanism that ensures that one currency must be transferred simultaneously to another (or multiple) currencies for final and irrevocable settlement, that is, the transaction Both (or more) currencies are delivered at the same time.

Delivery-versus-payment (DvP) is a settlement mechanism that links the transfer of assets with the transfer of funds to ensure that delivery only takes place when the corresponding payment occurs.

1. Tokens and Tokenization

1.1 Definition of Tokens and Tokenization

Tokens refer to ownership certificates (Claims) recorded on a programmable platform that can be traded [1]. More than just a single digital certificate, a token often brings together the rules and logic that govern the transfer of underlying assets in a traditional ledger (see figure below). Therefore, tokens are programmable and customizable to meet personalized scenarios and regulatory compliance requirements.

Tokenization refers to the process of recording claims on financial or real assets that exist on traditional ledgers onto programmable platforms [2]. The tokenization process is completed through the Ramp contract (see figure below), which maps assets in traditional databases (such as financial securities, commodities or real estate, etc.) into the form of asset tokens on the programmable platform. Assets in traditional databases are frozen or “locked” to serve as collateral backing tokens issued on programmable platforms. The locking of assets ensures that the underlying assets can be transferred at the same time when the tokens they are mapped to are transferred, that is, the ownership changes simultaneously.

Tokenization introduces two important features, decentralized operation execution and conditional execution of smart contracts.

Decentralized operation execution – Unlike traditional systems that require an intermediary account manager to update and maintain asset ownership records, in a tokenized environment, tokens or assets become “executable objects” that are maintained on a programmable platform ”, platform participants transfer assets by issuing programming instructions, without the need for intermediary account managers to keep accounts. This approach makes the scope of composability wider, and several operations can be put into one execution package for execution. Such tokenized transactions do not necessarily eliminate the role of the intermediary, but the nature of the intermediary’s role changes from “updating and maintaining asset ownership records” to “manager of programmable platform rules”, thereby eliminating the dependence on a dedicated person to update the ledger.

Contingent Performance of actions of smart contracts – The programmable platform can achieve conditional execution through the use of logical statements in smart contracts, such as “if, then, or else”, etc.

Through the joint use of the two features of tokenized operation composability and conditional execution, transactions that require complex conditional execution can be simplified and implemented.

1.2 CBDC and privatized tokens

Tokenization requires a monetary unit of account (Unit of Account) for pricing transactions and its means of payment (Means of Payment) to be fully applied. Compared with applications that use stablecoins as payment methods to implement tokenization in decentralized financial scenarios, CBDC has a better foundation due to its settlement finality and central bank endorsement. Programmable platforms can directly use embedded legal currency settlement As a necessary component of tokenization arrangements, it is the best choice for tokenized applications.

The development of wholesale CBDC is key to tokenized applications. As a tokenized settlement method, wholesale CBDC can, on the one hand, serve as a function similar to reserves in the current monetary system; on the other hand, it can be given new functions by tokenization. For example, transactions conducted using wholesale CBDC can Embed all the features mentioned above including composability and conditional execution. This CBDC-enhanced token could also become a retail variant for use by residents and businesses, allowing central banks to further support the singleness of the currency by providing the public with digital cash that has a direct link to a digital form of a sovereign unit of account.

The role of CBDC in a tokenized environment has become clearer, but there is still room for discussion as to how privatized tokens that complement CBDC can exist in an appropriate form. There are currently two mainstream forms of tokenization, tokenized deposits and asset-backed stablecoins. Both represent liabilities of the issuer, which promises customers that they can redeem their equity at the face value of the sovereign denomination unit. The difference between the two is reflected in the transfer method and its role in the financial system, which affects the properties of the two as privatized tokens that complement CBDC.

Tokenized Deposit

Tokenized deposits can be designed to operate in a manner similar to regular bank deposits in the existing system. Banks can issue tokenized deposits to represent the liabilities of the issuer. Like regular deposits, tokenized deposits cannot be directly transferred. The central bank The clearing liquidity provided will still ensure the normal operation of payment functions.

The following example can illustrate the similarities between tokenized deposits and traditional deposits by comparison. In the example, John and Paul’s accounts belong to two different banks, and both have passed KYC.

In the traditional system, when John pays Paul £100, Paul does not receive a deposit of £100 in John’s bank. Conversely, John’s bank account balance is reduced by £100, while Paul’s bank account balance is increased by the same amount. At the same time, adjustments to the individual accounts of the two banks were realized through the transfer of central bank reserves between the two banks.

In a tokenized environment, the same payment outcome could be achieved by reducing the tokenized deposits held by John at his bank and increasing the tokenized deposits held by Paul at his bank, while simultaneously settling the payment via a concurrent transfer of wholesale CBDC. Paul still has a claim only against his bank, of which he is a verified customer, and has no claim against either John’s bank or John.

Tokenized deposits could preserve and enhance some of the key advantages of the current two-tier monetary system.

First, tokenized deposits will help maintain currency unity. The existing system has the central bank operating the settlement infrastructure, thereby ensuring the final transfer of payments denominated in sovereign currency and achieving the singleness of deposit payments in commercial banks. Tokenized deposits retain this mechanism. At the same time, because the settlement of wholesale CBDC is completed through smart contracts, it improves timeliness, reduces the time difference between receipt and payment, and reduces risks.

Second, tokenized deposits settled in wholesale CBDC ensure settlement finality. The central bank debits the corresponding amount from the payer’s account and credits it to the payee’s account, reaching final settlement by updating the balance sheet, confirming that the payment is final and irrevocable. In the above example, settlement finality ensures that Paul has no claim against John (or John’s bank), but only against his own bank.

Finally, tokenized deposits will ensure that banks still have the flexibility to provide credit and liquidity. In the existing two-tier monetary system, banks provide loans and on-demand liquidity support (such as credit lines) to residents and businesses. Most of the money circulating in the existing monetary system is created in this way, because borrowing People hold deposit accounts in the bank at the same time, and the loans issued by the bank directly form deposits in the borrower’s account, realizing money creation. Different from narrow banks [3], this flexible approach allows banks to meet the capital needs of residents and enterprises according to changes in economic or financial conditions, but this model also requires adequate supervision to prevent excessive credit growth and high-risk behaviors. .

Stablecoin

Stablecoins are another form of privatized tokens that have certain drawbacks. Compared with tokenized deposits, stablecoins represent transferable claims issued by the issuer, similar to digital bearer bonds, and using stablecoins to pay is equivalent to transferring the issuer’s liabilities between users.

Still taking the transfer between John and Paul as an example, John holds one unit of stable currency issued by the stable currency issuer (that is, one unit of the issuer’s claim). When John pays Paul one unit of stable currency, the claim held by John was transferred to Paul, who did not hold any claims against the issuer before the transfer. In this case, Paul may passively hold claims against the issuer that he does not trust. The question then is does Paul trust stablecoin issuers?

This is because stablecoins have the properties of bearer bonds. Stablecoin issuers do not need to update their balance sheets when this transfer occurs, and because they are privatized tokens, the central bank’s balance sheet does not Without settlement of the transaction, the stablecoin itself is the certificate of the issuer’s claim, and the issuer’s consent or participation is not required to transfer the bill certificate.

Compared with tokenized deposits, stablecoins mainly have the following disadvantages:

The first is that stablecoins may undermine monetary unity, a situation in which currency values ​​are inconsistent. This is because stablecoins are tradable, and if there are differences in liquidity between stablecoins or differences in the creditworthiness of issuers, their prices may deviate from their face value, or even suffer greater uncertainty. For example, in the Silicon Valley Bank incident, because users were worried that the liquidity of Silicon Valley Bank would affect the price of stablecoins, users sold stablecoins in large quantities, causing the price of stablecoins to plummet, destroying the unity. The lack of clear supervision and credit endorsement from the central bank is an important reason for these problems.

Second, unlike tokenized deposits that can flexibly provide liquidity, asset-backed stablecoins operate more akin to narrow banks. This is because in principle, all U.S. dollars corresponding to stablecoin issuance should be invested in highly secure liquid assets. This causes stablecoins to reduce the supply of liquid assets that can be used for other purposes, and therefore cannot flexibly provide liquidity.

In addition, compared with tokenized deposits, stablecoins lack supervision in aspects such as KYC, AML and CFT, and there are certain risks. In the above example, John transferred the stablecoin to Paul, but the issuer did not verify Paul’s identity or conduct compliance checks, and could not confirm Paul’s true identity, leading to fraud risks. Rather than requiring significant regulatory reform to ensure KYC, AML, and CFT compliance for stablecoins, tokenized deposits can operate within the existing regulatory framework by emulating the transfer process of traditional deposits.

2. Tokenization and unified ledger

Tokenization’s full application depends on the ability to combine the trading and operation of currencies and a range of assets on programmable platforms. Tokenization provides a necessary means of payment capable of mirroring underlying asset transactions, and at its core is a tokenized form of central bank currency to facilitate settlement finality. The unified ledger is a “public place” that unifies these functions, placing CBDC, privatized tokens, and other tokenized assets on the same programmable platform to ultimately realize new economic arrangements in the form of seamless integration.

2.1 How to create a unified ledger

The concept of a unified ledger does not mean that “one ledger rules them all”. The form used depends mainly on the balance between short-term and long-term interests. This is mainly because the establishment of a unified ledger requires the introduction of new financial market infrastructure. (FMI), the specific needs of each jurisdiction also need to be considered.

Using APIs to connect multiple ledgers and existing systems to form a unified ledger [4] will lower upfront costs in the short term, make it easier to coordinate stakeholders, and meet the needs of different jurisdictions. Connecting existing systems through APIs can enable some automated data exchange processes similar to those operating in a tokenized environment. Multiple ledgers can coexist and new functionality can be incorporated over time. , the scope of the unified ledger will determine the parties involved in the governance arrangements of each ledger. However, this progressive approach also has certain limitations. It is constrained by foresight and compatibility with existing systems during construction. Under the conditions of continuous expansion, the constraints will become increasingly strict, ultimately hindering innovation.

Directly introducing the unified ledger new financial market infrastructure, although the short-term investment costs and the cost of switching to new standards are higher, it can comprehensively evaluate the benefits that the application of new technologies can bring. Tokenization brings such an opportunity to break the old and create new. The value generated by the programmable platform in the future will be far greater than the short-term investment.

To be clear, neither implementation is absolutely better or worse, and the specific implementation will largely depend on the technical foundation and the specific needs of the jurisdiction.

2.2 The composition of the unified ledger

The unified ledger enables tokens on a common platform to give full play to their advantages. In this secure environment where data is encrypted, stored and shared, new types of transactions can be created and the execution of contracts can be optimized. There are two key factors in the design of the unified ledger. First, all components required for transactions need to be stored on the same platform. Second, tokens or tokenized assets are executable objects, so that they do not rely on external messages and identity verification. , they can still be transferred safely.

The figure below shows the simplified structure of the unified ledger, which consists of two modules: data environment and execution environment. The unified ledger as a whole is subject to a common governance framework.

Data environment. The data environment mainly includes three parts, privatized tokens and token assets, necessary information for ledger operation (such as data required to transfer funds and assets safely and legally), and all real-world information required for contingent operations (both It is the result of transactions within the ledger, or it can be obtained from the external environment). Privatized tokens and token assets are independently owned and operated by corresponding qualified operating entities.

Execution environment. Used to perform various operations, which can be performed directly by users or smart contracts, according to the specific application, combining only the institutions and their assets that are required by the business. For example, when two individuals transfer money through a smart contract, the payment brings together the user’s bank (the supplier of tokenized deposits) and the central bank (the supplier of CBDC), and information on external conditions if required during execution will also be included. .

Shared governance framework. Privacy rules that govern how different components should interact and apply within the execution environment to ensure strict confidentiality. Data partitioning and data encryption are primary ways to achieve confidentiality and data control. Data partitioning isolates different areas, and only authorized entities can access data in their respective areas; while data encryption ensures that data is encrypted during transmission and storage, and only authorized parties can decrypt and access the data. The two complement each other and jointly ensure the security and credibility of financial transactions and operations.

3. Application cases

As mentioned above, tokenization and unified ledgers can provide new economic arrangements for existing financial businesses, thereby achieving the effect of improving existing business models and innovating business models.

3.1 Improve existing business models

The application of tokenization can improve existing payment settlement and securities settlement services.

3.1.1 Payment settlement

The current payment system can meet the basic needs of users, but the payment process still has problems of high cost, slow speed and low transparency. This is mainly because digital currency is currently located at the edge of the communication network and must be connected by external messaging systems to banks and non-banks. Operations’ proprietary database enables collaboration. The separation of messaging, reconciliation and settlement can lead to delays, and participants cannot fully understand the progress, which can lead to high error correction costs and operational risks when errors occur[5].

The figure below shows a simple domestic wire transfer notification process. The transfer of funds from payer Alice to payee Bob involves a large number of message notifications, internal checks and account adjustments. It is very complicated and it is difficult for participants to track the payment progress. The payee and payer The payment status can only be known passively[6]. In actual business, the cross-border transaction payment process is more complex, involving a series of factors such as cross-border messaging, time differences and holiday differences, foreign exchange settlement, etc., which further hinders timeliness and increases payment risks.

A unified ledger can improve these problems in payments. Private tokens and CBDC on the same programmable platform no longer need to send messages sequentially between various proprietary databases. The unified ledger uses atomic settlement (that is, two assets are exchanged simultaneously). When one asset is transferred, another asset is also transferred, which makes wholesale payment settlement from one bank to another bank during the payment process. , concurrent wholesale CBDC settlement, thus combining messaging and payment flows, eliminating latency and reducing risk. At the same time, due to the unified ledger data partitioning and setting of access permissions, it not only provides participants with data privacy and transaction transparency, but also provides transaction parties with a better payment experience.

3.1.2 Securities settlement

Securities settlement [7] is also a typical scenario where unified ledgers empower existing businesses.

The existing securities settlement process involves many participants, such as brokers, custodians, central securities depositories, clearing houses and registration agencies, etc. The message instructions, capital flows and reconciliation procedures involved in transaction settlement are complicated. This makes the overall process long and costly, resulting in replacement cost risk and principal risk.

In the traditional securities settlement business, Central Securities Depositories directly or indirectly manage securities for the beneficiaries of securities. The buyer or seller of securities initiates the transaction process by issuing instructions to their broker or custodian, and final settlement can take up to 2 working days to complete (see the Hong Kong Exchange’s securities settlement process in the figure below), which makes the transaction difficult for all parties. Exposed to replacement cost risk (i.e., the risk that a transaction fails to settle and must be traded again at a more unfavorable price). At the same time, due to the asynchronous delivery of funds and securities delivery, there is also the risk that the seller cannot obtain funds or the buyer cannot obtain the principal of securities.

(Image source: https://sc.hkex.com.hk/TuniS/www.HKEX.com.hk/Services/Clearing/Securities/Overview/Clearing-Services?sc_lang=zh-CN)

Unified ledgers and tokenization can improve securities settlement operations. As shown in the figure below, by bringing together tokenized currencies and securities on a programmable platform, settlement delays can be shortened and the need for messaging and reconciliation eliminated, thereby reducing replacement cost risk. The simultaneous delivery of funds and securities delivery can expand the scope of securities covered by DvP and further reduce principal risks. Implementing this new securities settlement method requires a corresponding liquidity saving mechanism [8], because atomic settlement in the system requires higher liquidity, which is similar to moving from delayed net settlement (DNS) to real-time gross settlement (RTGS) transition.

The Evergreen project launched by the Hong Kong Monetary Authority in 2022 is a typical application of a unified ledger to empower securities settlement business. For details, please see the green finance section below.

3.1.3 Foreign exchange settlement

Unified ledgers and tokenization can also effectively reduce settlement risks in the trillion-dollar foreign exchange market.

The existing simultaneous settlement (PvP) mechanism for foreign exchange transactions helps reduce settlement risks, but risks still exist, and the PvP system is not available or applicable for certain transactions, and market participants also believe that its cost is too high.

Atomic settlement 24/7 eliminates settlement delays, further reducing risk. Smart contracts that combine foreign exchange and authorized foreign exchange providers can expand the scope of PvP settlement and reduce transaction costs.

3.2 Create new business scenarios

A unified ledger can not only improve existing businesses, but also expand the scope of collaboration and create new types of business arrangements and transaction models through the joint use of smart contracts, a secure and confidential information storage and sharing environment, and tokenized execution transactions. .

3.2.1 Mitigating bank run risks

The application of smart contracts can effectively broaden the scope of collective collaboration, thereby overcoming the “free-riding” behavior of individual individuals [9], thereby effectively reducing the bank’s run risk.

A term deposit contract is a bilateral agreement between a bank and its depositors, and the value of the deposits may be affected when a bank or the banking industry faces liquidity stress, in which case the value of the deposits will depend on the collective decisions of all depositors. Since banks mainly invest depositors’ funds in illiquid assets, when banks face short-term liquidity pressure, the value of deposits of depositors who are the first to withdraw their deposits can be guaranteed on a first-come, first-served basis, which results in bank runs.

The application of smart contract deposit contracts can mitigate this risk. Smart contracts enable all depositors to achieve collective coordination by enforcing their contingent conditions (that is, the value of depositors’ deposits does not differ based on the order of withdrawals), eliminating depositors’ worries about other Motives for people to withdraw their deposits first and withdraw money early. While this approach will not prevent all runs from occurring, it can alleviate typical first-mover advantages and coordinated failures.

3.2.2 New supply chain finance

By incorporating real-time information into smart contracts, supply chain finance can achieve improvements using a unified ledger.

The diagram below is a simple supply chain. A buyer (usually a large company) purchases goods from Supplier 1 (usually an SME) who in turn needs to source raw materials from Supplier 2 for production. The buyer usually pays Supplier 1 after the goods arrive, and Supplier 1 needs to pay wages and raw material costs before receiving the payment. In this case, Supplier 1 needs to provide financing and pay Supplier 1 after receiving the payment. Repayment.

Due to the possibility that the buyer will not pay after delivery, the supplier’s financing form is mainly a mortgage (pledge) trade loan. For example, an Italian SME purchases semi-finished products from an Indian supplier. The semi-finished products are delivered by freighter one month later. In order to start production, the SME uses these goods in transit as collateral to obtain a loan from a bank or supplier. If the SME defaults, the creditor will The right to repossess the collateral. Creditors may provide insufficient credit or raise borrowing costs due to the risk of collateral damage or devaluation (for example, by pirates or storms). In addition, SMEs may also commit fraud, such as pledging collateral to multiple lenders at the same time. These common financing issues leave suppliers relying solely on their own funds to meet operational needs.

A unified ledger can alleviate trade finance issues by integrating different components of the supply chain relationship and different steps of the financing process into one place. The use of smart contracts between buyers and suppliers stipulates that the buyer automatically pays the price when the goods are delivered, or makes partial payments when a certain intermediate step is reached, thus reducing the risk of the buyer not fulfilling its payment obligations after the goods arrive. Smart contract loans are used between banks and suppliers to automatically execute the terms of the loan at different stages of transportation based on real-time freight data provided by IoT devices. For example, after a ship passes a certain high-risk area, the interest rate is automatically reduced or additional credit is added. . In this way, the supplier’s early working capital can be met, and since the collateral has been recorded in the unified ledger, it cannot be repeatedly pledged, which reduces the risk of the financing party and will further increase the financing party’s willingness to provide credit.

3.2.3 Loan service optimization

Through its secure and confidential information storage and sharing environment, the unified ledger is also able to leverage the power of data to reduce the cost of credit and the difficulty of obtaining credit.

First, the data integrated by the unified ledger enables lenders to incorporate more diversified data into the borrower’s credit risk assessment system, thereby reducing borrowing costs and reliance on collateral.

Secondly, the application of data encryption technology allows users on the unified ledger to retain control over their data, which improves the high borrowing costs caused by network effects. Although the network effect gathers a large amount of user data and provides borrowers with convenient borrowing channels, as these services attract more and more users, the increase in the amount of data brings more user-created data, forming DNA (Data-Network-Activities) loop. The resulting market concentration has become higher, and excess profits or monopoly profits have led to high borrowing costs. The unified ledger retains an arrangement in which users retain control over their data. Users can decide for themselves whether lenders can share or use their data, thus reducing lenders’ profits due to market concentration and ultimately lowering borrowing costs, benefiting residents and businesses. .

In addition, the unified ledger can also improve financial inclusion through improved data sharing arrangements, so that the data of disadvantaged groups such as ethnic minorities and low-income households can be included in the credit system. These applicants with “small credit records” will be screened from non-traditional data. Because banks’ traditional credit scores interfere more with their default risk metrics than other groups, the more comprehensive data available in the unified ledger improves the quality of credit assessments, thereby lowering borrowing costs for these groups.

3.2.4 Anti-Money Laundering

By using cryptography, a unified ledger could also introduce new ways to strengthen AML (Anti-Money Laundering) and CFT (Combating the Financing of Terrorism).

Financial institutions are required by law to protect highly sensitive and proprietary data, and the inability to share this sensitive data without exposing confidential information hinders the implementation of AML and CFT. A unified ledger can provide a transparent and auditable record of transactions, transfers and ownership changes, while encryption methods allow financial institutions to share this information confidentially with each other across borders, and detect fraud while complying with local data regulations. and money laundering.

The advantages can be further enhanced by leveraging tokenization and the dual properties of tokens containing identifying information and stipulating transfer rules. For example, in the payment business, regulatory compliance information such as transaction parties, geographic attributes of transaction parties, and transfer types can be directly embedded in tokens. The BIS Innovation Center’s Aurora project is exploring how privacy-enhancing technologies and advanced analytics can be leveraged to combat cross-financial institution and cross-border money laundering.

3.2.5 Asset-backed securities

A unified ledger that combines smart contracts, information, and tokenization can also improve the process of asset securitization and bond issuance and investment.

Take mortgage-backed securities (MBS) as an example. MBS is an investment product that pools mortgage loans and stratifies them into different grades of bonds, which are then sold to investors. Even in a market like the United States, where MBS liquidity reaches US$12 trillion, the securitization process requires the participation of more than a dozen intermediaries, making the process very complicated.

By applying automated smart contracts, delays in information and capital flows can be eliminated and the securitization process can be simplified. Tokens can integrate real-time data on borrower repayment and repayment collection methods as well as investor allocations, further reducing reliance on intermediaries.

3.2.6 Green Finance

Green finance is another typical use case where unified ledgers and tokenized applications enable innovation.

By creating a digital platform where investors can download an app and invest any amount into tokenized government bonds through the app to fund green investments. Investors can not only check the accrued interest during the bond period, but also track the amount of clean energy and carbon emission reduction generated by this investment in real time. The bond also allows investors to trade on a transparent secondary market.

In the Genesis project of the BIS Innovation Hub, BIS and the Hong Kong Monetary Authority have jointly continued to explore in this area and launched the Evergreen project in 2022 to issue green bonds using tokenization and unified ledgers. The project’s architecture and first-level issuance process are shown in the figure below. The project makes full use of the distributed unified ledger to integrate the participants involved in bond issuance on the same data platform, supports multi-party workflow and provides specific participant authorization, real-time verification and signature functions, improving transaction processing efficiency, while the bond The settlement realizes DvP settlement, reducing settlement delays and settlement risks. The platform’s real-time data updates for participants also improve the transparency of transactions. Although the project still takes the form of API integration of traditional systems and a unified ledger platform, it is a meaningful attempt in terms of transaction efficiency and risk reduction.

1. The overall architecture of the Evergreen project

(Image source: https://www.hkma.gov.hk/media/chi/doc/key-information/press-release/2023/20230824c3a1.pdf)

1. Workflow process for the first-level issuance of the Evergreen project settled in DvP mode

(Image Source:https://www.hkma.gov.hk/media/chi/doc/key-information/press-release/2023/20230824c3a1.pdf）

4. Basic principles of unified ledger application

There are some general guidelines to follow when applying the unified ledger and its tokens. The first principle is that any application should be consistent with the two-tier structure of the monetary system. Based on this, central banks can continue to maintain the single currency through settlement of wholesale CBDC, while the private sector can continue to innovate and enable residents and businesses to Benefit.

In addition, principles related to scope of application and governance are also critical. These principles can clarify how best to ensure a level playing field and promote competition, and can also ensure data privacy and operational resiliency (Operational Resilience). The implementation of these principles ultimately depends on the needs and preferences of each jurisdiction, as well as on the details of their specific application.

4.1 Scope, governance and competition

4.1.1 Scope of the unified ledger

As mentioned before, the unified ledger can contain multiple ledgers, and each ledger has specific use cases. Therefore, the application of the unified ledger can start with specific scenarios, and the effect will be more obvious. The figure below shows the scope and characteristics of tokenization applications. When implementing tokenization, the implementation effect should be comprehensively weighed. Because tokenization is relatively easy to apply, its unit income may not be significant, but tokenization is relatively easy. For difficult applications, the benefits after implementation may be huge. So in the short term, tokenization can focus on identifying assets that are suitable for tokenization and can be traded at scale. Starting from specific use cases, the scope of the unified ledger can be expanded over time, but its ultimate scope will depend on the specific needs and constraints of each jurisdiction.

The unified ledger is actually a new type of FMI (or a combination of multiple FMIs). As stated in the “Principles of Financial Market Infrastructure” [10], the most basic principle of FMI is that it should be available under feasible and usable conditions. Providing clear and unambiguous final settlement of central bank currencies applies to infrastructure as diverse as payment systems, central securities depositories, securities settlement systems, central counterparty clearing and transaction databases.

4.1.2 Governance and competition

The scope of the unified ledger directly affects its governance arrangements, competitive landscape and incentives for participation.

Governance of the unified ledger could follow existing arrangements where central banks and regulated private sector actors participate in governance according to established rules. Taking payment settlement as an example, when the unified ledger involves currency and payments, the central bank will still be responsible for the final settlement of assets, and in order to ensure integrity, regulated and supervised private sector players continue to provide services to users, they should also comply with the current KYC, AML and CFT regulations in place and conduct ongoing due diligence to ensure privacy compliance.

As the scope of the ledger increases, so do the requirements for governance arrangements. For example, a unified ledger for cross-border payments requires seamless interoperability between Private Payment Service Providers (PSPs) and central banks located in different jurisdictions with different regulatory frameworks, thus requiring a large number of cross-jurisdictional transactions. In contrast, the unified ledger for domestic securities settlement requires relatively few coordination efforts.

An open and fair environment is essential for competition and financial inclusion. From a regulatory policy perspective, it is important to consider how the introduction of a common platform will impact money and payments industry organizations and, ultimately, the financial system as a whole. Open platforms can foster healthy competition and innovation among private sector players, thereby reducing costs for end users by cutting into high margins. Regulatory authorities need to achieve this goal when designing platforms and corresponding rules to ensure that network effects serve the interests of consumers and prevent the emergence of monopolistic players.

Providing appropriate financial incentives to potential participants is key to promoting competition. Without appropriate incentives, private payment service providers may choose not to participate. If the application of new technology affects the distribution of existing economic incentives and reduces the influence or benefits of vested interests, it may hinder participants from implementing the new technology. Mandatory participation while providing infrastructure that allows private players to innovate will likely become the key to implementation. Participants will be able to obtain economic incentives from it. As the number of participants increases, network effects will become more prominent, forming an agglomeration effect.

4.2 Data Privacy and Cyber ​​Resilience

A unified ledger aggregates currencies, assets, and information on the same platform, making data privacy and operational resilience particularly important.

4.2.1 Privacy protection

The aggregation of different types of data in one place may raise concerns about data being stolen or misused. In order to protect the privacy of users, adequate safeguards need to be taken, and the data on the unified ledger should be managed using conservative methods to achieve the purpose of privacy protection. The same problem exists with business secrets. Only when their confidential information is fully protected can companies be willing to become participants in the unified ledger.

Creating partitions in a unified ledger data environment is an important way to protect privacy, which allows each participant to only see and have permission to access relevant data on his or her own partition. The application of private keys further strengthens data protection. The update of data in the partition, identity authentication and authorization of transactions are all completed through the private key, ensuring that only authorized accounts can manage partition data.

Encryption technology is another effective way to protect privacy. When different participants interact in a transaction, information from different partitions needs to be shared and parsed in the execution environment. Secure data sharing technology allows mathematical calculations to be performed directly on encrypted or anonymized data without exposing sensitive information. This not only satisfies the desire of financial institutions and users to share data in a form that protects privacy, but also promotes competition and innovation because of decentralization. Trade secrets can be protected by encrypting individual smart contracts, as only the code owner or his designated parties can access the contract details.

There are a variety of technologies that can achieve information confidentiality and privacy protection in a unified ledger, and each has advantages and disadvantages due to its purpose, and also differs in terms of privacy protection, computational burden, and implementation difficulty.

In addition, as an institution that serves the public interest and has no commercial interest in personal data, the central bank can ensure the implementation of privacy protection from the source when designing the unified ledger, such as embedding privacy laws directly into the token of the unified ledger. Data privacy laws give consumers the right to authorize or refuse third parties to use their data. For example, the European Union’s General Data Protection Regulation requires companies to delete consumers’ personal data, and California’s Consumer Privacy Protection Act gives consumers the power to understand companies. Details of gathering information etc. Effective enforcement of data privacy laws can be enhanced by leveraging the unified ledger and embedding options to prohibit the sale of personal data or delete personal data directly into the smart contracts of tokens and transactions.

4.2.2 Cyber ​​attacks

In addition to privacy protection, network resilience is also critical. In recent years, the losses caused by cyber attacks have increased significantly, and strong network resilience protection is needed from both the institutional and legal levels. When FMI or the unified ledger suffers a cyberattack, compared with the huge financial and reputational losses caused, it will cause widespread paralysis of the financial system and ultimately immeasurable social losses. The wider the scope of the unified ledger, the greater the risk of a single point of failure, and the greater the losses it can cause. For these reasons, adequate investment in network resilience and security is critical, requiring the implementation of multiple layers of security measures for the integrity and confidentiality of unified ledger data.

5. Conclusion

In order to fully realize the innovation potential of currency, payments and wider financial services, and to build a future monetary system that can adapt to real needs and innovative development, the role of central banks is crucial.

This article outlines a blueprint for a future monetary system that harnesses the transformative potential of tokenization to improve existing structures and open up new possibilities. This blueprint proposes a new financial market infrastructure called Unified Ledger, which integrates CBDC, tokenized deposits and tokenized rights and interests in other financial and real assets into a single platform. Its advantages are that, firstly, it allows seamless integration and automatic execution of a wider range of financial transactions, achieving synchronization and instant settlement; secondly, it concentrates all information data content on the same platform, using smart contracts to overcome information and incentive problems, and services Public Interest.

The concepts of tokenization and unified ledgers reveal the development context of the future monetary system, but in actual application, the specific needs and restrictions of each jurisdiction determine the scope and order of its application. During this development, multiple ledgers can coexist and be interconnected through APIs for interoperability.

Furthermore, realizing this vision requires joint efforts from the public and private sectors to drive research and development of technological solutions, establish common digital platforms, and ensure appropriate regulation and oversight. Through cooperation, innovation and continuous integration, we believe that we can establish a monetary system based on mutual trust, realize new economic arrangements, improve the efficiency and accessibility of financial transactions, and meet the changing needs of residents and businesses.

Endnote

[1] See original page 88

[2] See original page 89

[3] Banking in the narrow sense refers to the realization of a complete reserve system, which requires commercial bank deposits (bank liabilities) to be supported by 100% deposit reserves (commercial bank deposits with the central bank). Under this model, commercial banks transfer all their deposits to the central bank and cannot issue loans to achieve credit expansion. Commercial banks are only channels through which the central bank releases money. All credit expansion is achieved by the central bank’s balance sheet expansion. Under the narrow banking system, all currencies are base currencies supplied by the central bank, and there is no money multiplier effect achieved by commercial banks through loans.

[4] For the specific architecture, please see Figure B1 of the original text.

[5] For details, see box C on page 99 of the original text

[6] When customers make card payments to merchants, additional authorization and verification processes are required. These processes involve the merchant, the buyer’s bank, the acquiring bank, etc., and many times also include access control services to verify the payment instrument (inflow debit or credit card)

[7] For details, see box D on page 100 of the original text

[8] The Liquidity Savings Mechanism (LSM) is an additional feature of the payment system that is used to help banks manage their liquidity and reduce liquidity risk. It is often used in conjunction with a real-time gross settlement (RTGS) system. The function of LSM is to control the release of queued payments based on the offset or partially offset payments received during the payment queuing process. This means banks can manage their payment liquidity more efficiently, rather than having to wait for all payments to arrive before clearing them. This helps make the payment system more efficient and reduces the likelihood of payment delays. LSM helps ensure the smooth operation of the payment system and reduces the liquidity risk of the payment system

[9] Free-riding behavior refers to an individual or organization enjoying the benefits of a certain resource or service without bearing the corresponding costs or obligations. This behavior occurs both on public goods and on shared property. Free-riding behavior occurs in bank runs because not all depositors have the ability to identify bank risks. When some depositors with risk identification abilities gain insight into bank risks, they will be the first to withdraw their deposits, but other depositors without identification abilities will. Follow the trend and make withdrawals, eventually leading to a run.

[10] The Principles for Financial Market Infrastructures (Principles for Financial Market Infrastructures) is a set of principles issued by BIS in 2012 to guide and standardize the operation of financial market infrastructures (FMI). For details, seehttps://www.bis.org/cpmi/publ/d101a.pdf

references

https://www.bis.org/publ/arpdf/ar2023e3.htm

https://www.zhihu.com/question/20258395

https://www.ccvalue.cn/article/1273028.html

http://www.thfr.com.cn/post.php?id=46333

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