Today, the global monetary system is undergoing a historic breakthrough. After digitization, tokenization (the digital expression of equity in an asset on a programmable platform) is pivotal to this leap. Tokenization revolutionizes how intermediaries serve users, bridging the gaps in information exchange, reconciliation, and settlement, significantly bolstering the capabilities of currency and financial systems. Tokenization will engender new economic activities that are currently unattainable within existing monetary frameworks.

Cryptocurrency or decentralized finance (which is recently devouring RWA assets) merely scratch the surface of tokenization. They still have limitations, not only in their ability to connect with the real world but also due to the lack of endorsement from central banks, even stablecoins are not that stable.

In our previous article Citigroup RWA Research Report: Money, Tokens and Games (The Next Billion Users and Trillion-Dollar Value of Blockchain), we introduced a new trillion-dollar tokenization market. Yet, before embarking on this vast and tumultuous voyage, it’s imperative to return to the basics, re-examining tokenization, RWAs, and even token payments, much like the meticulous study of the Bitcoin whitepaper in the beginning.

As such, we’ve distilled insights from the Bank for International Settlements’ (BIS) 2023 Economic Report concerning tokenization. These insights are intended for industry professionals to gain further comprehension of the underlying mechanics governing tokenization.

BIS dissects tokenization from the perspectives of the monetary and banking systems, presenting a blueprint for the future of the global monetary system. Key components in crafting this blueprint include Central Bank Digital Currencies (CBDCs), tokenized deposits, and other tokenized rights to financial and tangible assets. The blueprint envisions integrating these elements into a novel financial market infrastructure called the “Unified Ledger,” showcasing the full advantages of tokenization to improve existing systems and construct new frameworks.

Highlights

• Tokens and the tokenization of assets possess enormous potential, but the endorsement of central bank currencies and their ability to connect with the financial system are pivotal for the success of tokenization;
• “Unified ledger”, a novel financial market infrastructure, amalgamates CBDCs, tokenized deposits, and tokenized assets onto a programmable platform, thereby harnessing the maximum advantages of tokenization.
• CBDCs and tokenized deposits hold certain advantages in maintaining singleness of money, settlement finality, providing liquidity, and risk mitigation.
• The application of tokenization and unified ledgers not only improve existing financial market infrastructures by seamlessly integrating multiple systems but also create novel economic arrangements using a programmable platform, offering immense commercial value.
• Multiple use case-specific ledgers can coexist while ensuring interoperability through Application Programming Interfaces (APIs), fostering financial inclusion and fair competition.
• Governance arrangements play a pivotal role in driving the adoption of unified ledger and tokenization technologies, where reasonable incentives are key to attracting participants to engage in new applications and ultimately generate network effects.

Glossary

Token – A digital representation of rights or assets on a blockchain or distributed ledger.

Tokenization – The process of recording claims on real or financial assets from traditional ledgers onto a programmable platform.

Private Tokenized Monies – Tokens issued by the private sector (not central banks).

Singleness of Money – It means that in a specific monetary system, there is only one main currency, and different forms of currency or assets can be equivalently exchanged for this main currency. In other words, the value of currency is not affected by different forms of currency, whether they be privately issued money (like deposits) or publicly issued money (like cash).

Settlement Finality – The irreversible confirmation of funds as the legitimate property of the receiving party after transferring from one account to another.

Unified Ledger – A new financial market infrastructure (FMI) that integrates information from multiple data sources, platforms, or systems (financial transactions, data records, contracts, digital assets, etc.) to record all transactions and data without the intervention of centralized institutions.

Programmable Platform – A technology-agnostic platform including a Turing machine with execution environment, ledgers, and governance rules.

Ramp – A smart contract that links non-programmable platforms with programmable ones, securing assets on their original platform as collateral for tokens issued on the programmable platform.

Atomic Settlement – It 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 successfully trade assets or no transfer of assets occurs. Atomic settlement enables T+0 settlement.

Payment-versus-payment (PvP) – A settlement mechanism ensuring the simultaneous transfer of one currency for another (or multiple currencies) as final and irrevocable settlement. That is, two (or more) currencies of the transaction were completed at the same time.

Delivery-versus-payment (DvP) – A settlement mechanism associating asset transfer with fund transfer to ensure delivery only occurs when the corresponding payment is made.

1. Tokens and Tokenization

1.1 Definition of Tokens and Tokenization

Tokens refer to claims recorded on a programmable platform that are available for trading^[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 diagram below). Therefore, tokens are programmable and customizable to meet unique scenarios and regulatory requirements.

Tokenization refers to the process of recording claims on financial or real assets that exist on traditional ledgers onto programmable platforms^[2]. This process is executed via Ramp (see diagram below), which maps assets from traditional databases (e.g., financial securities, commodities, or real estate) into asset tokens on the programmable platform. Assets within traditional databases are “locked” or frozen to serve as collateral supporting tokens issued on the programmable platform. 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 execution of operations and contingent performance of actions through smart contracts.

Decentralized execution of operations – In contrast to traditional systems that rely on intermediaries to update and maintain ownership records, in a tokenized environment, tokens or assets become “executable objects” maintained on the programmable platform. Platform participants transfer assets by issuing programming instructions, eliminating the need for intermediaries. This approach enables a wider range of composability, enabling several operations to be put into a bundle for execution. While this approach doesn’t necessarily eliminate the role of intermediaries, it transforms their nature from “updating and maintaining asset ownership records” to “managing programmable platform rules,” thus eliminating the need for dedicated ledger keepers.

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

The combined use of the two features simplifies transactions that require complex contingent execution.

1.2 CBDC and Private Tokenized Monies

Tokenization needs the monetary unit of account in which transactions are priced and means of payment to be fully utilized. Compared with applications that use stablecoins as payment methods to achieve tokenization in decentralized financial scenarios, CBDCs offer a stronger foundation due to their finality in settlement and central bank endorsement. Programmable platforms can directly use fiat currency settlement as a necessary component of tokenization arrangements, making it the best choice for tokenization applications.

The development of wholesale CBDCs is crucial for tokenization applications. As a tokenized settlement method, wholesale CBDCs can function similarly to reserve currencies in the current monetary system. Additionally, they can be endowed with new functionalities through tokenization. Transactions in wholesale CBDC could incorporate all the features such as the composability and contingent performance of the actions mentioned above. This enhanced form of CBDC could also become a retail variant for use by residents and businesses, allowing central banks to further support the singleness of currency by providing the public with digital cash that has a direct link to a digital form of the sovereign unit of account.

The role of CBDC in a tokenized environment is becoming clearer. However, discussions persist on how private tokenized money that complements CBDCs can exist appropriately. Presently, there are two mainstream forms of private tokenized monies: tokenized deposits and asset-backed stablecoins. Both represent liabilities of the issuer, who promises to redeem customers’ claims at par value in the sovereign unit of account. The two forms differ in their transfer methods and their roles within the financial system, which affect their attributes as a tokenized form of money that complements CBDCs.

Tokenized Deposits

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 a claim on the issuer. Like regular deposits, tokenized deposits cannot be transferred directly, and the central banks’ liquidity provision for settlement would continue to ensure smooth functioning of payments.

The following example illustrates the similarities between tokenized deposits and traditional deposits through comparison. In this scenario, John and Paul have accounts in two different banks, both having undergone KYC procedures.

In a traditional system, when John pays 100 GBP to Paul, Paul doesn’t receive a deposit of 100 GBP in his bank directly from John’s bank. Instead, John’s account balance at his bank is reduced by 100 GBP, while Paul’s balance at his bank increases by the same amount. Meanwhile, the adjustments in the individual accounts at the two banks are matched by a transfer in central bank reserves between the two banks.

In a tokenized environment, this can be achieved by reducing John’s tokenized deposit held in his bank and increasing Paul’s tokenized deposit held in his bank, while simultaneously settling the payment through a concurrent transfer of wholesale CBDC. Paul still only holds a claim against his bank; he’s a verified customer of his bank, and has no claim on John’s bank, nor on 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 the singleness of money. The existing system has the central bank operating the settlement infrastructure, thereby ensuring the final transfer of payments at par value in terms of the sovereign unit of account and achieving the singleness of deposit payments in commercial banks. Tokenized deposits preserve this mechanism, enhancing it through the settlement via smart contracts using wholesale CBDCs, improving timeliness, reducing payment time differences, and thereby mitigating risks.

Secondly, tokenized deposits settled using wholesale CBDCs 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 scenario, settlement finality ensures that Paul holds claims against his own bank only, not against John (or John’s 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 access to liquidity (such as credit lines) to households and businesses. Most of the money circulating in the existing monetary system is created in this way, because borrowers simultaneously hold deposit accounts in banks; loans issued by banks directly become deposits in borrowers’ accounts, enabling money creation. Unlike narrow banking models^[3], this flexible approach allows banks to cater to the needs of households and businesses based on economic or financial conditions. Further, robust regulation and supervision are also necessary to prevent excessive credit growth and high-risk behaviors.

Stablecoins

Stablecoins are another form of private tokenized money, but they have certain drawbacks. In contrast to tokenized deposits, stablecoins represent transferable claims on the issuer, resembling digital bearer instruments. Using stablecoins for payment effectively transfers the issuer’s liability from one holder to another.

Assume that John holds one unit of stablecoin (representing one unit of the issuer’s debt) issued by the stablecoin issuer. When John pays Paul one unit of stablecoin, John transfers his claim on the stablecoin to Paul. Before the transfer, Paul doesn’t hold any claims against the issuer. In this case, Paul is left with a claim on an issuer he may not trust. Here comes a question: Does Paul trust the stablecoin issuer?

This is because stablecoins have the properties of bearer bonds. Stablecoin issuers do not need to update their balance sheets during this transfer. Since stablecoins are private tokenized money, the central bank’s balance sheet doesn’t settle this transaction. The stablecoin itself serves as evidence of the issuer’s claim, and the transfer of this claim doesn’t require the issuer’s consent or involvement.

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

Firstly, stablecoins might undermine the singleness of currency, causing discrepancies in currency value. This is because stablecoins are tradable, differences in liquidity between stablecoins or variations in the issuer’s credibility can lead to prices deviating from par or even suffer greater uncertainty. For instance, in the Silicon Valley Bank incident, users were concerned that the bank’s liquidity may affect stablecoin prices, hence sell off their stablecoin holdings, causing significant price drop and disrupting singleness of money. Lack of explicit regulation and central bank endorsement are critical reasons causing these issues.

Secondly, unlike tokenized deposits that can flexibly provide liquidity, the operation of asset-backed stablecoins is more akin to narrow banks. This is because ideally, all the USD corresponding to stablecoin issuance should be invested in highly secure, liquid assets. Consequently, stablecoins reduce the available supply of liquid assets for other purposes, rendering them inflexible in supplying liquidity.

Additionally, compared to tokenized deposits, stablecoins lack supervision in compliance with know-your-customer (KYC), anti-money laundering (AML) and combating the financing of terrorism (CFT) rules, thus posing certain risks. Going back to the example mentioned above, John transfers stablecoins to Paul but the issuer did not verify or conduct compliance checks on Paul’s identity, which might cause fraud risks. Tokenized deposits can operate within existing regulatory frameworks by mimicking the transfer process of traditional deposits without requiring significant regulatory reforms to ensure KYC, AML, and CFT compliance like stablecoins.

2. Tokenization and Unified Ledger

The full application of tokenization relies on its ability to combine the trading and operation of currencies and a range of assets on programmable platforms. Tokenized money provides a necessary means of payment that mirror underlying asset transactions, with the core being the central bank currency in tokenized form, thereby facilitating settlement finality. A common ground for these functionalities is a unified ledger, integrating CBDCs, private tokenized monies, and other tokenized assets seamlessly into a single programmable platform to ultimately realize a new economic arrangement.

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), while considering the specific needs of each jurisdiction.

In the short term, connecting multiple ledgers and existing systems using APIs to form a unified ledger ^[4] presents lower initial costs and is easier to coordinate stakeholders. This can meet the needs of various jurisdictions. Connecting existing systems using API 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 ledger will determine the parties involved in the governance arrangements for each ledger. However, this progressive approach has limitations. It is constrained by forward-thinking and compatibility with existing systems during construction. As expansion continues, the constraints will become increasingly strict, ultimately hindering innovation.

Directly introducing a unified ledger as a new FMI incurs higher short-term investment costs and transition costs to new standards. However, it allows a comprehensive assessment of the benefits derived from the application of new technologies. Tokenization presents an opportunity for innovation; the long-term value generated by programmable platforms will outweigh short-term investments.

It’s essential to note that neither implementation method is inherently good or bad; the specific approach depends significantly on technological foundations and the specific needs of the jurisdiction.

2.2 Components of the Unified Ledger

A unified ledger enables tokens on a universal platform to fully leverage their advantages. In this secure environment of encrypted storage and shared data, it fosters new types of transactions and optimizes contract execution. The design of a unified ledger hinges on two key factors: first, all components necessary for transactions must reside on the same platform; second, tokens or tokenized assets are executable objects, allowing secure transfers without relying on external messages or identity verification.

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

Data environment: The data environment mainly includes three parts, namely private tokenized money and token assets, information necessary for the operation of the ledger (such as the data required for secure and legal transfer of money and assets), and all information necessary to incorporate real-world events into any contingent performance of actions (it can be the result of transactions within the ledger, or may be obtained from the outside environment). Private tokenized money 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 through smart contracts. According to each specific application, operations in the execution environment combine only the intermediaries and assets required for each application. For example, when two individuals transfer money through a smart contract, the payment will bring together the users’ bank (the provider of tokenized deposits) and the central bank (the provider of CBDC). And information will also be included if the payment is conditional on some real-world contingency.

Common governance framework: It is privacy rules that govern how different components interact and apply in the execution environment to ensure strict confidentiality. Data partitions and data encryption are primary ways to achieve confidentiality and data control. Data partition 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. Use Cases

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

3.1 Improving 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 meets basic user needs, but it suffers from high costs, slow speeds, and low transparency in the payment process. This is primarily due to digital currencies currently residing at the edge of communication networks, requiring collaboration between external messaging systems connecting banks and non-bank proprietary databases. The separation of messaging, reconciliation, and settlement results in delays, and means that participants often have an incomplete view of completed actions. This can incur higher error resolution costs and increased operational risks.^[5]

The figure below shows a simple domestic wire transfer notification process. The transfer of funds from payer Alice to payee Bob involves numerous messages, internal verifications, and account adjustments, making it a complex process. Participants generally cannot track payment progress in real time, and both payer and payee passively receive payment status^[6]. In real business scenarios, cross-border transaction payment processes are even more intricate, involving international message transmissions, differences in operating hours and/or holidays, foreign exchange settlements, and other factors that further impede timeliness and increase payment risks.

Unified ledgers can ameliorate these issues in payment processes. Having private tokenized monies and CBDC on the same platform eliminates the need for the sequential messages across siloed databases. The unified ledger adopts atomic settlement (i.e. simultaneous exchange of two assets), meaning that the transfer of one occurs only upon transfer of the other. In the process, settlement, i.e. the wholesale leg of the payment from one intermediary to another, also occurs instantaneously in wholesale CBDC. By bringing messaging and payment flows together, the ledger eliminates delays and reduces risks. Additionally, through data partition and access control settings within the unified ledger, it ensures data confidentiality for participants while providing transparency in transactions, offering an enhanced 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 parties, including brokers, custodians, central securities depositories, clearing houses, registration agencies, etc. The messaging instructions, money flows and reconciliation procedures involved in transaction settlement are complicated. This makes the overall process lengthy and costly, resulting in replacement cost risk and principal risk.

In traditional securities settlement business, the central securities depositories manage securities directly or indirectly for the beneficiaries of the securities. A buyer or seller of securities initiates the transaction process by issuing instructions to their broker or custodian, and the final settlement might take up to two working days (see the securities settlement process of the Hong Kong Exchanges and Clearing Limited in the diagram below). This exposes involved parties to replacement cost risk (i.e. the risk of trades failing to settle, necessitating new trades at unfavorable prices). Additionally, due to the asynchrony between fund delivery and security delivery, there is principal risk where sellers may not receive funds or buyers may not receive 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 diagram below, by bringing together tokenized currencies and securities on a programmable platform, settlement delays can be reduced 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 in delivery-versus-payment (DvP) arrangements and further mitigate principal risks between counterparties. The implementation of this new securities settlement method requires appropriate liquidity saving mechanisms^[8], as atomic settlement in the system requires higher liquidity, similar to the transition from deferred net settlement (DNS) to real-time gross settlement (RTGS).

The Evergreen project initiated by the Hong Kong Monetary Authority in 2022 is a prime example of how unified ledgers empower securities settlement operations. Details can be found in the following section on Green Finance.

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 payment-versus-payment (PvP) mechanism in foreign exchange trades helps mitigate settlement risk. However, risks persist, and this PvP system might be unavailable or unsuitable for certain transactions, with market participants finding it costly.

24/7 atomic settlement can eliminate settlement delays, further reducing risks. Combining foreign exchange with authorized foreign exchange providers through smart contracts can expand the scope of PvP settlement and reduce transaction costs.

3.2 Create New Business Scenarios

Unified ledgers not only improve existing operations but also extend collaboration scope and create entirely new types of business arrangements and transaction models. This is made possible through the combination of smart contracts, secure and confidential information environment for storing and sharing information, and tokenized transaction executions.

3.2.1 Mitigating Bank Run Risks

Smart contracts effectively expands the scope for coordination, overcoming the free-riding ^[9] behavior and thereby reducing bank run risks effectively.

Term deposit contracts are bilateral agreements between banks and depositors, where the value of deposits may be impacted when a bank or the banking sector faces liquidity pressure. In such a scenario, the value of deposits will depend on the collective decisions of all depositors, especially during stress periods in the banking sector. In this context, strategic uncertainty arises as early withdrawals are met on a first-come, first-served basis, while the bank invests funds in illiquid assets. Depositors who withdraw first thus have an advantage and this can lead to bank runs.

The use of smart contract deposit contracts can alleviate this risk. Smart contracts enable all depositors to achieve coordination by imposing contingent performance of actions (that is, the value of depositors’ deposits does not differ based on the order of withdrawals), eliminating the motivation to withdraw funds purely out of fear that others might do the same. While this method may not prevent all bank runs, it can alleviate the typical scenarios of first-mover advantage and coordination failure.

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. The buyer (often a large corporation) purchases goods from supplier 1 (typically a small and medium-sized enterprise, SME), who, in turn, sources raw materials from supplier 2 for production. The buyer usually makes payments to supplier 1 upon receipt of goods, while supplier 1 needs to pay its workers and purchase material before receiving the payment from the buyer. In such cases, supplier 1 needs financing and repays it upon receiving the payment from the buyer.

Due to the possibility that the buyer will not pay after delivery, supplier financing primarily relies on collateralized (pledged) trade loans. For instance, an Italian SME purchases semi-finished goods from an Indian supplier, with delivery via ship in a month. To set up production now, the SME uses these goods as collateral to obtain a loan from a bank or its suppliers. Should the company default, the creditor has the right to reclaim the collateral. Risks like collateral damage or devaluation (e.g., encountering piracy or a storm) may lead creditors to offer insufficient credit or increase borrowing costs. Furthermore, SMEs might engage in fraudulent activities, such as pledging collateral to multiple lenders simultaneously. These common financing issues limit suppliers to relying on their own funds to meet operational needs.

Unified ledgers can alleviate trade finance issues by integrating different components of supply chain relationships and financing processes into one place. Smart contracts between buyers and suppliers stipulate automatic payment by the buyer upon delivery of goods or partial early payments when intermediate steps are reached, reducing the risk of the buyer defaulting on payment after goods arrive. Smart contract-based loans between banks and suppliers, leveraging real-time shipment data provided by IoT devices, automatically execute loan terms at various stages of transportation. For instance, when a ship passes through a high-risk area, the interest rates automatically decrease or additional credit be granted. This facilitates early operational capital for suppliers, reduces the risk for fund providers due to collateral already recorded in the unified ledger, and increases the willingness of fund providers to offer credit.

3.2.3 Loan Service Optimization

Through its secure and confidential environment for information storage and sharing, the unified ledger could also leverage the benefits 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.

Besides, 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 network effects gather a vast amount of user data, providing convenient borrowing channels for borrowers, as these services attract more users, the increased data volume generates a Data-Network-Activities (DNA) loop. This leads to increased market concentration, fostering high borrowing costs due to excess or monopolistic profits. Unified ledgers maintain users’ control over their data, allowing users to decide whether lenders can share or use their data, thereby reducing lender profits resulting from market concentration and ultimately lowering borrowing costs, benefiting households 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 “thin credit file” applicants applicants stand to benefit disproportionately from screening via non-traditional data, as banks’ traditional credit scores are noisier indicators of their default risk than for other groups of the population, additional data yield a more precise signal of their credit quality, thereby lowering borrowing costs for these groups.

3.2.4 Anti-Money Laundering

Unified ledgers can introduce new methods to strengthen AML (Anti-Money Laundering) and CFT (combating the financing of terrorism) through the use of encryption technology.

Financial institutions, bound by legal obligations to safeguard highly sensitive and proprietary data, face challenges in sharing such sensitive information without compromising confidentiality, hindering the implementation of AML and CFT measures. Unified ledgers offer transparent and auditable records of transactions, transfers, and ownership changes, while encryption methods enable financial institutions to share this information securely with each other and across borders, facilitating fraud detection and money laundering activities in compliance with local data regulations.

These benefits could be further enhanced by leveraging tokenization and the dual nature of tokens encompassing both identifying information and the rules governing transfer. For instance, in the case of payments, regulatory compliance information such as the parties involved, their geographical attributes, and the type of transfer can be embedded directly into tokens. The BIS Innovation Hub’s project Aurora is exploring how enhanced privacy techniques and advanced analytics can combat money laundering across financial institutions and borders.

3.2.5 Asset-backed Securities

Unified ledgers combining smart contracts, information, and tokenization can also improve the issuance and investment process of asset-backed securities.

Taking mortgage-backed securities (MBS) as an example, MBS involves pooling mortgage loans into tranches of debt that are subsequently purchased by investors. Even in markets like the United States with MBS liquidity reaching up to $12 trillion, the securitization process involves participation from a dozen intermediaries.

Automation through smart contracts can eliminate delays in information and payment flows, streamlining the securitization process. Tokens can integrate real-time data on borrower repayments and how they are pooled and distributed to investors, reducing the need for intermediaries.

3.2.6 Green Finance

Green finance is another exemplary use case for the application of unified ledgers and tokenization.

By establishing a digital platform, investors can download an application and invest any amount in tokenized government bonds that fund green initiatives. Throughout the bond’s life cycle, investors can not only view accrued interest but also track real-time data regarding the clean energy produced and carbon emissions reduced due to their investment. These bonds allow investors to trade on a transparent secondary market.

In the Genesis project of the BIS Innovation Hub, BIS partnered with the Hong Kong Monetary Authority, continuously exploring this field. In 2022, they initiated the Evergreen project, issuing green bonds using tokenization and unified ledgers. The architecture and primary issuance process of the project are illustrated in the diagram below. Leveraging a distributed unified ledger, the project consolidated all involved parties onto a single data platform, supporting multi-party workflows and providing authorization, real-time validation, and signature capabilities of specific participants, which enhances transaction processing efficiency. DvP is enabled in bond settlement, reducing settlement delays and risks. Moreover, the platform’s real-time data updates for participants improved transaction transparency. While the project continued integrating traditional systems with the unified ledger platform through APIs, it represented a significant attempt toward enhancing transaction efficiency and reducing risks.

Architecture of Evergreen

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

Workflow for the Primary Issuance of Evergreen with DvP settlement

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

4. Basic Principles of Unified Ledger Application

When applying unified ledgers and their tokens, adhering to overarching guiding principles is essential. The foremost principle is ensuring that any application aligns with the two-tier structure of the monetary system. Within this framework, central banks can sustain the singleness of currency through wholesale CBDC settlements, while the private sector can continue innovating to benefit households and businesses.

Apart from this, principles related to application scope and governance are equally crucial. These guidelines clarify how to best safeguard a fair competitive environment and promote competition while ensuring data privacy and operational resilience. The implementation of these principles ultimately depends on the preferences and needs of each jurisdiction, as well as the specific details of their application.

4.1 Scope, Governance and Competition

4.1.1 Scope of the Unified Ledger

As mentioned earlier, a unified ledger can contain multiple ledgers, each with specific use cases, so the application of unified ledgers can start from specific scenarios, exhibiting more pronounced effects. The diagram below shows the scope and characteristics of tokenization applications. When implementing tokenization, it is essential to comprehensively assess its effects. Applications that are relatively easy to tokenize may not yield significant individual returns, while those more challenging to tokenize might present substantial benefits post-implementation. 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 FMIs. As stated in the Principles for Financial Market Infrastructures^[10], the fundamental principle of FMI is that it should provide clear and unambiguous final settlement in central bank currency under feasible and available conditions. These principles apply to various infrastructures such as payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories.

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 participants engage in governance according to established rules. Taking payment settlement as an example, when money and payments are involved on a ledger, the central bank will still be responsible for the final settlement of assets. In order to ensure integrity, regulated and supervised private participants continue to provide services to users, they should also comply with established KYC, AML, and CFT regulations and conduct ongoing due diligence to ensure privacy compliance.

As the ledger’s scope expands, so do the demands on governance arrangements. For instance, a unified ledger for cross-border payments would require seamless interoperability between private payment service providers (PSPs) and central banks in various jurisdictions with diverse regulatory frameworks. Therefore, extensive cross-jurisdictional collaboration is required. In contrast, a unified ledger focusing on domestic securities settlement requires comparatively less coordination efforts.

In terms of competition and financial inclusion, an open and fair environment is paramount. From a regulatory policy standpoint, it is important to consider how the introduction of a common platform might impact the industrial organization of money and payments, and ultimately the entire financial system. Open platforms can foster healthy competition and innovation among private participants, thereby reducing costs for end users by trimming excessive profits. Regulators should aim for this while designing platforms and corresponding rules, ensuring that network effects serve consumer interests and preventing monopolistic participants.

Providing appropriate economic incentives for potential participants is crucial for promoting competition. Without adequate incentives, PSPs may decide not to join. If the application of new technology affects the allocation of existing economic incentives, reducing the influence or benefits of vested interests, it might hinder the adoption of new technology by participants. Mandatory participation while providing infrastructure that allows private participants to innovate may become the key to implementation. This infrastructure would enable all participants to derive economic incentives. As the number of participants increases, network effects become evident, creating a clustering effect.

4.2 Data Privacy and Cyber ​​Resilience

The unified ledger consolidates money, assets, and information on a single platform, making data privacy and operational resilience particularly crucial.

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 the ledger’s data environment is an important way to protect privacy. This allows each participant to only view and access relevant data on their 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 use of private keys, ensuring that only authorized account owners can manage data in the partition.

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 privacy-protected manner, but also fosters competition and innovation because of decentralization. Commercial secrecy can be protected by encrypting individual smart contracts, as only the code owner or parties designated by the code owner can access the contract details.

There are various technologies available to maintain information confidentiality and privacy protection within the unified ledger, each with its own advantages and disadvantages in terms of their degree 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 ground up when designing ledger applications, 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. Likewise, the California Consumer Privacy Act grants consumers the right to understand the details of information collected by companies. Utilizing the unified ledger, embedding options to prohibit the sale or deletion of personal data directly into tokens or smart contracts of specific transactions can enhance the effective implementation of data privacy laws.

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, demanding robust network resilience protection at both institutional and legal levels. When an FMI or unified ledger faces a network attack, the potential financial and reputational losses pale in comparison to the extensive financial system paralysis and incalculable societal losses. The broader the scope of the unified ledger, the higher the risk of a single point of failure and the resultant losses. For these reasons, substantial investment in network resilience and security is imperative, necessitating multiple layers of security measures for the integrity and confidentiality of unified ledger data.

5. Conclusion

To fully unleash the innovation potential in the realms of money, payments, and a broader spectrum of financial services, the role of central banks is paramount in constructing a future monetary system that accommodates real-world demands and fosters innovative developments.

This article outlines the blueprint for a future monetary system harnessing the transformative potential of tokenization to enhance existing structures and unlock new possibilities. This blueprint introduces a novel financial market infrastructure known as the unified ledger, which integrates CBDCs, tokenized deposits, and other tokenized claims on financial and tangible assets into a single platform. A unified ledger has two key advantages. First, it facilitates seamless integration and automatic execution of a wider array of financial transactions, enabling synchronous and real-time settlements. Second, by consolidating all information data on a single platform, it allows new types of contingent contracts that serve the public interest by overcoming obstacles associated with information and incentive problems.

The concepts of tokenization and the unified ledger unveil the trajectory of the future monetary system. However, in practical application, the specific needs and constraints of each jurisdiction dictate which applications of the concept will take root first, and on what scale. In this process, multiple ledgers can coexist and interconnect through APIs to achieve interoperability.

Furthermore, realizing this vision requires joint efforts from the public and private sectors to develop technological solutions, establish common digital platforms, and ensure appropriate regulation and oversight. Through collaboration, innovation, and continual integration, it is possible that a trust-based monetary system can be established, ushering in new economic arrangements, enhancing the efficiency and accessibility of financial transactions, and meeting the evolving needs of households and businesses.

Disclaimer：

1. This article is reprinted from [Web3小律]. All copyrights belong to the original author [Will 阿望；Diane Cheung；菠菜菠菜]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.