A Cross-Border Payments, Exchange, and Contracting Platform for the 21st Century
IMF News, November 18, 2022
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- Published: November 18, 2022
Overview
- Remarks by IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, Tobias Adrian, at the Twelfth Annual BIS Consultative Council for the Americas Research Conference, Mexico City, November 18, 2022.
- Core proposition: a newly designed multilateral exchange and contracting platform (dubbed the “X-C platform”) could materially improve cross-border payments, foreign exchange transactions, risk sharing, and financial contracting by combining a common ledger, smart contracts (programmability), and cryptography (privacy-preserving proofs).
Current landscape: key frictions and market structure
- Cross-border payments are characterized as slow, expensive, and risky due to the absence of a common settlement asset, lack of common governance, and reliance on costly bilateral trusted relationships.
- Historical international recognition:
- October 2020 Roadmap for Enhancing Cross-Border Payments endorsed a set of 19 Building Blocks to achieve faster, cheaper, more transparent, and more inclusive cross-border payment services.
- Main frictions identified:
- No common and widely available settlement asset; reliance on nostro/vostro accounts or local branches.
- Currency conversion in the payment chain implies concentrated risk and high costs.
- Compliance (vetting/monitoring) is expensive and uncertain across jurisdictions.
- Market consequences:
- Networks of bilateral correspondent banking relationships and closed-loop solutions with high fixed costs and economies of scale.
- Concentrated market structures and large intermediaries with market power and higher markups.
- Current innovations and experiments:
- Emergence of fast (retail) payment systems from private and central bank initiatives.
- FinTechs building credit and insurance atop digital payment functions.
- Wholesale blockchain-based solutions by large intermediaries (example cited: JP Morgan for instantaneous digital transfers of Treasury and collateral).
- Regional platforms, interlinking domestic payment systems, and stablecoin-based solutions.
- Distributed Ledger Technology experiments by public consortia, central banks, BIS Innovation Hubs, and private sector projects.
X-C platform: architecture and technological building blocks
- Primary design goals:
- Centralize payments and settlement; integrate compliance, lower FX conversion costs, and improve financial risk management.
- Leverage new technologies to create markets, infrastructures, and contracts that are currently missing.
- Core technological features:
- One common ledger to keep a unique state and track ownership.
- Programmability via smart contracts to automatize financial contracts and ensure consistency across commitments.
- Cryptography to preserve privacy while enabling verifiable, privacy-preserving checks and audits.
- Public goods provided by architecture:
- (i) A common infrastructure with rules and governance that shortens transaction chains and provides legal certainty.
- (ii) Common settlement assets issued by central banks to reduce settlement risk.
- (iii) A trading environment to trade different settlement assets on-platform.
- Key instrument and nomenclature:
- “Certificates of escrow”: digital monies issued by central banks on X-C for programmable final settlement.
- “Dynamic ledger”: links messaging, settlement, and committing contracts so settlement can be immediate and irrevocable or guaranteed at contracted future dates/states.
How X-C addresses specific market failures and operational needs
- Contract and information frictions addressed:
- Limited commitment: cryptographic commitments and atomic swaps; automatic transfers.
- Untrusted messages: domestic certification combined with cryptography to preserve data sovereignty and privacy.
- Unobserved states: aggregation of privacy-preserving messages to inform contracts.
- Unobserved actions (e.g., front-running): contracts executed by programmed rules.
- Market design effects:
- Reduce transaction chains, settlement risk, and FX transaction costs.
- Increase competition and lower spreads by centralizing information and exchange in a multi-currency market.
- Provide just-in-time liquidity transfers, a centralized multi-currency market, and on-platform hedging instruments.
- Foreign exchange markets and derivatives:
- Centralized, multi-currency trading environment and introduction of multi-currency auctions implemented via smart contracts (no third-party auctioneer required).
- On-platform foreign exchange derivative markets and forward/contingent contracts for hedging.
- Smart contracts enable mutualization of idiosyncratic risks contingent on aggregate shocks by taking inputs from agents with private shocks and implementing cross-agent allocations.
- Financial-stability controls:
- Dynamic ledger prevents double spending and double commitments of rights to future funds.
- Smart contracts embedded in the ledger can be made consistent with each other to manage derivative-related risks without full escrow or collateral.
Privacy, compliance, and supervisory functionality
- Privacy-preserving compliance:
- Cryptography enables regulators and compliance officers to conduct checks, monitor, and audit while preserving privacy.
- Strong privacy retained while preventing untraceable transactions via “credential providers” and control agencies using cryptographic proofs.
- Decoupling of controls/user authorization from transaction submission and execution.
- Practical compliance example:
- Transaction orders can read lists (e.g., sanctioned individuals) and attach cryptographic proofs that participants were vetted and comply with AML-CFT rules.
- Capital flow and financial integrity management:
- Automatization of compliance checks and policy rules on-platform can reduce costs and speed up cross-border payments while respecting domestic and international regulations.
Central bank functions, policy tools, and coordination
- Central bank utilities on X-C:
- Escrow accounts on the platform allow central banks to trade in spot auctions and other markets, shortening payment chains and reducing balance sheet interconnections.
- Central banks can convert central bank reserves to certificates of escrow and vice versa.
- Central banks can expand their balance sheet directly by trading on the platform.
- Cross-border liquidity arrangements possible on X-C:
- Routine liquidity bridges.
- Currency swaps for exceptional circumstances.
- Regional financial arrangements and other borrowing/lending arrangements using certificates of escrow.
- Privacy-preserving policy coordination:
- Cryptography lets central banks keep FX positions and policy preferences private while allowing aggregated, privacy-preserving tailoring of swap line contracts and coordinated actions.
- Central banks can input contingent bids and volatility-band preferences; smart contracts can find bands that satisfy reserve commitments and automatically intervene when limits are reached—improving on current swap line use.
- X-C as a tool for multilateral safety nets and coordinated intervention:
- Platform enables implementation of domestic or multilateral safety nets, FX intervention rules, and coordinated central bank policies via smart contracts.
Policy implications, governance, and open challenges
- Expected benefits:
- Streamlined compliance, reduced FX conversion costs, and improved financial risk management.
- Faster, cheaper, and safer cross-border transactions with final and irrevocable settlement.
- Hurdles requiring multinational coordination:
- Governance agreements, aligned AML/CFT, legal, and regulatory frameworks.
- Ensuring operational stability of platforms given their systemic nature.
- Ensuring interoperability across regional platforms to counter geopolitical fragmentation.
- Role questions to be resolved:
- Public sector: responsibilities of country authorities and international organizations in operating/developing platforms.
- Private sector: role in adoption and sustainable business models.
- Further work needed:
- Legal and political coordination.
- Technical and operational stability safeguards.
- Interoperability standards and regional coordination.
Conclusion (author’s closing points)
- New technologies combined with appropriate economic and market design can substantially improve cross-border transactions by creating a multilateral exchange and contracting platform where participants can truthfully share information with smart contracts while retaining privacy.
- Significant legal, regulatory, governance, and operational challenges remain and will require multinational coordination and further reflection; however, leveraging technological innovations for public policy objectives can spur solutions to these challenges.
Remarks by IMF Financial Counsellor and Director of the Monetary and Capital Markets Department, Tobias Adrian, November 18, 2022.