The advent of blockchain technology has spurred experimentation among a broad range of market players, including banks and financial market infrastructures. The application of distributed ledger technology to wholesale financial transactions is still at the exploratory stage, despite the financial industry’s strong interest in DLT. Currently only around 22% of European banks use DLT, while another 22% are testing or experimenting with it, said Piero Cipollone, member of the Executive Board of the ECB in a recent speech.
But a majority of market stakeholders surveyed by the Eurosystem expect a significant uptake of DLT for wholesale payments and securities settlement in the next five to ten years.
The benefits of DLT for trading financial assets are twofold. First, it can enhance efficiency by allowing market participants to perform the three key phases of a transaction – trading, settlement and custody – on the same distributed ledger. Of the many advantages this offers, participants mention lower credit risk, fewer failed transactions and less need for extensive reconciliation. DLT can operate on a 24/7 basis, which would tackle the issue of international market fragmentation caused by different time zones. Lastly, the use of smart contracts can help streamline the process of verifying and executing transactions.
Second, DLT opens avenues for new applications, such as providing new ways to raise capital and trade financial instruments. A shared platform could make the trading of financial instruments more efficient and resilient, particularly those not currently serviced by financial market infrastructures like over-the-counter traded securities or credit claims. Thanks to lower costs and reduced complexity, DLT platforms could be more easily accessed by small and medium-sized enterprises (SMEs). This would underpin the EU’s capital markets union objective to improve SMEs’ access to capital.
Moreover, experiments with tokenized bank deposits are underway to assess innovative ways of transferring funds – using blockchain technology, for example – between clients of the same bank or group of banks.
DLT is also being explored as a possible means to improve cross-border payments.
However, it is worth noting that these solutions are not always radically innovative, as the benefits associated with them can also be achieved in other ways. For instance, the Eurosystem’s TARGET Instant Payment Settlement (TIPS) service offers immediate payment settlement in central bank money 24/7, facilitates automated and conditional payments through application programming interfaces and is establishing itself as a useful platform for cross-border payments.
Potential DLT-based innovations are still at an early experimental stage. Nevertheless, central banks cannot afford to sit on the sidelines, as any widespread adoption of such innovations could jeopardize the anchoring role of central bank money in guaranteeing the efficiency and stability of our payment system. Many explored DLT use cases involve transactions, notably in securities, currently settled between banks using central bank money. These include delivery-versus-payment settlement in both primary and secondary markets, along with recurring payments during the life cycle of securities, such as coupon payments.
Insofar as these applications lead to a proliferation of decentralized private money-based settlement systems, including stablecoins and tokenized deposits, they could lead to the refragmentation of wholesale payments. This in turn could impair central banks’ ability to provide liquidity in periods of financial stress, elevating financial stability risks.