25 Oct1st of 3 Financial Service things that could be better with real money in Blockchain
Why bother? Why do we need to have the central banks act as an agent to translate fiat currency balances into Blockchain platform ones? In last week’s post, I promised to offer some arguments for that.
Just assume for the purposes of this post, that one or more central banks would be willing to perform this role and would translate fiat to Blockchain at a constant 1:1 exchange rate. They might do this themselves or outsource to a trusted third party.
I will cover the three things over the course of the this post and the ones which follow. They are: Payments, Payment vs. Payment and Delivery vs. Payment for securities.
Instant payment is already possible on the Blockchain; the folks at Ripple have done this and there are myriad other ways to move money instantly. Comparing just two of them will make it clear where the limitations are with the platforms available.
Ripple enables an instant payment, if and only if, the bank of the person or entity receiving the money is willing to accept having an “open receivable” from the person making the payment. For more on this see prior posts. This is important; a receivable adds risk and uses the balance sheet of the institution receiving the payment. A receivable does not have finality; you do not yet have the money for sure. Banks have been down this road before; in the past they had multiple correspondents and ‘buckets” of money all over the place. Now whilst nobody is going to lose money betting on banks doing stupid things, I would hope they have learned this lesson.
Paymit is a new service in Switzerland. It is offered by SIX, which is the national financial services infrastructure provider owned by the banks, and uses SIC, the Swiss RTGS system. Real Time Gross Settlement. So real money is moved in the real world. The system works in Swiss francs and between any two parties with a bank account or credit card, for the debit side, whose provider is connected to the national payments system
Paymit is a step up form Ripple though, because payment is absolutely final. But, participation is limited to locals. A lot of potential for innovation, limited only by the national boundaries and the rules that apply to participants in the Swiss payment system.
If the platform were on Blockchain and institutions other than locals had access, there would be even more potential. This is a variation on the “remote access” concept that is offered by several payments systems, i.e. institutions that are not in the country. SIC allows this, as does SAMOS in South Africa for banks from some nearby countries. Foreign institutions can hold and make payments on the national platform.
The consequence would be that the service offered by traditional correspondent banks, aka Nostros, could be unbundled into its component parts: payment services and liquidity. Today, if UBS acts as Swiss Franc correspondent for a bank in London, for example Nomura, it supplies both a service, paying and receiving funds, and the liquidity to enable that in the form of an intra-day overdraft.
Time was, correspondent banking was a great business; increasingly, providing those intra-day limits is very expensive and to date those costs have not been consistently priced properly and passed on the user.
If payment were via a Blockchain platform, with wider access, then for example a South African bank with some natural GBP balances could choose to make their own payments and simply raise liquidity when it needs it. When they need more pounds, they can raise them.
The price of those funds would likely be tied to the speed at which they are needed; they might be raised on a secured basis, such as via Repo, or on an unsecured basis. For sure, the price will vary. This is not too far fetched; the Repo markets function well today, albeit on a simple “value date” basis, in other words “anytime on that day”. In Switzerland the national Repo system allows participants to raise not just Swiss francs, but Euro too. The central bank, the SNB, accepts collateral in multiple currencies: CHF, DKK, EUR, GBP, NOK, SEK, USD. (see: SIX Repo)
The difference between an obligation and a right is an important issue to understand. If the platform were open, a participant would have the right, in other words an option, to make payments in any currency, but no obligation. So a single participant might choose to manage its own currency, US dollars, British Pounds and the Euro, but for all others use a traditional correspondent bank. That relationship could even be hidden in the background and be invisible to the recipient of the payment; once more, the provider would charge for and be rewarded for liquidity.
As soon as an institution had a balance on the Blockchain platform in one or many currencies, then all the “smart payment”, “smart contract” things that many have imagined could be “chained” together in new. creative ways; a commodity delivery is made to a bonded warehouse and signed for digitally, releasing a payment.
Lessons Learned: The potential one-liners for the hecklers and nay-sayers are easy to compose: Who regulates the participants? What happens if there are payments not made? What about a level playing field; the Swiss are happy to let any regulated entity from their own or another equally regulated country, but what happens if Switzerland likes Russia, but that stance is unrequited and the Russians do not like the Swiss? What about finality? For sure, there will be things to think of, but they are not show stoppers.
First, reciprocity is easy. If you have a platform, you have a club and you can have rules. The platform overseers, the Central Banks, can choose to admit a country and its institutions either just to make payments in their own currency, in some currencies, if for example the Swiss act all neutral and the Russians like them, but the Brits don’t, or in the best case, a new member wants to sign up for reciprocity with all the countries and all the members. No bilateral anythings needed; just a join-the-club agreement. We have these today for example in CLS for In-Out swaps.
Regulation has to be a matter for local regulation. The Brits will be responsible for any institution they supervise. We already have something like this with recognised jurisdictions in KYC / AML.
If participants do not pay on time, their clients will eventually vote with their feet. In today’s payment systems there are often rules on what volumes and values have to be paid by when. Digital or not, banks will, I think, still need an end of day, so there will need to be a cut-off. Perhaps, there is the potential for very late payment and potential disruption; staggered pricing will certainly curb some of that and perhaps each national regulator will apply club rules to anybody making payments in their currency. With a club and club rules, setting these should be possible.
Given the challenge of having enough liquidity, a Blockchain platform might be enhanced by assigning payments to clearing sessions and allowing for netting. If there are 10’000 payments in EUR for EUR 100 million going from Citi to Deutsche and 12’000 for 95 million going the other way, Citi and Deutsche might sign up to an “in app add-on”; netting sessions for queued payments at a certain time.
Finality, in other words, the certainty that what you have been paid will not be taken away by some legal process, is always an issue with payment systems. But, if things go all digital and Blockchain, nothing is worse and in fact things are almost easier. If a currency has some rules, or even a country within a currency, such as Italy as a Euro user, has such rules, then nothing changes. Today, those involved in those countries know the score. In a digital world, “the same rules apply”. And, if there is a bankruptcy event, the trail will be easy to follow. Any currency that did not have finality would be limited at other stages, such as for payment vs. payment, but that is a topic for next week.
None of those possible heckles represent insurmountable problems and we have precedents where these issues have been solved. The payments world would be richer and be able to offer true instant payments if money made it to the Blockchain. “Blockchain” would though be a single global system.
More next week on the prospects for payments vs. payment.
Understanding Bitcoin and Blockchain
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