Research Presentation
Safe Cash for On-Chain Finance
A core issue for on-chain finance is the existence of a programmable cash settlement asset that is sufficiently safe and efficient for large-scale collateralization and settlement of tokenized financial transactions. International principles for critical financial market infrastructure specify the safety and liquidity of central bank deposits for these sorts of applications. Currently, few central banks provide their deposits in a tokenized form, although the Swiss National Bank has done this and there is some related development work under way at other central banks, for example, Project Appia at the ECB.
A key issue for central banks is the perimeter within which their deposits can be held. I will explore various solutions to the problem of a suitable cash settlement instrument and explain why this problem should be resolved in advance of the likely migration of a large fraction of financial trade settlement to programmable ledgers. I will also explain the rationale for this on-chain migration.
There are options for those central banks who prefer not to tokenize their reserves. In these cases, a private-sector payment service provider could hold pooled participant funds in an omnibus central-bank deposit account and issue digital representations of those funds on one or more programmable ledgers. The Bank of England has provided such an omnibus account to the Sterling Fnality Payment System, which issues tokenized funds on its own ledger, backed entirely by Sterling settlement balances. This system is operational, although with no reported usage beyond testing.
In the United States, Fnality has indicated that discussions with regulators are under way. The Fed has shown a general reluctance to provide master accounts to narrow banks. The Fed has, however, provided master accounts for various types of financial market infrastructure, allowing customer funds to be 100% backed by central bank deposits.
An effective cash settlement asset for on-chain finance could be provided by a platform that would hold customer funds in a pooled (omnibus) central-bank deposit account; issue its own deposits into customer wallets at one or more programmable ledgers; enable customers to use their walleted funds to make payments to other customers, 24x7, with suitable speed, security, finality, and privacy; and enable customers to create and redeem these walleted funds via transfers of central bank deposits to and from the omnibus central-bank account.
The hurdle to central-bank acceptance of this sort of arrangement is lowered if the customers of the payment service are composed entirely of firms that already hold their own central-bank deposit accounts. In that case, the perimeter of central-bank money is unaffected by the availability of this service. This approach, however, may not be preferred by proponents of decentralized finance, which entails broad and direct access to the cash settlement instrument.
Darrell Duffie — Stanford Graduate School of Business
Moderator: Paul Wong — Stellar Development Foundation
