Digital assets issued and managed on distributed ledger technologies (DLT) offer new opportunities to institutions in the financial services sector. The most relevant feature of DLT is that digital assets and payments can occur within the same system. This means, for example, that buying and selling digital assets like cryptocurrencies, tokenized securities or other ‘real-world’ assets can be settled instantly and efficiently within a DLT system.
However, this feature also brings new risks to regulated institutions. One such risks is that payments are technically made with new forms of programmable and encrypted money and without the need for traditional payment systems. Stablecoins - the new form of money required for the payment - are pegged mostly to USD and issued by unregulated private companies on public DLTs. The lack of regulation in this area poses an additional risk for banks. Nevertheless, banks and other traditional payment service providers need to update their products or develop new solutions for digital assets, to withstand competition from new players entering the market.
HOW CAN A TRIGGER SOLUTION BRIDGE THE GAP?
To adapt and remain competitive some financial institutions have attempted use-cases that connect traditional payment networks with DLT networks. The high-level concept is that smart contracts on DLT systems trigger payments on existing traditional market infrastructures - so-called trigger solutions.
Publications and proof-of-concepts from the German Banking Industry Committee1, Banca d’Italia2 and SWIFT’s updates on message structures within traditional payment networks3 show the early ideas of how to integrate DLTs with existing market infrastructures. Additionally, individual market participants such as DekaBank have made the first practical steps in this area with their SWIAT project.4
The German Banking Industry Committee working paper describes two ways to trigger payments from DLT systems to process them on traditional payment networks. The DLT system sends a trigger either indirectly via the payer’s Electronic Banking System or directly to the bank, without the payer involvement. The payer’s bank continues the procedure via payment networks and sends a payment status directly or indirectly via the payee’s Electronic Banking System to the DLT system.
With trigger solutions banks can support their customer’s DLT use-cases and provide highly automated and integrated new services to trigger payments, particularly those made with digital assets on traditional networks. Below we highlight some noteworthy projects by SWIFT, Deutsche Börse, VISA and central banks, working towards improving the connectivity between DLT and payment infrastructures.
SWIFT MT messages’ standard change (security)3
With standard release 2022, the security messages (category 5) were enhanced to cater for digital asset identification and token related features. In 2023, further updates will be done to include blockchain address or wallet account number. This means a regular safekeeping account can be used for digital assets.
In a successful tokenization experiment Swift successfully transfers value across multiple blockchains5
In another set of experiments, SWIFT collaborated with financial institutions (such as DTCC, ANZ, BNP Paribas, BNY Mellon, Citi, Clearstream, Euroclear & LBG) to showcase how they can connect with multiple blockchain networks. SWIFT along with a Web3 service platform Chainlink successfully transferred tokenized value across multiple public and private blockchains.
DLT-based securities settlement in central bank money (TARGET2 or T2) successfully tested6
Deutsche Börse, Deutsche Bundesbank and Germany’s Finance Agency have developed and successfully tested a settlement interface for electronic securities, in conjunction with other market participants.
Two software modules – a trigger chain from the Bundesbank and a transaction coordinator from Deutsche Börse – connect T2 with a DLT securities system. The securities and central bank money do not change hands until the transfer has been successfully confirmed by all parties. This delivery versus payment (DVP) mode of settlement minimizes counterparty risk for both the buyer and the seller but requires a central agent.
Central Bank Digital Currencies (CBDC)7
Digital asset regulatory frameworks are introduced by supervisors around the globe to protect consumers and investors while ensuring financial stability and supporting innovation. In this context over 130 central banks worldwide are developing and testing digital currencies for retail and wholesale payment use cases. The investigation phase of the Digital Euro project by the ECB started in October 2021 and is expected to complete in October 2023.
VISA collaborates with Solana blockchain8
Visa has chosen to collaborate with Solana blockchain to enhance its USDC stablecoin settlement capabilities. This collaboration has been seen as a big step towards next-generation digital payment by both parties. Collaboration of the payment giant with global blockchain network such as Solana and Ethereum can also improve cross-border settlement.
WILL TRIGGER SOLUTIONS BECOME REALITY?
In the future, digital asset transactions could be processed and settled in real-time, reducing the risk associated with using multiple solutions developed by private and public stakeholders. Trigger solutions are a promising interim step for traditional financial institutions, as a temporary workaround to leverage DLT’s potential today.
Appropriate upgrades of traditional payment networks could simplify the integration with DLT systems. However, a collaborative approach by market participants is required to create a solution that generates the necessary network effects, such as a growing number of users and transactions to facilitate wider adoption. According to Burkhard Balz, member of Deutsche Bundesbank (German central bank) Executive Board, “Following successful testing, the Eurosystem should be able to implement such a solution in a relatively short space of time – at least in far less time than it would take to issue CBDC, for instance.”
