Why central banks are getting serious about blockchain

By Steve Webb, Partner at PWC

Given the initial concept behind bitcoin, a mechanism to exchange value without the need for a trusted central party, it may seem surprising that Central Banks are now becoming so interested in blockchain. To bitcoin purists who saw bitcoin as having the potential to wholly revolutionise banking and payments, the idea of central banks taking a role in a blockchain environment may even be something of an anathema.

18 months ago, regulators and central bankers were generally either sceptical or hostile towards the technology, partly due to the association of bitcoin with transactions on the dark web. Now though, the banks that they supervise are turning their attention to the potential for blockchain to deliver really significant cost savings and efficiency benefits. Central banks are picking up on that and they have started to seriously explore the technology and consider how it can help them in their core missions to oversee efficient, fair, stable and resilient markets.

At a conference of central bankers and regulators in Washington DC earlier this month, Janet Yellen, chair of the Board of Governors of the Federal Reserve, said that central banks needed to better understand blockchain. The Bank of Canada is said to be exploring a blockchain enabled currency “CAD-Coin” and the Bank of Japan has also said that the technology must be understood and monitored.

The Bank of England has perhaps been most vocal with a series of announcements starting with a speech in January from Minouche Shafik, the Bank of England’s deputy governor for markets and banking, who discussed distributed ledgers in the context of plans for the RTGS payments settlement system. This was followed by a speech in March in which Ben Broadbent explored the use of the technology to create wider access to central bank money accounts. The culmination was the release of Mark Carney’s planned mansion house speech which went into some detail with regards to how the bank could benefit from and assist with the adoption of the technology. (Note that over the past few months, PwC’s blockchain team in Belfast have worked with a team from the Bank to help them develop a Proof of Concept and explore blockchain).

Why should central bankers be interested? It comes down to them starting to recognise the potential for blockchain to help them deliver on their key objectives; to ensure a resilient and stable financial system that can withstand shocks; and the secondary goal, to promote fair completion and efficiency in the financial markets.

Adam Ludwin, CEO of the blockchain infrastructure provider Chain, argued at the Washington DC conference that the technology provides a tool to measure leverage in the system and counterparty exposure, and can monitor compliance in real time. It can also answer questions about collateral ownership that were behind the run on banks during the financial crisis. “Ultimately,” he said, “blockchain networks will lead to a safer and better payments system.”

Many banks and Fintech firms have actively been exploring the potential for blockchain to simplify the settlement process around securities transactions within the capital markets. The resulting reductions in costs, opportunity for faster settlement and enhanced transparency all contribute to issues very close to central bankers’ hearts: risk management, transparency and liquidity.

If blockchain technology is going to be adopted wholesale in capital markets though we need to understand how we can settle the cash leg DVP in ‘real’ central bank money. In Ludwin’s world view, a central bank could mint its currency directly onto the network, and this new money would be just as real as its paper equivalent.

In Mark Carney’s Mansion House speech he notes the potential to create efficiency “That is why it is welcome that FinTech innovators are exploring the potential of distributed ledger technology to simplify the settlement chain, reduce its cost, and raise its speed while increasing resilience. “ He then notes the need to settle in central bank money saying “The Bank has for many years sought to ensure that, wherever possible, wholesale securities settlement occurs in central bank money.” Having noted the problem he then goes on to highlight the bank’s willingness to be part of the solution saying “We are already clear that we stand ready to act as settlement agent both for regulated systemically important schemes supervised by the Bank, and, on a case-by-case basis, for other new systems. The Bank will use this to enable innovation and competition, without compromising stability”.

Carney’s speech goes on to highlight the potential to use Distributed Ledger for RTGS, the payments settlements system. He notes the potential resilience benefits of removing the centralised system as a single point of failure. He also noted that the bank intends to make access RTGS far broader to create a level playing field between new entrants and incumbent banks. This leads me to an interesting thought around the effect that this wider access will have on the market impact of any future bank crisis. By creating wider access the reliance on each individual bank is reduced and therefore this is one additional small step in addressing Too Big to Fail concerns.

In amongst the positive messages there are a number of concerns that are highlighted. Rightly the Bank has very low tolerance for risk when considering a system like RTGS, which clears £ 500 bn of transactions daily. Assurance around scalability, data integrity, resilience and resistance to cyber-attack are all highlighted. For those of us working to develop solutions these concerns are clearly the ones that we know we will need to work with our clients to resolve. However, technology issues can and will be overcome and with central banks open to working with the industry to play their part, the potential to truly transform financial markets just came one step closer.

Visit www.pwc.co.uk/fintech for more insight.

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