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Payments and Securities settlements with multi-currency digital cash tokens

Even with stable coins and CBDCs, can we use them for transactions involving assets denominated in two currencies ?

Single currency pegged stable coins such as USDT, USDC and others as well as Central Bank Digital Currencies (CBDCs) currently in discussion or pilots in China, France, Switzerland and other countries have yet to answer the question on how transactions for payments and settlement of trades in two currencies can be executed.

Stable coins have been used mostly to hold value in digital form on blockchains when investors in crypto assets switch between holding crypto assets and cash, as the cost of switching from crypto to cash in bank is quite expensive. However, there is no practical way of settling a payment in, lets say, the Philippine peso in Philippines by sending a US dollar pegged stable coin like USDC unless the beneficiary in Philippines wants to hold the USDC. Top crypto exchanges like Coinbase, Kraken and even Binance do not settle in many currencies and even when they do, volumes and spreads may not be attractive. Besides that many currencies like the Philippine peso may not have a stable coin yet to which a potential exchange from another currency pegged stable coin may take place.

CBDCs are no better than stable coins in at least one respect that their issuers may not share a common standard or infrastructure for issuing and transferring payment tokens. While most stable coins currently are ERC20 standard compatible, they may still be pegged, algorithmic or hybrid when it comes to pricing them. CBDCs may be more standard on how they are priced, but the discussion on technology standards for issuing and transferring them across borders have not probably reached the discussion stage.

Global remittances and settlements of securities and investments therefore need a standard framework for issuing digital cash tokens denominated in multiple fiat currencies, and standard technology infrastructure for transferring and holding them. The large market opportunity in global remittances and capital flows justifies an attempt at working on it.

(Left) Global capital flows, and (Right) Country wise share of global remittances (receipts). Source : World Bank

In our work on issuing and trading of digital securities on the Verified Network described in another article, we needed digital cash tokens in multiple currencies to enable settlement of trades. The Verified Network is a Layer 2 Ethereum network of financial service providers that enable tokenization of private financial assets, investments in and trading of tokenized assets, and their settlement in multiple currencies. Our work based on digital cash tokens is based in this context, but the current solution can work for the global remittances use case as well.

High level architecture of the Verified Network

The Layer 2 network does most of the transaction processing and heavy lifting without incurring Ethereum gas fees and validators on the L2 network stake their share of fee from transactions on the network. L2 validators may be country specific payment acquirers such as money transfer agents or payment processors, payment settlement companies such as authorized dealers of foreign currencies and payment banks. Balances of digital cash tokens and fiat currency in custody against which they are issued are rolled up to the Layer 1 Ethereum main net which reinforces security and the ability to interface with individual users on the main net, in addition to users who interface with digital cash issuing, exchange, transfer and settlement related smart contracts directly through L2 using Decentralized applications (Dapps) with built in ERC20 compliant wallets.

Individual or Business users wishing to remit payments or settle financial or non financial trades can purchase or borrow or request for a new issue of digital cash tokens by paying in fiat currencies that are held in custody of banks in those jurisdictions. Digital cash tokens issued against fiat currency deposits can be transferred on the Verified Network to recipients directly or through regulated payment service providers that settle receipts in favor of recipients in fiat currency of the receiving jurisdiction. However, if the receiving country does not originate payment and settlement transactions in the same order of volume, the recipient or settling payment service provider in the receiving jurisdiction carries the risk of being stuck with a glut of illiquid digital cash tokens. This has been referred to as the Opportunity cost of Cryptocurrencies in an earlier article published here.

So, how do we address these concerns? We need to first offset the opportunity costs that the settlement company incurs by holding received digital cash tokens Rx corresponding to the received fiat currency R. That is only possible if Rx holders earn from their holdings which in turn requires demand for Rx. We have earlier discussed that remitters can either buy or borrow Rx which creates demand for it. However, whether a remitter buys or borrows Rx depends on whether it is more profitable for the remitter to buy or borrow Rx. To keep the exchange rate of the Rx stable against the underlying fiat currency R, the cost of holding the Rx needs to be equal to the returns its holders get by holding the Rx digital cash tokens.

We have implemented this on the Verified Network by making it possible for digital cash token holders to purchase bonds (which has the effect of lending money) to issuers of bonds (which has the effect of borrowing money) where issuing of bonds is based on posting collateral of a liquid financial asset.

Schematic of a typical payment’s cash flow

The above cash flow diagram is self explanatory. It applies to both remittances which are one way transactions where digital cash moves from the remitter to the recipient, as well as to settlement of trades which involve an exchange of physical goods or services or securities with digital cash that is paid for them.

Note : We are setting up a DAO or a decentralized organization of interested parties in the payments ecosystem in many countries. If you are interested to know more, please write to us at interest@verified.network.

You can also sponsor our work on the open payments system here.

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We share opinions and analysis on topics at the intersection of finance, economics and the emerging economic and technology fabric with digital currencies and blockchains.

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Kallol Borah

Kallol Borah

Entrepreneur, Technologist, Explorer. Tweets@BorahKallol

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