The Future of Money and Payments

1200 words, 4.5 minute read

Central bank balance sheets are ballooning the world over, and in parallel, adoption of shared ledgers using blockchain is accelerating. These major shifts indicate the global architecture for money and payments is on the cusp of structural change.

Blockchain analysis and debate are dominated by a focus on cryptocurrencies, digital assets, central bank digital currencies (CBDCs), tokens, stablecoins and so on – in particular, their uses, pricing and monetary implications. However, in my opinion these are secondary considerations to the core, but often under-appreciated benefit of blockchains, which is the ability for multiple parties to transact securely on a shared ledger.

Focusing on ledgers, where money is created (and deleted), recorded, and exchanged (payments), here are some possible models to characterise the future architecture for money and payments:  

1. The As-Is Model – More of the Same - Fragmented, Proprietary Individual Ledgers: Every bank today has its own ledger of bank accounts, and their central bank has its own ledger to manage their reserve accounts through an RTGS. Money consists of reserves, commercial bank deposits and cash. New money is created/issued through commercial bank lending to consumers and business, and through central bank operations (lending to commercial banks, issuing physical cash, and asset purchases/quantitative easing).  The majority of payments are made through the exchange of commercial bank deposits, either on a commercial bank’s own ledger (book transfer), or between banks using a clearing system, RTGS or bilateral exchange, settled in central bank reserves; the remainder are physical cash payments. Cross-border payments are made through accounts (nostros) which banks and payment providers hold on other bank ledgers in destination countries. This model has been in operation for decades and will likely continue for a few more.

2. Single Shared National Distributed Ledger: One shared ledger used by the central bank and the domestic commercial banks it supervises. Commercial banks issue wallets (likely custodial wallets to insulate consumers from losing access to their money) to their customers who deposit money into their bank on the shared ledger using their wallets. These wallets are analogous to bank accounts and indistinguishable from mobile banking.

New money issued on the shared ledger is created by commercial banks when lending to consumers and businesses, and by the central bank when lending to commercial banks. Payments are made between wallets, with transactions validated by the commercial banks on the shared ledger (instantly, irrevocably and 24/7). Alternatively, the central bank could be the sole issuer of new money, issuing it to commercial banks on the shared ledger every time the commercial bank makes a new loan.

The central bank may still issue physical cash, selling it to commercial banks to distribute to their customers, with the payment to the central bank recorded on the shared ledger. In effect the shared ledger is owned by the central bank, and all money on the shared ledger is a claim on the centra bank. This includes commercial bank deposits held in custodial wallets under the commercial bank’s control, but remain on the central bank’s shared ledger (if a commercial bank goes bust, its customer wallets are transferred to another, solvent commercial bank). However, reserves are no longer needed to settle payments between commercial banks, as every payment between commercial bank customers is made on the same shared ledger. Cross-border payments are made through wallets held by banks and payment providers on the single shared ledger of other countries.

This model is relevant to the CBDC debate which central banks are engaged in currently. They are feeling their way forwards on how to use CBDCs, and many have published papers and consultations over the past 18 months.  Overall, the picture is confusing, with different technology and monetary models proposed, backed up by theory, hypotheses and a few practical experiments. However, by taking a ledger view of CBDCs, in my opinion, this concept of a single shared national distributed ledger is the logical model for a successful CBDC. Whether we see it in practice is up to central banks to decide, but adoption of this model is likely to be driven by efforts to improve retail and corporate payments systems.

3. Multiple Private Sector Distributed Shared Ledgers: A private company sets up its own shared distributed ledger, where money on the ledger is issued as IOUs, or deposit receipts to users for a particular currency or asset, who deposit the actual currency/asset with the company as reserves. These IOUs are claims on the reserves, and are often termed stablecoins e.g. as Libra is proposing to do with dollars and other currencies, and as already happens with a range of companies such as Bitfinex with Tether (USD), Circle with USDC (USD), Stasis with EURS (euros), or PAX for gold. Payments take the form of transfers of the IOUs between wallet holders on the shared ledger.

These shared ledgers are borderless, with stablecoins used for payments anywhere in the world (even if the reserves they represent are a fiat currency such as USD). This model is being driven by market demand to integrate payments into applications and to exploit smart contract capabilities, at the moment mainly for digital asset exchanges, but over time is likely to branch out into financial applications, ecommerce and machine-to-machine payments.

4. Multiple Public Distributed Shared Ledgers: These are open source, public shared ledgers, where the currency of the ledger is a digital asset in its own right, usually with a fixed supply, or a guaranteed rate of supply, whose value is set through demand for the digital asset, which itself is driven by its utility and usage. Examples are bitcoin whose utility is as a speculative store of value, XRP as a liquidity bridge in cross-border payments, and Ethereum to run or monetise applications on the Ethereum network. This model started existence with Bitcoin launched in 2008, and is developing rapidly through fast paced innovation such as distributed finance, or DeFi, applications.

Other models are feasible, for example the use of wholesale CBDCs by governments to encourage use of their fiat currency (and associated regulations) for institutional use across borders. There are also some we can consider unlikely such as widespread use of non-custodial wallets by the general  population (lost passwords leading to irrevocable loss of funds) and to central banks issuing wallets and lending directly to consumers and businesses (they have no experience or capability to do this, and probably have even less appetite).

Multiple models will co-exist, as is already apparent today, with the private sector setting the pace and driving innovation. The as-is model will give way, over time, to the transformative benefits of using single shared distributed ledgers in support of logical ecosystems such as a national economy, a digital domain or product-set over which multiple, independent actors transact.

Much of the debate today on the future of money is centred on the different types of money – central bank reserves, cash, commercial bank deposits, private money, and on the possibility of creating new types such as CBDC. However, the key consideration for building a new financial architecture is actually the type of ledger used to create, hold and transact money, rather than the type of money itself.

Viewing it this way, it is clear the future of money and payments is the widespread use of shared distributed ledgers.