Tokenization for cross-border payment and settlement
A reader asked me to take a look at Project Jura, an experiment in cross-border settlement using distributed ledgers. A joint effort by the BIS, the Banque de France and the Swiss National Bank, along with three commercial banks and several technology providers, the project executed a series of transactions testing the cross-border exchange of money and securities using digital assets.
The project shows what a new generation of payment technologies might look like, incorporating ideas from crypto into systems that meet the legal and technical needs of incumbent institutions. The name is borrowed from the Latin term for the rights conferred by citizenship, and is well chosen, as we shall see, because much of the project's work is to create a payment and settlement technology that smoothly interacts with juridical boundaries. Financial and legal systems are closely intertwined, and transactions in digital assets must reckon with that fact.
Creation of assets on the distributed ledger
Project Jura enabled the exchange of various digital assets, both money and securities. Before these assets could be used, they had to be created. The T accounts below illustrate the creation of wholesale central bank digital currency on the distributed ledger of the Swiss Digital Exchange (SDX). A commercial bank transfers funds to the issuing central bank, in this case the Banque de France. The BdF transfers those funds into what the Project Jura paper calls a "technical account," and issues wholesale CBDC to the commercial bank. It must be something like this:
The purpose of such a transaction is not obvious from the T accounts alone: the commercial bank starts and ends with a claim on the Banque de France. But the two claims are not the same: unlike reserve balances, the wCBDC exists as a token on the SDX distributed ledger, which allows it to be used in the transactions to follow.
Issuance of digital commercial paper is similar in principle. In the present example, Natixis issued commercial paper using France's domestic digital asset repository (DAR). The securities were frozen in the DAR, then mirrored, meaning a new, unfrozen representation of the same assets was created on the SDX's cross-border ledger.
More generally, creation of a digital asset involves two steps—first, the creation of the financial obligation between the issuer and the buyer, and second, the creation of a digital representation of that obligation within the distributed ledger. This latter step is called tokenization. Project Jura, that is, operated on tokenized currency (i.e. wCBDC) and tokenized commercial paper.
Securities and currency exchange on the distributed ledger
As part of the Project Jura experiment, euros, Swiss francs and commercial paper were issued as above, by the Banque de France, the Swiss National Bank and Natixis respectively. Then these assets were used in a series of transactions on the SDX distributed ledger.
The following T accounts describe the transactions, which in financial terms were quite straightforward. I show balance sheets for the three private-sector banks, omitting the issuers of money. On the first day, investment bank Natixis sold its commercial paper to UBS for euros, then sold the euros to Credit Suisse for francs. On the second day, UBS sold the commercial paper to Credit Suisse for euros. On the final day, the commercial paper was redeemed, and Natixis sold its franc balances back to Credit Suisse. All parties finished with the same positions with which they began.
The financial substance of the transactions was unremarkable, but several complexities show up in the details. The experiment involved three digital instruments (euro and franc wholesale digital currencies, and Natixis commercial paper), two payment systems (TARGET2 for euros and SIC for Swiss francs) and two jurisdictions (France and Switzerland).
The last mile of digital finance
Importantly, Project Jura's transactions all took place with tokenized assets—that is what it means for digital assets to trade on a distributed ledger. After the assets had been brought into the SDX, all of the coordination and timing required to complete these transactions was provided by R3's Corda technology. The white paper emphasizes that particular attention was given to the documentation and finality requirements presented by a wholesale payment and settlement system.
What is a bit hard to see, through the fog associated with new technology, is that a lot of the work is being done by tokenization. To put assets into digital relationship with one another, they have to be brought into a common payment and settlement platform. Buyers and sellers on that platform will want to have their usual legal rights with respect to these assets, and so that has to be ensured as part of the various tokenization processes. That entails interacting with legal systems in each jurisdiction.
These processes, whether issuance of CBDC or mirroring of commercial paper, are all described as "manual interfaces" in the Project Jura white paper. Building and scaling such manual interfaces is likely, I think, to become a "last mile" for digital finance to cross—a smallish problem that will have to be solved a very large number times.