Today BNY Mellon published two papers about innovation in payments, one of them focused on digital currencies. It separates them into three buckets, cryptocurrencies, central bank digital currencies (CBDC) and stablecoins.
The bank believes that digital currencies “could change the way we look at settlement speed, liquidity, reconciliation and risk.”
It predicts the current payment systems will persist, and “no one initiative or technology is a silver bullet for delivering optimized payments.” Nonetheless, it expects stablecoins will fill a digital currency void until CBDCs launch.
However, not all stablecoins are created equal, which is something BNY Mellon doesn’t delve into. Unlike retail stablecoins such as Paxos, USDC and Tether, financial institutions are especially interested in so-called settlement coins. In other words, tokenized bank account cash that is purely used for payments.
An amount is tokenized, a payment is made, and the recipient immediately converts the token to a bank balance rather than keeping it as a coin. One example is the JPM Coin and another is the consortium of banks behind Fnality and what was formerly referred to as the Utility Settlement Coin.
BNY Mellon is one of the 15 institutional backers of Fnality. So unsurprisingly, Fnality featured strongly in the paper, which explored the institutional benefits of digital currency for FX swaps, securities settlement and cross border payments.
Instant payment using digital currencies offers significant advantages compared to the current two-day settlement that most financial markets use. That delay creates risk and cost. In a future of tokenized securities, exchanging securities for tokenized cash enables delivery versus payment. So there’s close to zero risk of non-payment. And having a shared ledger eliminates time-consuming reconciliation.
Digital currencies will enable real-time liquidity, so bank treasury departments will manage cash very differently compared to today. “These real-time elements can deliver a truly optimized cash management experience, centered on efficiency and enabling an abundance of capital be released,” says the paper.
That may be so, but the in-between step of having some real-time and some two-day settlement will likely make it even more complex.
Won’t correspondent banking disappear?
One area BNY Mellon explored is correspondent banks’ future role. Currently, they act as intermediaries. If a foreign bank makes a payment to the U.S. but lacks a U.S. presence, they pay the correspondent bank, which passes the money onto the local bank. In a digital currency world of P2P payments, that role disappears, along with the delays and opaqueness the correspondent banking creates.
However, BNY Mellon expects to see a pivot for correspondent banks rather than extinction. It predicts that banks will become gateways to the P2P system, similar to a settlement agent. And they’ll provide liquidity and added value services.