Last week the IMF published a paper on X-C, a platform for cross border payments, co-authored by the IMF and members of MIT’s Digital Currency Initiative.
The solution proposes a global centralized ledger for cross border payments in which central banks, banks and payment providers participate. An X-C platform would not just centralize payments and settlement, but also provide a foreign exchange (FX) market, hedging and compliance.
At a technical level, X-C can use a centralized database or distributed ledger (DLT), but either way, it relies on smart contracts to automate significant amounts of functionality and encryption for privacy.
The need to reduce the friction in cross border payments has been widely discussed. Too many intermediaries make payments slow and expensive. And in emerging markets, foreign exchange costs are high.
Arguably Facebook unveiling the Libra multicurrency stablecoin created an added urgency. A year after Libra’s unveiling, the BIS and G20 unveiled a set of building blocks to address payment frictions.
Two years on, an updated report shows the challenges in achieving the goal, including with cross border CBDC. The BIS Committee on Payments and Market Infrastructures (CPMI) also highlighted the decline in the use of lower risk payment versus payment (PvP) in FX transactions.
No need for multi-CBDC cross border projects?
Instead of central bank digital currency (CBDC), central banks would provide Certificates of Escrow (CE) to be used on the X-C platform. These have similarities to CBDC but are limited to the X-C platform and can only be exchanged for central bank reserves by banks.
Because these central bank-issued CEs are the only instruments on the platform, there isn’t the usual counterparty risk. And in contrast to SWIFT, which is purely a messaging system, X-C integrates the message with the money movement, like most digital currency projects.
One of the benefits of the CE concept is that CBDC projects can focus on domestic use cases.
Blockchain inspired features
X-C will use similar underpinnings to blockchain to reduce the need for intermediaries, automating most functionality with smart contracts.
Encryption and credentials will play important roles. X-C participants, such as banks and payment providers, will receive anonymous credentials from credential providers. This allows participant identities to be vetted off-ledger, but any restrictions in their credential such as transaction limits can be verified on the platform.
Privacy also applies to the end customer that’s making the payment. Instead of sharing KYC data with foreign counterparties of unknown trustworthiness, the customer’s identity can be run against sanctions lists off-ledger, and a cryptographic proof stored verifying they have been vetted. However, this involves relying on external data and the parties that do the vetting.
A centralized foreign exchange market
The X-C concept aims to reduce foreign exchange spreads, address the fragmentation of FX markets and the dominance of larger players by creating a centralized exchange. One implementation would include a centralized FX order book open to all dealers, where participants must honor any quotes they list. The challenge with this approach is dealers will be unwilling to commit to larger volumes.
Hence another suggested route is a centralized multi currency auction where the privacy of the bidding is preserved. This could use technologies prevalent in the blockchain world that allow calculations to be made on data while hiding the input data, such as FX bids. The concepts include multiparty computation (MPC) and Fully Homomorphic Encryption (FHE).
X-C: A big idea
X-C is a big idea inspired by a wide variety of contemporary work, including cross border CBDC projects such as MBridge and its predecessor, Project Inthanon-LionRock. It also borrows ideas from private initiatives such as Citi’s concept of a Regulated Liability Network and Partior, the multicurrency payment system backed by JP Morgan, DBS Bank and Temasek. And it incorporates technical designs from MIT’s Digital Currency Initiative. The list of inspirations is a long one.
The paper’s goal is to encourage consideration of multiparty platform design and stimulate the creation of public goods and infrastructures.
A couple of times in passing, the X-C paper mentions the elephant in the room: geopolitical fragmentation. Centralized platforms like SWIFT have been used to enforce sanctions. “Further work is needed to ensure regional platforms are interoperable,” the report says, to help to counter geopolitical fragmentation.