Published: 10/10/2024
Tokenized & standardized: future financial system
As technology drives innovation ever forward, visions of the future compete for “mindspace.” This is true for the global financial order as well. The growth of distributed ledger technology and the attendant tokenization of money is striking, but some level of forethought and regulation is required to ensure it remains equitable for all. We look at a few ways in which the global financial system may develop, and the role of different forms of money.
Advances in technology change customer expectations. This simple fact is known to everyone, yet adapting to those expectations can be demanding for all stakeholders. The financial system is no exception.
As economies have become progressively more digitalized and consequently networked, some challenges to the global system have become even more visible:
- While a digitalized economic ecosystem should, at least in theory, leave nobody behind, financial inclusion initiatives have not reached everyone yet. Indeed, more than 2.5 billion people worldwide remain offline.1
- Geopolitical challenges and dependencies on a few private players can impact financial transactions, and pose a threat to a country’s sovereignty
- Natural disasters or technical glitches can lead to connectivity and power outages, making digital payments impossible. This has a negative impact on economies. As a recent example, the banking industry suffered a $1.4 billion loss from the CrowdStrike outage in July 2024, according to cloud risk firm Parametrix. 2
- The abiding high cost – and slow nature – of cross-border payments is another issue that acts as a drag on economies, for individuals, and for small and medium enterprises. Remittance fees worldwide average 6.3%, and remittances can take several days to complete.3
The good news is that the scope for innovation is vast and growing. Leveraging new technologies can help us to overcome these challenges and build a financial system that puts the user at the center. However, while the focus on new technologies is justified, there is lots of room for improving what we already have. Connecting existing technologies with new ones can be made better and easier through the use of standardized APIs. Such an approach would have a great and immediate impact.
Coming to the new technologies:
- Artificial intelligence (AI) has already supercharged the global financial sector’s transformation, enabling better and faster fraud detection, speeding up customer onboarding, or providing more user-friendly experiences for all concerned.
- Widespread adoption of distributed ledger technology (DLT, of which blockchain is one example) has also contributed.
- Tokenization is a key technology that can be harnessed to this effect. The market for tokenization of financial and real-world assets is expected to grow to almost $4 trillion by 2030.4
However, there is debate on how best to utilize technology’s transformative powers for a future financial system. While others are available, let’s look at two visions of what a future financial system could look like.
Web3 and the Finternet
To Web3’s evangelists, a decentralized financial system that is based on DLT would be the answer to their prayers. The foundation of Web3 in finance is built upon three crucial elements: decentralization, blockchain technology, and smart contracts. This would theoretically move power from banks and financial institutions to the user.
The issue with this view of Web3 is that it assumes a high level of financial and technological know-how to navigate the various technologies involved. This may be out of the reach of many, if not most, people. Crucially, the lack of regulation that its adherents point to as a positive can be a problem when there are bad actors at work, or situations that require redress. Although there is much to be learned from Web3 and other existing crypto initiatives, it seems to be a step too far. Which brings us to the next vision of the financial system of the future.
A recent paper issued by the Bank for International Settlements (BIS) makes a persuasive case for what it calls the “Finternet”: “multiple financial ecosystems interconnected with each other, much like the internet, designed to empower individuals and businesses by placing them at the center of their financial lives.”5 Among other things, it would address key pain points of the current global financial system:
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Instead of expensive and time-consuming transfers, “individuals and businesses would be able to transfer any financial asset they like, in any amount, at any time, using any device, to anyone else, anywhere in the world. Financial transactions would be cheap, secure, and near-instantaneous.”6
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These transfers would be designed to be inclusive, helping underserved populations enter the economic mainstream.
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It would offer more access, less risk, better access to information, and, crucially, it would be cheaper.
Once in place, the Finternet would provide support for more personalized financial systems that would improve welfare for all concerned. It also calls for using all available technologies, including ledgers, tokenization, advanced cryptography, and AI, but builds upon the idea of unified ledgers, which “provide a ‘common venue’ (i.e., a shared programmable platform) where digital forms of money and other financial assets co-exist.”7
In essence, multiple tokenized assets (among other classes) would be available on common platforms, instead of being fragmented in their own private ecosystems. This also ensures interoperability as these ledgers are unified due to the fact that they follow certain standards. In such a standards-compliant system, a user can open an account on any ledger and move those assets anywhere else. Once completed, those transactions would be irreversible, atomic, and secure. In this way, and with the backing of good governance and regulation, state the authors, “the full benefits of tokenization would be unlocked.”8
Good governance and regulation require another element, however.
Tokenized public money required
There are many forms of regulated tokenized money:
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Retail and wholesale CBDC, which is central bank money in digital form.
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Tokenized deposits, which are the tokenized form of money held in commercial banks.
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Stablecoin, which is privately issued, but pegged to another asset, most likely a public currency.
Stablecoins and especially tokenized deposits are exciting developments, driving innovation and fueling the growth of the digital economy. As a recent collaboration between DG Nexolution, DZ BANK, Festo, and Giesecke+Devrient demonstrates,9 you can even use tokenized deposits in offline machine to machine (M2M) payments.
Some may ask why we need retail CBDC. However, there is a school of thought that a monetary system without retail public money is prone to fragmentation, and the ill effects of different sorts of private money that aren’t trading at par.
Private ecosystems might create closed-loop “walled gardens,” making it harder for their participants to exit the system or use their funds in other places. This actively hinders choice and reduces interoperability. In this view, a financial system that is operating at a high technical level but without the stabilizing effect of a digital public currency carries inherent risks for users, including market failures. The presence of public money in a system also implies regulatory supervision.
There is a further objective that functional public money provides, which is sovereignty. In fact, the European Central Bank specifically states as much in its justification for its planned rollout of its own digital currency: “A digital euro would make the euro area more robust. It would support Europe’s strategic autonomy and monetary sovereignty, making our payments landscape more competitive and resilient to non-European payment providers.”10
Teresa Riedl, Senior Strategy Consultant at G+D, stressed, “There is a need for a backup infrastructure in this new financial system that guarantees both inclusion and sovereignty, both of which are key objectives for central banks. G+D’s extensive experience in the field of token-based payments leads us to conclude that stablecoins, tokenized deposits, and CBDCs could work together very well, and in an interoperable fashion.” She added with emphasis, “Given the right regulatory frameworks, of course.”
Foundation of a tokenized financial ecosystem
As we have seen, there is a need for public money, to maintain stability and to reduce fragmentation. Providing a wholesale central bank digital currency (wCBDC) as a foundational settlement layer can enable the interoperability and secure scalability of a future financial ecosystem. As a central bank settlement asset, it would enable reserves to be tokenized, unlocking efficiencies in interbank settlements involving tokenized securities and tokenized deposits. BIS’s Project mBridge takes a very interesting, multi-CBDC approach to wholesale cross-border payments. As multiple currencies are supported, local monies are used wherever possible, and transactions are almost instant, cheaper, and fully secure.11
While mBridge’s focus is on boosting international trade through bettering the connection between central banks, BIS’s Project Agorá has actively solicited private participation in its mission, which is to see how tokenized deposits in commercial banks can be integrated with wholesale CBDC. Agorá specifically quotes BIS’s unified ledger concept as it seeks partners in building a “public-private programmable core financial platform.”12 The aim is to study whether platforms of this nature would enhance the global monetary system, specifically regarding smart contracts and programmability.
What these projects reveal is a desire to connect the existing financial system with the new one, to take the stability and experience of what already exists and charge it with the dynamic technologies at our disposal today. While global regulation is a laudable objective, standardized application programming interfaces (APIs) would be a good place to start, so the ecosystem to come will have the correct foundations.
“It is our considered belief at G+D that the future financial system will foster competition by lowering access barriers for players,” Riedl pointed out. “This would have a net positive impact on the user, because they would have more choice. Among other benefits, pricing would probably be more competitive.”
Questions remain, of course. Will wholesale CBDC become the heart of a tokenized economy, and will retail CBDC fill in the gaps in the payments system? Another intriguing question is how stablecoins and deposit tokens will enhance corporate efficiencies. A first step to making that digital world more resilient and inclusive is G+D’s recently launched Filia® Unplugged, which can be integrated into existing payment systems in order to enable offline digital payments. It is part of G+D’s comprehensive suite of services that includes in-house tech innovation, consulting at every stage, and research to drive the transformation from today’s economy to the one to come.
Key takeaways
- The Finternet, a financial conception of the internet that is based upon unified ledgers that promote interoperability between tokenized money ecosystems, is one way to overcome the challenges the financial system is facing today.
- While new technology is in the spotlight, it needs to be connected to existing technologies with standardized APIs: there is a lot of scope for growth and improvement here. Robust regulation is also critical.
- Central banks aim for financial inclusion and sovereignty; in this scenario, retail and wholesale CBDC will be key components in the future financial system.
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Accelerating digital inclusion for 1 billion people by 2025, World Economic Forum, 2024
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Extending the benefits of digital technologies to cross-border payments, Fabio Panetta/ECB, 2023
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Money, Tokens, and Games: Blockchain’s Next Billion Users and Trillions in Value, Citigroup, 2023
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BIS Working Papers No 1178 Finternet: the financial system for the future, by Agustín Carstens and Nandan Nilekani/BIS, April 2024
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Ibid.
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Ibid.
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Ibid.
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DZ Bank, G+D to demo offline M2M payments using tokenized deposits, Ledger Insights, August 2024
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Why do we need a digital euro?, European Central Bank
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Project mBridge Update: Experimenting with a multi-CBDC platform for cross-border payments, BIS Innovation Hub, October 2023
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Private sector partners join Project Agorá, BIS, September 2024
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