Katherine Ross

Central banks interested in exploring “some form” of a central bank digital currency (CBDC) rose to 93%, according to a 2022 Bank of International Settlements survey.&nbsp;



Eighty-six banks responded to the BIS survey. However, a June <a href="https://www.atlanticcouncil.org/cbdctracker/">survey</a> from the Atlantic Council found that around 130 countries are exploring <a href="https://blockworks.co/tag/cbdc">CBDCs</a>.



The survey, which was conducted in the latter half of 2022, also found that the number of banks willing to issue a CBDC in the next three years notched up slightly to 18% from 15%, but 68% of respondents said that issuance of a CBDC is “unlikely” any time soon.&nbsp;



“A clear divergence has emerged: compared to last year, some central banks have become more likely to issue a retail CBDC within the next three years, while others indicated to be less likely to do so. The share of central banks likely to have a wholesale CBDC in the short term more than doubled,” the <a href="https://blockworks.co/tag/bank-of-international-settlements">BIS</a> said.



Fifteen retail CBDCs, alongside nine wholesale CBDCs are expected by the end of the decade.&nbsp;



“Work on retail CBDC is more advanced than on wholesale CBDC: almost a quarter of central banks are piloting a retail CBDC. More than 80% of central banks see potential value in having both a retail CBDC and a fast payment system, mostly because a retail CBDC has specific properties and may offer additional features,” the BIS wrote.



BIS also found that the volatility in crypto assets, from the collapses of TerraUSD and FTX — which had wide-ranging effects on crypto and caused volatility, led to piqued interest in CBDCs.



“60% of central banks said that the emergence of stablecoins and other crypto assets has accelerated their work on CBDCs. These central banks generally attach more weight to a broader set of motivations for issuing a CBDC,” the BIS noted.



The BIS has been working on various papers concerning CBDCs. Just last week, it published steps for <a href="https://blockworks.co/news/bis-cbdc-framework">“secure and resilient” CBDCs</a>.



In May, BIS looked at how <a href="https://blockworks.co/news/bis-tackles-offline-cbdcs">central banks can implement offline</a> CBDC technology.



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93% of banks exploring potential CBDC: Bank of International Settlements

Research into safe and sustainable CBDC systems has continued apace, with the Bank of International Settlements on Friday outlining the agency’s latest steps to provide a “security and resilience framework” for them.



The idea behind the Bank of International Settlements’ paper, published on Friday, was to help banks safeguard against risks when it comes to CBDC implementation. 



The paper, dubbed Project Polaris, is designed to get ahead of <a href="https://blockworks.co/tag/cbdc">CBDC</a> launches and protect “critical infrastructure.”



While some central banks — <a href="https://blockworks.co/news/cbdc-kenya-central-bank">such as Kenya</a> — have said the once-promising allure of CBDCs has faded, other financial institutions, like the IMF, are <a href="https://blockworks.co/news/imf-lukewarm-on-crypto">receptive to possible adaptation</a>.



While central banks largely have cyber security measures in place, the introduction and rollout of CBDCs could lead to new risks. While over 100 countries — <a href="https://blockworks.co/news/banks-pen-paper-cbdc-implementation">including the UK and US</a> — are currently exploring a potential CBDC, few have moved beyond small-stage, pilot projects and into actual implementation.&nbsp;



“CBDC systems will need to remain highly resilient in a broad range of scenarios, including short-term (such as temporary system outages), ongoing situations (such as in areas without reliable internet, telecommunications connectivity or power), or civil contingency conditions (such as natural disasters or war), 9 besides being highly responsive in normal operations,” the BIS <a href="https://www.bis.org/publ/othp70.pdf">wrote</a>.



Successful and safe implementation requires modernized technology to not only support a CBDC, but also to protect it, the agency found — <a href="https://blockworks.co/news/the-bank-of-england-is-looking-to-build-a-digital-pound">echoed by other central banks</a>.



Among the suggestions, Project Polaris pushed for central banks to hire a chief security officer (CSO).&nbsp;



The CSO would then be able to have “regular” communication with counterparts across the globe, since CBDCs will require an international framework. There would also be an “incident response team” who could respond to a variety of potential scenarios.



It also urges central banks to consider other operators needed in a CBDC ecosystem, from commercial banks to merchant partners. This would lead up to the fulfillment of a resilience requirement — similar to a stress test — depending on the CBDCs “weakest link.”



Overall, frequent check-ups and assurances of secure technology are said to be key for any CBDC if central banks decide to deploy them.



“The framework could also help central banks assess their cyber security and resilience maturity level as it stands today as compared with what could be required when operating a CBDC system, by assessing and ranking how the organization adheres to the practices outlined in this framework,” the BIS wrote.



Project Polaris is not the first foray into CBDC research that the BIS has conducted. It put out another report in late June <a href="https://blockworks.co/news/cbdcs-tokenized-deposits-unified-ledger">focused on how commercial banks</a> could tokenize customer deposits.



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BIS lays out steps for ‘secure and resilient’ CBDC systems

James Cirrone

The Bank for International Settlements (BIS) put out a report Tuesday arguing that commercial banks tokenizing their customers’ deposits could revolutionize the global financial system.&nbsp;



But for that to happen, <a href="https://blockworks.co/tag/bis">BIS</a> said that DeFi projects need to realize that actively walling themselves off from the rest of the financial system (i.e. central banks and commercial banks) isn’t a good strategy.



“Not only is crypto self-referential, with little contact with the real world, it also lacks the anchor of the trust in money provided by the central bank,” BIS wrote in the <a href="https://www.bis.org/publ/arpdf/ar2023e3.htm">report</a>. “While stablecoins have mushroomed to fill this vacuum by mimicking central bank money, the implosion of the crypto universe in the past year shows that there is no substitute for the real thing.”



“Central bank money and the settlement finality that it brings is a much firmer foundation for tokenization,” the report continued.



BIS mentioned efforts by commercial banks and private sector groups that are exploring use cases for tokenization.&nbsp;



JPMorgan, the biggest bank in the world by assets, is one example. Like BIS, <a href="https://blockworks.co/tag/jpmorgan">JPMorgan</a> feels stablecoins aren’t regulated enough and <a href="https://blockworks.co/news/deposit-tokens-stablecoins-defi-jpmorgan">bank-issued deposit tokens would be a much better alternative</a> to move value across blockchains.&nbsp;



BIS also hyped up financial infrastructure it called a “unified ledger,” with ledgers being <a href="https://blockworks.co/news/consensus-mechanisms-guide">one of the most important concepts in crypto</a>.&nbsp;



A unified ledger, BIS said in a press <a href="https://www.bis.org/press/p230620.htm">release</a>, “would combine tokenized forms of central bank digital currency (CBDC) with tokenized bank deposits and other tokenized claims, opening up a new era in the joint development of the monetary system and the economy.”



An insider at the International Monetary Fund (IMF) echoed a similar sentiment at CBDC roundtable discussion this week, saying that a trusted ledger would go a long way in <a href="https://blockworks.co/news/imf-global-ledger-cbdc">protecting people’s property rights around the world</a>.



Later on in the report, BIS clarified by saying that unified ledgers won’t mean “one ledger to rule them all.” Rather, it appears to mimic the network of networks concept of existent distributed ledgers.



“Depending on the needs of each jurisdiction, multiple ledgers, each with a specific use case, could coexist. APIs could connect these ledgers to each other and existing systems. Over time, they could incorporate new functions or merge as overlaps in scope expand,” BIS wrote in the report.&nbsp;



The BIS seems to have softened its view on digital assets a bit since January when <a href="https://blockworks.co/news/central-bank-for-central-banks-floats-ways-to-contain-crypto-including-ban">it floated a crypto ban as a possibility</a>. Although the bank didn’t pull any punches on crypto in the report, referencing 2022’s collapse twice, it acknowledged the validity of cryptographic techniques.



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Combine CBDCs, tokenized deposits on a unified ledger, BIS says

The Bank of England and the Bank of International Settlements released a 44-page paper on Project Meridian which focused on distributed ledger technology and synchronized settlement — meaning that an exchange of assets takes place between all parties and if the transfer isn’t able to successfully take place, then the transfer is voided. 



The Bank of England first released a paper on synchronization back in June 2019.&nbsp;



“Synchronization builds on the existing concept of interlinking asset ledgers with RTGS systems, seeking to develop functionality that allows synchronized settlement in central bank money for a wide range of assets,” the <a href="https://www.bis.org/publ/othp63.pdf">report</a> states.



Project Meridian builds on the BOE’s real-time gross settlement system and the findings helped to build on use cases for central bank digital currencies (CBDCs), while also allowing financial market infrastructures to be interlinked. 



When buying a home — which is a scenario acted out by the project — a “synchronization operator” would connect “the operator of an RTGS system, the asset ledger and the commercial banks and legal representatives of the buyer and seller.” However, due to the complicated nature of buying and selling a house, more modern technology would have to be developed for both the RTGS and the land registry system.



The Bank of England is currently working on a new settlement engine for the RTGS, and while it’s not clear when the rollout could occur, synchronization could be added as a service after 2024.



While real-world users have not yet tested the system, the bank believes it could “improve domestic and cross-border payments, and retail payments.” As well as making it possible to use synchronized settlements for “new asset classes,” which could include CBDCs.



But with any new technology, there are some caveats. The Project Meridian report states that an identity service should be considered so that the synchronization operator would be able to “secure its own network from being compromised” by validating the participant&#8217;s identities.&nbsp;



Operating hours are also questioned and become important if the synchronization system is utilized for cross-border transactions, according to the report.



“Extending RTGS operating hours could increase opportunities for synchronization, especially for cross-border payments,” the report said.



The BOE has already said that a <a href="https://blockworks.co/news/the-bank-of-england-is-looking-to-build-a-digital-pound">digital currency could be necessary in the future</a>, though the development and consultation stage could take up to three years. 



“Users would interact with digital pounds by using their wallet to see their balance and instruct payments and transfers of digital pounds. It is likely most people would access the wallet via their smartphone, but there would be alternative options, such as a smart card,” the BOE said in a February <a href="https://www.bankofengland.co.uk/paper/2023/the-digital-pound-technology-working-paper">paper</a> on digital currencies back in February.&nbsp;



The BOE has also indicated that it is closely looking at <a href="https://blockworks.co/news/stablecoins-efficient-bank-of-england">stablecoins for payments</a>, though “systemic stablecoins will need to be back with high quality and liquid assets to be able to meet” Financial Policy Committee standards, according to BOE’s Jon Cunliffe in a recent speech. 



Cunliffe said, “The question is not whether but how we should develop the machinery for tokenized transactions to settle in central bank money — in other words what will provide the most efficient, effective and fastest route to this end, given our current starting point.”



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Bank of England Wraps Up Distributed Ledger Technology Project

Jocelyn Yang

<div id="highlights-block_62ac9d8ecaed5" class="highlights">
 <ul>
 <li>Bank of International Settlements’ economists said current DeFi loans don’t finance real economy activities</li>
 <li>Total value locked in DeFi lending protocols reached $50 billion in early 2022, up from nearly zero at the end of 2020, according to BIS data</li>
 </ul>
 
</div>



The recent Terra LUNA collapse and <a href="https://cms.blockworks.co/celsius-withdrawal-halt-reveals-run-risks-on-other-crypto-banks/" target="_blank" rel="noreferrer noopener">Celsius’ restrictions on withdrawals</a> have sparked fears of a crisis in crypto lending. Economists at the <a href="https://www.bis.org/publ/bisbull57.pdf" target="_blank" rel="noreferrer noopener">Bank of International Settlements</a> (BIS) said while on-chain collateral in DeFi lending overcomes asymmetric information, it doesn’t make the space immune from boom-bust episodes, compounded by liquidation spirals. 



Cryptocurrency lending platforms — where borrowers can deposit cryptoassets as collateral to secure a loan from the lenders — are critical to the DeFi (decentralized finance) ecosystem, according to the institution’s bulletin released this week. However, BIS economists found these platforms’ institutional features mostly “facilitate speculation in cryptoassets” rather than “real-economy lending.”&nbsp;



“Smart contracts assign each collateral type a haircut, or margin, that determines the minimum collateral borrowers must pledge to receive a loan of a given amount. The high price volatility of cryptoassets means that there is overcollateralization: the collateral required tends to be much higher than the loan size,” the bulletin read.&nbsp;



“As DeFi loans are disbursed in cryptoassets and secured by crypto collateral, they do not currently finance real economy activities,” it added.&nbsp;



Meanwhile, BIS economists believe that the need for collateral blocks the fundamental goal of DeFi: “democratizing finance.” Those not so asset-rich are often excluded when it comes to accessing financial services.&nbsp;



“Due to the anonymity of borrowers, overcollateralization is pervasive in DeFi lending,” the report read. “Reliance on collateral also limits access to credit to borrowers who are already asset-rich, negating financial inclusion benefits.”



As high returns attract investors, the total value locked in DeFi lending protocols reached $50 billion in early 2022, up from nearly zero at the end of 2020, according to BIS.&nbsp;



Now that trend has reversed — total value locked <a href="https://defillama.com/chains" target="_blank" rel="noreferrer noopener">has plummeted</a> along with asset prices.



<h3 class="wp-block-heading">Is it collateral or opaqueness that’s the problem?</h3>



It’s not surprising that a champion of central banks would dismiss the concept of decentralization. But Chase Devens, research analyst at Messari, argues centralization is largely responsible for the current mess, noting that it was poor risk-management mixed with a lack of understanding of asset and protocol functions — such as Terra and stETH — that left large centralized players such as Celsius searching for liquidity.&nbsp;



“The falling dominoes have been fueled by a lack of transparency as to how much leverage was built up within the system,” Devens said.



<blockquote class="wp-block-quote">“As we know, the state of DeFi is publicly verifiable and allows the health of the system to be assessed in real time. However, [over-the-counter] deals and off-chain leverage can build up beyond this ecosystem and trigger surprise liquidation cascades as they are unraveled.” </blockquote>



If DeFi lending wants to make it into the real-world economy, BIS economists suggested it must engage in “large-scale tokenisation of real-world assets” and rely less on crypto collateral. However, “developing its ability to gather information about borrowers,” would eventually lead the system to “gravitate towards greater centralization.”&nbsp;&nbsp;



“The similarities between DeFi and legacy intermediaries are increasing, which has two important implications,” the report read. “The first is that elements of DeFi, mainly smart contracts and composability, could find their way into traditional finance. The second implication is that, once more, decentralization proves to be an illusion.”&nbsp;



Devens agreed that large-scale tokenization has always been a goal for DeFi. Yet, he thought abandoning anonymity and relying on centralization might not be the best strategy over the long term because “centralized entities have proven to be opaque and create bottlenecks of their own,” he said, pointing once more at Celsius.&nbsp;



“Although the identities of the borrowers are (mostly) unknown, we know exactly what price levels will trigger liquidations from on-chain lending protocols such as Maker or Aave,” he said.&nbsp;



<blockquote class="wp-block-quote">“As zero-knowledge technology continues to improve in the coming years, identity and reputation-based lending systems will have room to flourish.”</blockquote>



Protocols such as MakerDAO are <a href="https://forum.makerdao.com/t/aggressive-growth-strategy/13958" target="_blank" rel="noreferrer noopener">specifically focusing</a> on onboarding real-world assets to expand the collateral base of DAI and, by extension, all of DeFi.



“The evolution of crypto will continue to play out for many years to come and ultimately result in an antifragile system that is anchored on decentralization at its core,” he added.



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bank of international settlements