RESEARCH France Jumps the CBDC Line with a Successful Trial Central Bank Digital Currencies Will Be Here Sooner Than You Think BY DIANA BARRERO ZALLES [DATE] France has been experimenting with central bank digital currencies (CBDCs) for over a year. Its latest successful trial shows that a CBDC future is getting closer to reality. What Happened After launching a program in March 2020 to experiment with CBDCs, the Banque de France successfully completed a simulated securities settlement using a wholesale CBDC, which as opposed to a retail CBDC, restricts access to predefined users such as commercial banks. The trial took place in collaboration with Swiss-licensed digital asset bank SEBA Bank, the Banque Internationale a Luxembourg, and the central securities depository service LuxCSD. A June 21, 2021 press release from the Banque de France confirmed that days earlier on June 18, the parties simulated an initial issuance of CBDC tokens onto an undisclosed public blockchain, deployment of a dedicated smart contract to ensure delivery versus payment (DvP), and settlement of listed securities. This simulation, where settlement triggered delivery, took place under the conditional securities delivery functionality of the Eurosystem’s existing TARGET2-Securities (TS2) platform. Since its launch in June 2015, TS2 has revolutionized securities settlement in Europe by harmonizing and simplifying cross-border settlement across countries that previously relied on different rules and procedures. Participating banks utilize their accounts at their respective central banks to pay for securities on the TS2 platform in a way that reduces transaction risk significantly. 2 Because settlement for transactions on TS2 already makes use of central bank money, the platform is a logical choice for the CBDC trial. It demonstrated not only the possibility to enable interoperability between distributed ledger technology and the TS2 system, but also the ability to ensure control and preserve confidentiality of transactions. Key Actors Nathalie Aufauvre Director General of Financial Stability & Operations, Banque de France Francois Villeroy Galhau Governor of the Banque de France Guido Buehler SEBA Bank CEO Broader Context The global financial system has not innovated at the same pace or degree as other industries that are embracing digital transformation. Clearing and settlement in particular retains the inefficiencies of a highly intermediated system that was initially envisioned for the industrial revolution, yet came to adopt trades in increasingly complex financial instruments over initial physical assets. Hence the standard “T+2” term that refers to the trade date plus two days to complete the settlement of a securities trade: a period of uncertainty regarding who owns a given asset that adds significant risk. For more complex financial products, the settlement period can be even longer. Distributed ledger technology enables peer-to-peer transactions with settlement periods much closer to real time, and high-quality tokenized collateral in the form of CBDCs can serve as the form of payment in exchange for delivery of an asset. Wholesale CBDC models can improve settlement efficiency for transactions that involve securities and derivatives. Their overall design can logically be structured to meet the existing central bank system’s requirements with respect to capacity, efficiency, and robustness of transactions. Thus, a wholesale CBDC trial would logically adopt a model similar to existing financial market infrastructures. 3 France, whose regulators were among the most outspoken against Facebook’s Libra stablecoin1 while acknowledging the benefits of peer-to-peer DLT transactions, has been actively piloting CBDC solutions since its first call for applications in March of 2020 to begin experimentation. The objective was to experiment use cases within the private sector, identify the benefits for the current ecosystem, and analyze implications on financial stability, monetary policy, and overall regulation. This would involve assessing CBDC use cases for delivery-versus-payment of financial instruments, payment-versus-payment across CBDCs from different central banks, and payments of digital assets. For all these cases, it is key to ensure adequate settlement structures. A prior experiment by the Banque de France completed an interbank settlement of over 2 million Euros on a private blockchain provided by the UK startup SETL. This pilot unleashed a series of experiments leading up to the latest simulation on a public blockchain. Its success is a positive indicator for the Eurozone’s transition toward digital cash. Looking forward, Project Jura, an additional experiment incubated out of the BIS Innovation Hub, will explore DvP settlement for French digital financial instruments against a CBDC based on the Euro, as well as PvP (payment versus payment) settlement to convert Swiss francs and Euros using their respective CBDCs. Transactions will occur between banks domiciled in France and Switzerland. “The Banque de France is now engaging with the innovators from the private sector to conduct a program of 8 experiments, with a view to integrating a wholesale CBDC into innovative 1 France’s finance minister Bruno Le Marie had strongly opposed the prospect of Libra’s status as a sovereign currency, a stance justified by the intent to preserve adequate controls for a currency with potential to become systemically important and impact the global monetary and financial systems. 4 procedures for exchanging and settling tokenized financial assets.” - Francois Villeroy de Galhau Key Numbers If DLT settlement systems interoperable with the Eurozone’s T2S system can ensure efficient clearing and settlement, the scale of transactions can be massive. In 2020, T2S settled 176,681,247 transactions, representing a combined value of 172.34 trillion Euros and an average daily count of 687,476 transactions. The most widely used form of settling transactions was through delivery-versus-payment (DVP), accounting for 72.34% of total traffic with a daily average of 497,348 transactions for the year, and also representing 96.38% of total traffic in terms of value and a daily average of 648.2 billion Euros. The COVID-19 pandemic increased the daily average settled volume, as shown by the spike in T2S settlements during March 2020. 5 Outlook and Implications Getting clearing and settlement right for a CBDC model can position France at the forefront of the EU’s transition toward digital currency transformation. While a wholesale CBDC model could be “low hanging fruit” of a CBDC solution that can be easily adapted to the existing system, it may not necessarily be superior to the existing system in merely replacing the form of digital cash representation being used to settle transactions. Yet it can pave the way toward further innovations with benefits could significantly improve the economic competitiveness of the system that adopts it. New system designs for wholesale CBDCs will continue to require further experimentation and collaboration across stakeholders in the public and private sectors, in order to address technical, legal, and market issues and specifications. Faster, cheaper, and more transparent money transfers can greatly facilitate the array of payments across industries, and power a new generation of financial innovations already being unfolded through smart contract implementations, stablecoin adoption, and developments in decentralized finance (DeFi). CBDCs enable programmability of money, in that they can embed taxes and fees into transactions automatically, and they may also improve financial stability. In the midst of digital transformation across industries, even non-financial institutions and startups are providing customized financial services embedded into the delivery of products and services. Eventually this may point toward a global monetary system with complementary formats of currencies, customizable for specific needs and purposes. Decision Points Much of our existing system relies on credit, and it’ll be important to define the structure of a debt and lending ecosystem that can support the use of CBDCs. New system designs for wholesale CBDCs, (and even more so with retail CBDCS), may present challenges with respect to the role of lenders and borrowers, interest rates, and the monetary policies which support the current structure of the economic system today. 6 Further Reading • Banque de France Press Release • SEBA Announcement of CBDC experiment with Banque de France • BIS Central Bank Digital Currencies Publication • Francois Villeroy de Galhau Speech • BIS Project Jura Press Release • Target2-Securities Annual Report 2020 7 @DianaZalles [email protected] Forbes Digital Assets is published by Forbes Media, LLC (collectively, the “Forbes”), a bona-fide publisher that routinely publishes research, on an impersonal basis, for its subscribers and prospective subscribers. 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