Wholesale central bank money in the context of technological innovation

In modern monetary systems, trust in money and payments builds upon a time-tested two-tier structure. Commercial banks issue money to economic agents in the form of commercial bank deposits, and central banks ensure the convertibility of these deposits by providing commercial banks with an ultimate risk-free asset (in the form of central bank reserves) to settle transactions among themselves. The existence of a central bank settlement asset aids in maintaining the "singleness" (or uniformity) of different forms of (regulated) money.  This means that payments denominated in the sovereign unit of account can be settled at par, even if they use different forms of money. In this way, the provision of central bank money provides an important anchor for the financial system and the economy and is a necessary – but not sufficient – condition for achieving confidence in money, price stability and, thus, monetary stability.

A group of seven central banks (the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Board of Governors of the Federal Reserve System (until January 2025), Sveriges Riksbank and the Swiss National Bank) together with the Bank for International Settlements (BIS), have been working together in a dedicated group to explore how new technologies, particularly tokenisation and distributed ledger technology (DLT), may improve the settlement of large-value transactions between commercial banks.

Indeed, tokenisation and DLT can serve as a trigger to develop new features, such as programmability, composability (ie bundling several actions) and atomic settlement (see below). They also pose important questions for central banks, notably on how to embrace technological innovation while maintaining the time-tested principles upon which trust in money and payments are built. The group's analysis is summarised in this report, and three questions in particular stand out.

First, what is the role of private sector (commercial bank-led) solutions for the settlement of wholesale transactions relative to central bank solutions?

• Private settlement solutions may have certain benefits, such as timely market presence and alignment with market needs. Central bank solutions may be preferrable in wholesale settlement to avoid credit and liquidity risk, as well as to achieve possible public policy goals, which may vary by jurisdiction and may relate to, for example, neutrality, cost and liquidity efficiency, market-wide reach, harmonisation and competition.

Second, should a central bank-led solution be fully integrated or allow for synchronisation with current legacy digital solutions?

• An integrated settlement solution brings all parts of a transaction – such as the movement and settlement of money and assets – together onto a single platform supporting programmability. This offers potential benefits like smoother processing and better automation. For instance, so-called atomic settlement, which means that the different parts of a transaction are settled all at once or not at all. Instead of going through many different steps, often on different infrastructures, assets are exchanged in one single, synchronous step on the same programmable platform. This can mean higher speed, lower costs and lower risks. Programmability could also allow for the bundling of different functions, such as the triggering of a payment settlement upon the fulfilment of certain criteria. Yet the path to fully integrated solutions is potentially more complex and may take more time to build and launch. Additionally, depending on the design of the integrated settlement solution policy, challenges such as liquidity fragmentation need to be addressed.
• A synchronised solution keeps different types of money and assets (eg traditional digital assets vs tokenised assets) on separate systems but coordinates transfers, so that they can happen simultaneously as they are managed by a trusted entity that has access (overviews) to the different systems. This solution is less complex than integrated settlement but seems to offer less utility.
• Introducing a new settlement solution means that, for a period of time, separate platforms will need to be operated in parallel. This can result in duplicated costs and fragmented liquidity – making it harder for institutions to manage their funds efficiently. Nonetheless, this could be configured to allow for the incremental development of new ecosystems, while allowing for select new functions that are not available in existing systems.

Third, what is the role of third parties in building and operating new settlement systems that include central bank reserves?

• The involvement of third parties may have some benefits, such as better alignment with the needs of the market. However, if third parties are involved, it is also important to consider the critical systemic nature of such infrastructure and the need for the central bank to ensure appropriate control over settlement, in line with their monetary policy and financial stability remits, as well as robustness over disaster recovery plans.

Central banks around the world are working to answer these questions. As they do, international cooperation and information exchange will be important – particularly when it comes to the use of these technologies to improve settlement for cross-border transactions. There is no one-size-fits-all solution. Ultimately each central bank's approach will depend on their country's legal framework, market structure and policy priorities.