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Underpinning wholesale payment systems with distributed ledger technology (DLT)
would introduce greater costs and risks for institutions than those which apply undergoing wholesale payment systems, the Bank of Canada has said. However, a study carried out by the Bank of Canada, into the feasibility of using DLT to create new distributed wholesale payment systems, identified the potential for DLT-based wholesale payment systems to deliver benefits if they could be linked in to other financial market infrastructure.
"Such benefits may be obtained by integrating other assets on the same ledger as payments – which could greatly simplify collateral pledging and asset sales – reaping economies of scope and reducing costs to participants by integrating back-office systems," the Bank of Canada said (11-page / 182KB PDF) in a report on its study. Benefits from the "interaction" between DLT-based wholesale payment systems and other infrastructure include "possible sector-wide" cost savings or efficiency gains, as well as shortened time for settling trades of some financial assets, such as stocks, bonds, and derivatives, the report said.
The costs of reconciliation could also be lowered, it said. "If a DLT-based system allows banks to validate their transactions at the very beginning, it could reduce back-office reconciliation work and potentially achieve major cost savings for the financial sector," the Bank of Canada said. "These cost savings depend on the nature of the DLTs." DLT is another term for blockchain, which is a shared digital ledger for recording information, such as the transfer of assets between two or more parties. A number of financial firms and regulators around the world have been exploring the potential of blockchain to support trades in financial assets.
The Bank of Canada's study, which began last year, has so far involved testing two different types of DLT platforms – Ethereum and Corda. Neither of the platforms is without their flaws, the Bank of Canada found when testing their potential to underpin wholesale payment systems. It concluded that "the versions of distributed ledger currently available may not provide an overall net benefit when compared with existing centralized systems for interbank payments".
In its report, the Bank of Canada noted that, when using the Ethereum platform, none of the payments made could ever be "fully settled" as there is "always a small probability that the payment could be reversed". That problem is, in theory, eliminated when the Corda platform is used for making payments, the Bank of Canada said. However, it said the Corda platform has still to be "stress tested".
The Bank of Canada also identified operational risk in using DLT. It said the way the technology works could create potential single points of failure in a payment system. There would be the risk that outages could prevent payments from being processed, it said. It might be "more expensive" to ensure the resilience of blockchain-based payment systems than the current centralized wholesale payment system in Canada, the Bank of Canada said. The Bank of Canada also said that the Ethereum platform was not suitable for providing an adequate level of privacy overpayments. While the Corda platform offers "increased privacy", it suffers from "lack of transparency".
"If the information at one or more nodes is corrupted, it may not be possible to reconstruct the entire network since even the notary does not have a full copy of the ledger," the Bank of Canada said in its report. "This creates the need for backups of individual nodes and a loss of the economies of scale associated with centralized systems." "Further, it raises the question of whether the proposed operational-resilience benefits of DLT are possible under the constraint that transactions remain private," it said.
Chuck Reynolds
Contributor
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