ari empirical insights

Lienhardt & Partner Privatbank Zürich AG is a small private bank in Zurich, Switzerland that specialises in private banking, real estate and financial provision (Lienhardt & Part-ner, 2022). As a small and domestically oriented bank, Lienhardt & Partner’s business is mainly focused on Swiss client savings accounts. This business model naturally includes both conventional equity portfolio diversification as well as investments in the Swiss alternative asset market such as commercial real estate and the nascent “Crypto Valley” ecosystem. Alongside the traditional client relationship management services typical of a private bank, and through its working relationship with the custodial wallet provider Bitcoin Suisse, Lienhardt also has a comprehensive level of in-house knowledge and ex-perience with digital currencies that is relatively atypical for a bank of its nature and size. Thanks to these prerequisites, the firm’s CEO was able to share his insights on the way that Lienhardt’s stakeholder interests in digital currencies and Swiss domestic in-terest rate policy could be affected by the SNB’s ongoing CBDC trial projects. Dr. Duri Prader is the CEO of Bank Lienhardt and was able to share his insights from a wealth of experience and familiarity with both the Swiss cryptocurrency industry and the SNB. 5.1.2. Approach to CBDC When it comes to digital currencies, the consumer retail element is less relevant for the operations and business model of a private bank than the ease of access and interopera-bility offered by new wholesale offerings of a combined messaging and settlement layer. As such, Lienhardt’s main consideration is around the use cases and rollout of a whole-sale CBDC. In principle, such developments are welcomed by private banks as they pre-sent an improved efficiency in the settlement layers than are currently on offer while offering minimal potential disruption to the business model of small financial actors like private banks. As well as its direct effect on banks and their balance sheets through the effect it could have on interest rate policy and risk premia, the SNB also needs to carefully consider what effect a CBDC could have on private stablecoins. This is an area where Prader sees the potential for a crowding out effect if direct interbank messaging and settlement were routed through a wholesale CBDC instead. “At present, stablecoins are appealing to banks such as Lienhardt because they allow us to hedge against the potential denomina-tion risks of volatile cryptocurrency prices while still being able to participate in attrac-tive staking yields” (D. Prader, personal communication, 21 February, 2022). When it comes to the potential for retail CBDCs, the private banking sector is less enthu-siastic. While the individual portfolio and wealth management of high-net-worth clients clearly isolates a small private bank from the same level of withdrawals that a bank with a large number of retail accounts might face, in Prader’s opinion the creation of a Swiss retail CBDC would still create systemic risk for the Swiss private banking sector. There is a danger that central bank access would offer consumers a credit risk-free “flight to safety”, with the effect being a total crowding out of private banks by the central bank taking part in conventional retail deposit offerings to the public. When this lower demand for private bank deposits is coupled with rising bank capital adequacy requirements, the result is an overall reduction in the room to manoeuvre for private banks. Prader sees the creation of a retail CBDC as posing a serious danger both to the money supply as well as interbank credit creation and lending. 5.1.3. Current Status The effect of CBDCs on the banking system will not necessarily be equally felt or evenly distributed among the different sizes and varieties of private bank actors. Indeed, there is good reason to believe that larger universal banks with a more international business model will feel the effects of lower retail demand earlier than do smaller and more do-mestically oriented actors (D. Prader, personal communication, 21 February, 2022). In spite of this, the lower margins available to small banks in the present interest rate envi-ronment mean that even relatively unaffected actors like Lienhardt are already taking the necessary precautions. While risk mitigation to the changing environment in digital payments is of course im-portant, there are also promising opportunities that wholesale CBDCs and stablecoins present to private banks. At present, the trial participants in Project Helvetia and Jura are mainly bulge bracket banks such as UBS. However, thanks to their familiarity with digital payments, it was also possible for the much smaller Hypothekarbank Lenzburg to also participate in the trial. Indeed, it is the modularity of CBDCs that could allow more traditional private banks like Lienhardt to make use of these wholesale payment systems at far lower marginal cost. Due to the increased scalability inherent to digital settlement that DLT makes pos-sible, Prader sees great potential in wCBDC adoption for banks of his size; “One of the main advantages of digitising central bank standing repurchase agreements through a wholesale CBDC is that the improved ease of access offered by database interoperability will make it a lot faster and cheaper to onboard smaller actors like ourselves” (D. Prader, personal communication, 21 February, 2022). 5.2. Swiss Financial Institution 5.2.1. Overview The interviewee, who explicitly wished to remain anonymous, is an economic advisor at a major Swiss financial institution. In the past, he has written extensively about the sys-temic risks inherent to quantitative easing, especially those around asset price inflation and the mortgage market. These include inflationary pressures from the flattening of the yield curve and a lower rate environment, as well as the effect that this can have on the velocity of money. Most recently, he has authored around the central bank risk transfer that CBDCs can create. As part of this current research, the interviewee has assessed and made sugges-tions around how the issuance of a retail CBDC could lead to an expansion of the central bank balance sheet. An expansion of this kind would be driven by greater demand for consumer and retail access to low risk deposits, which in turn could create substantial changes to the risk profile of the central bank portfolio (Anonymous, personal commu-nication, 11 March, 2022). With this in mind, it is incumbent on any responsible actor to first carefully consider the second-order effects and risk factors that the mass adoption of retail CBDC deposits could present. 5.2.2. Approach to CBDC It is the interviewee’s opinion that all central banks, but in particular those with foreign exchange holdings and that experience higher foreign demand, are acutely aware of the fact that disrupting the payment system could lead to a transfer of risk from private to public sector (Anonymous, personal communication, 11 March, 2022). Such a risk shift is to be avoided wherever possible, and to this effect the interviewee’s research differentiates between the substitutability of CBDC for central bank issued cash versus privately issued deposits. During a CBDC rollout and implementation phase, the increase of demand for either of these classifications of money is not perfectly linear. In addition, the demand profile is heterogenous between central banks based on the level of economic and sectoral development of their national economies. Taking the Swiss case of a high-income economy with a fully banked population, the great risk is that most of the substitution will be of private money from bank deposits into CBDC (Anon-ymous, personal communication, 11 March, 2022). The effective interest rate differential between private bank accounts and direct retail CBDC accounts will also be necessary in determining the level of demand for CBDC. Cru-cially, CBDC will also be able to implement rates on public money which cash is unable to. The actual rate of interest will be unaffected by this mechanic though, since policy rates are based on interbank lending with hedged risk on swap rates, rather than direct-ly based on the desired yield of a CBDC. From a central bank’s side, the minimal effect of a retail CBDC on interest rates is minimal compared to the potential for increased capital inflows. Rather than seeking higher yields, there is the potential that foreign investors will instead see a retail CBDC as a further opportunity to access a safe haven currency devoid of market risk (Anonymous, personal communication, 11 March, 2022). Irrespective of real interest rates, in the short-term wholesale CBDCs are much more pertinent to the effective management of any additional maturity or credit risk that cen-tral banks might need to take on. Beyond foreign denominated risk, the larger issue for a central bank trying to take a macroprudent approach to direct market intervention is that wCBDCs could be seen as a much more preferable counterparty than the interbank short term money market in times of systemic shocks that can cause an interbank credit crunch. Like in 2008, this could result in the central bank having a large amount of cred-it risk bearing collateral such as mortgages and other illiquid assets being posted by counterparties in financial distress. Naturally, it is the public sector’s preference that such transactions be carried out on the interbank market at a premium for profit, as is presently the case. 5.2.3. Current Status In the Swiss case we can differentiate between the status of retail CBDCs, which are cur-rently not under consideration, and wholesale CBDCs, which are being trialled as part of projects Helvetia, Jura, & Rio. At present, Switzerland has no intention to introduce a retail CBDC yet, if at all. For the immediate future there are no retail or account-based consumer payment prototypes, proofs of concept or research avenues being pursued around the introduction or rollout of CBDCs over the medium term. By contrast, Switzerland is actively pursuing proto-types of wholesale CBDC that could help to digitise the existing central bank repo money market, as well as allowing for a more direct and transparent involvement in the cross-border settlement of transactions. 5.3. BIS 5.3.1. Overview Asad Khan is a technical advisor at the Bank for International Settlements Innovation Hub with a specialisation in Distributed Ledger Technology, Central Bank Digital Cur-rencies, and Decentralised Finance. As part of this mandate, his research includes the provision of technical advice regarding distributed ledger technology and blockchains as well as offering opinions on the ideal status and classification of DLT node infrastruc-ture. Based in the Hong Kong branch of the innovation hub, Khan’s current work and research specialisation has consequently been based primarily around the local hub’s project subdomain fields. These include a topic focus on CBDCs, open finance, and green finance. Within these topics, there is ongoing or new digital prototype development for four different projects. These entail a multiple CBDC bridge (mCBDC), a retail CBDC, dig-itised trade finance, and the tokenisation of green bonds. 5.3.2. Approach to CBDC The BIS Innovation Hub seeks to develop prototypes and work on applied technology with novel applications and use cases. As part of this mandate, Khan has worked on one of the Hong Kong centre’s flagship green finance projects. This tokenised asset infra-structure, Project Genesis, seeks to tokenise green bonds using smart contracts on a de-centralised finance settlement platform. Many of the decentralised and interoperable features of the payment rails used by Project Genesis show great promise for the ability of CBDCs to increase both the speed and simplicity of user adoption. Khan also sees this platform design as the most effective way to improve adoption and spread of retail CBDC instruments in an accessible manner; “One of the main advantages of having a distributed ledger technology platform with a relatively high degree of standardisation is that it allows for the uncomplicated onboarding of multiple small and heterogenous actors” (Asad Khan, personal communication, 16 November, 2021). The development of platforms with the explicit aim of improving accessibility for smaller firms and individu-als gives this type of DLT payment platform an unprecedented level of scalability as it looks to aggregate the market participation of these actors. Thanks to the ability of more inclusive platforms to onboard these participants at a far lower marginal cost, this ex-pands a CBDC’s scope of application towards a userbase that could not otherwise be reached with conventional financial platforms and instruments. 5.3.3. Current Status The BIS Innovation Hub continues to conduct CBDC research, both in tandem with indi-vidual central banks as part of their ongoing trial projects, as well as independently where the BIS continues to be at the forefront of CBDC research. A core point of expan-sion is the Innovation Hub’s new twin branches in Paris and Frankfurt as part of the collective BISIH Eurosystem Center. As well as the potential for the Eurosystem Centre to iterate on the Innovation Hub Hong Kong branch’s work on multiple CBDC bridges and wholesale CBDCs, the new eu-rozone branches will also be able to expand the Basel Innovation Hub’s work around central bank money on tokenised platforms (Project Helvetia). Meanwhile, the Singa-pore branch is also developing a platform for settling cross border payments using mul-tiple wholesale CBDCs, and any crossborder work in this area naturally supplements the Basel hub’s regtech research, which is most contemporarily relevant with respect to its platform for the ongoing monitoring of fast-paced markets (project Rio). With its reputation as the central bank of central banks, it is perhaps unsurprising to find the BIS at the cutting edge of the research frontier when it comes to ongoing finan-cial developments with respect to digitisation and fintech. While its ongoing work with CBDCs are at the heart of much of the Innovation Hub’s work, there is naturally also scope for other fintech developments that might help facilitate the transition towards a full digitisation of central bank deposits. With respect to the potential disruptive effects that digitisation of payments could have on the banking system, the most consequential of these are likely to be the trial implementation and rollout of wholesale or retail CBDCs over the short to medium term. This does of course not exclude secondary de-velopments and fields of research from gaining in importance as well. For example, other areas of the Innovation Hub’s research that could be influential for banks’ core business models include; 1) the development of next generation financial market infrastructures and the effects that this could have on direct settlement, 2) green finance and the implications that new Environmental Sustainability Goals could have for private market participant’s optimal portfolio allocations, as well as 3) regtech and its effects on reducing transaction costs within bank infrastructure. With the ongoing trend towards market participation by non-bank financial actors that we see with the growing role of tech companies in the financial system, it becomes increasingly important for regulatory and technological adaptation to take account of new systemic risk factors that such changes might create. In this regard, the BISIH’s prototypes will likely be very influential in the coming years for ensuring that new methods and instruments of mar-ket financing, payment, and settlement are introduced into the financial system while maintaining market stability and minimising unwanted negative externalities and spillo-ver effects. 5.4. Soramitsu 5.4.1. Overview Makoto Takemiya is the co-founder and CEO of Soramitsu, a Japanese fintech company specialising in DLT. Soramitsu has developed several mobile point of sale blockchain payment services based on the company’s open-source development of the C++ and mobile implementations of IBM’s Hyperledger Fabric standard. Hyperledger is an enter-prise blockchain under development by the Linux foundation, and its primary aim is to set the technical standards with which enterprise blockchains can be integrated into existing corporate or government infrastructure projects. In line with these goals, So-ramitsu recently helped the Cambodian government to create a CBDC implementation of Hyperledger Iroha called Project Bakong. 5.4.2. Approach to CBDC As part of the mandate for developing a CBDC in Cambodia, Soramitsu was tasked with building a payment system that greatly improved the central bank’s cost efficiency while also using a technology stack that was both scalable and more financially inclusive than the existing payment architecture. When considering these requirements, Takemiya had to carefully weight the potential to integrate these features into the domestic national economy’s needs: “Cambodia has a large unbanked population that Bakong was able to reach directly, integrating these new actors into the country’s payments systems direct-ly allowed the national bank to make far better use of its foreign currency reserves while still managing any unforeseen liquidity risk that this could create” (M. Takemiya, personal communication, 24 February, 2022). In addition to the company’s work on Hyperledger Iroha, Soramitsu has also developed the Fearless Wallet, which is one of the most popular non-custodial cryptocurrency wal-lets for the Polkadot blockchain ecosystem. Fearless is especially popular for its mobile implementation, which means that the company can offer a strong point-of-sale wallet integration for mobile payments interactions. This is an extremely important accessibil-ity feature in developing markets, mobile phone penetration in countries like Cambodia is much higher than conventional bank account access. Soramitsu’s experience with cryptocurrency wallet development, especially for payment in multiple denominations of currency, allowed for the simultaneous payment for most transactions. Especially in its functional similarities to a bank checking account, the application of Bakong to pay-ments that were previously made in cash, allowed for the number of transactions de-nominated in domestic currency to increase. This created a commensurate increase in the everyday use of domestic Riels rather than USD (M. Takemiya, personal communica-tion, 24 February, 2022). 5.4.3. Current Status The implementation of a CBDC for retail deposit accounts is a novel development, and this meant that there were several design trade-offs that needed to be considered from first principles before the system could be put into practice. Along with the Bahamian “Sand Dollar”, Bakong is one of the first retail CBDCs to achieve a mass rollout. Unlike in the Bahamas, Cambodia’s CBDC is also built using DLT. This makes the Cambodian ver-sion the world’s first CBDC that uses DLT. From a systems engineering perspective, Takemiya believes that DLT consensus design offers several operational advantages that allowed for the project’s success: “While it is not based on proof of work transaction verification, the voting-based consensus mechanism is more robust and better able to include all of Bakong’s stakeholders than would be the case with a CBDC that relied on a more centralised consensus protocol such as proof of authority” (M. Takemiya, personal communication, 24 February, 2022). These features of decentralisation allowed the pro-ject to be integrated quickly and seamlessly into the existing banking system without creating any unwanted disruption or complexity. By basing the software of a CBDC on the existing protocol standards of an enterprise blockchain like Hyperledger Iroha, the design principles for Bakong’s implementation could be explained and presented to the bank more pragmatically than would be the case with a fully experimental prototype. Soramitsu was therefore able to build out a payment system using a tried and tested blockchain standard that has already found commercial applications and previously been put into practice elsewhere. It is this level of modularity, interoperability and decentralised cooperation that has allowed for the rapid proliferation of blockchain based DLT to continuously find new use-case applica-tions that can be realised and applied to a workable software system in an efficient way. Takemiya has previous experience contributing via open-source software to several prominent public blockchains, including Bitcoin and Polkadot. As such, he is well placed to suggest a cost-benefit comparison between the use of private and public blockchains, in addition to the arguments against a central bank using blockchains altogether. A core point in favour of using a public blockchain for any larger software system is that public blockchains are constituted of an open-source codebase. While this can still allow for a certain degree of centralised planning from core contributors, the organisational struc-ture of open-source software naturally allows it to obtain a far greater reach. Indeed, the open-source Hyperledger protocol has strong network effects and a high degree of in-teroperability between different versions. The comprehensive range of technical imple-mentations that already exist within the development ecosystem allowed the Cambodi-an government to sample and select the version of Hyperledger that best fit their needs. “Thanks to our existing body of work and the subsequent ability for Soramitsu to com-municate the specification requirements that might best fit the Cambodian economy, we were able to offer Bakong’s development as a much more tailormade experience than would have likely been possible with a protocol that used a more centralised database” (M. Takemiya, personal communication, 24 February, 2022). Thanks to these improvements, Bakong is able to offer the Cambodian banking system a net positive gain in payments efficiency, predictability, transaction speed, and transac-tion cost. Thanks to Hyperledger’s design principles and the open source nature of DLT best practice, the project’s ongoing success can be iterated on much more effectively than is usually the case with proprietary enterprise software. 5.5. University of Paris Panthéon-Sorbonne 5.5.1. Overview Xavier Lavayssière is a lecturer at the University of Paris, he instructs a course on the Technology of Blockchain for the master "Finance Technology Data". As a lawyer with a technical background and over a decade’s worth of experience with cryptocurrencies, Lavayssière’s work covers a broad spectrum of considerations with respect to regulato-ry law, functionality and retail use cases that are equally applicable and relevant to both privately issued cryptocurrencies as well as publicly issued CBDCs More specifically, his research around CBDCs concerns itself with the legal status of public money, and therefore consequently with the distinctions in mechanism design between forms of digital money and credit that are not necessarily apparent in their everyday usage at point of sale payment. When considered from a broader perspective however, it becomes evident that it is extremely important for the implementation of an effective mechanism design that the issuance and circulation of public money be ana-lysed from first principles. It is only when looking at retail CBDCs from the bottom up that a policymaker would be able to adequately understand what extent the conse-quences of a publicly issued form of consumer credit with digital cash like properties are likely to have on the systemic payment architecture of the financial system (X. Lavayssière, personal communication, 21 April, 2022). 5.5.2. Approach to CBDC Professor Lavayssière is a proponent of public blockchains and has conducted extensive work within the Ethereum development ecosystem. As the first instrument of fully pro-grammable money to achieve widespread user adoption while also making use of “Tu-ring complete” smart contracts, the Ethereum blockchain often serves as a useful benchmark when considering viable avenues of mechanism design for digital payments systems. Thanks to the legal design architecture of an immutable public ledger, such cryptocurrencies are able to retain many of the functional payment properties of pri-vately issued digital cash (X. Lavayssière, personal communication, 21 April, 2022). As such, it becomes necessary when assessing a CBDC and its ability to scale and sustain an effective public rollout to enumerate and compare some of the differences between the types of credit money issued by central banks; namely physical cash and private bank repurchase agreements. These two types of money are commonly distinguished as belonging to either cash or account-based accounting models. Lavayssière elaborates on this distinction in his work on the “Architectural Design of Institutional Physical Curren-cies” (Amphi Poissy, 2020) with the following four categories: Firstly, the most funda-mental distinction between cash and bank accounts is the custodial possession of the asset. With cash, as with a retail CBDC, this becomes a bearer asset that can be freely transferred with a high degree of censorship resistance. By comparison, the account custodian such as a bank is in full control of any credit account-based money. Secondly, the issuer of cash is the central bank, making it public money. By comparison retail ac-counts are issued by private banks who are individually liable for both the credit risk and circulating supply size of any credit that they issue. Thirdly, the transfer delay and processing time of cash is instantaneous whereas in an account-based model it is time-delayed. Lastly, there is the legal status and the properties that are bestowed upon each type of money by virtue of their differences in custody, issuer and processing times. Namely, that cash is a bearer instrument whereas an account is an identifiable nomina-tive credit instrument. 5.5.3. Current Status These differences between bearer instrument and account-based modelling become ap-parent when considering the potential architectural design properties and design speci-fications that might be necessary for any largescale CBDC rollout (X. Lavayssière, per-sonal communication, 21 April, 2022). In particular, the four dimensions enunciated above have a certain degree of compatibility that needs to be considered when making design trade-offs in both the technical functionality and normatively desirable political properties of a CBDC. For example, it could be very difficult for a central bank to make a full real-time processing and clearing architecture required for the transfer of digital cash like CBDCs that function as a bearer instrument. As such, it becomes virtually impossible to have a high throughput and live processing system of publicly issued digital money that is not also nominative account based by legal status (X. Lavayssière, personal communication, 21 April, 2022). Similarly, it is very difficult for the long-term assessment of individual firm level credit risks to be tak-en into account if a nominative, credit-based account model without real time transfer processing is issued publicly by the central bank. One consequence of this analysis is therefore that a dimension where subjective trade-offs must be made based on a political assessment of desirability; is between on the one hand the desire for a publicly issued bearer asset that functions like digital cash and can be processed in real time, and on the other a publicly issued credit based money that makes for an effective risk assessment and takes into account effective counterparty risk.