Are Distributed Wholesale Payment Systems Feasible Yet?
Financial sector participants are interested in this distributed ledger technology for several reasons. The Bank of Canada has recently published a report investigating this topic.
Distributed Ledger technology has the potential to reduce back-office costs by automating various settlement processes. It can increase the reliability and traceability of information stored in the ledger, since the consensus mechanism puts limits on who can change records and how they can change them. Finally, with decentralized processes, settlement of transactions could be faster—reduced to hours or minutes instead of days.
One area of interest has been the potential implications of DLT for financial market infrastructures (FMIs). FMIs act as the trusted third party between financial institutions, tracking and recording transactions in centralized ledgers. Operators of FMIs, participants and central banks are all interested in the efficiencies and opportunities that a DLT-based system could provide relative to current centralized systems. As a result, many recent DLT advancements have focused on ways for traditional operators of centralized systems to realize the benefits of DLT while mitigating its disadvantages. For example, a common trend has been toward creating DLT systems that restrict access to a group of trusted entities. This contrasts with open arrangements like Bitcoin, where any entity can participate.
To date, central banks have implemented DLT only in proofs of concept, and further examination of potential DLT applications can be expected. One of the areas being investigated is the possible application of DLT to wholesale payment systems. Canada’s existing wholesale payment system is the Large Value Transfer System (LVTS), operated by Payments Canada. The LVTS processes an average of $175 billion in payments each business day. It has been designated a systemically important FMI and is overseen by the Bank of Canada in accordance with the Principles for Financial Market Infrastructure (PFMIs).6 Wholesale payment systems make sense as an early potential application of DLT because they are relatively simple. They are also critical for financial stability. It is therefore important that overseers, like the Bank of Canada, understand how the use of DLT could change the way centralized systems are structured and operate, whether a DLT system could meet existing international standards, and any potential implications for payment system policy.
Download the report from here.