Project Cedar a potential breakthrough for a US wholesale CBDC or "innovation theater?" We can't say!
Two days or 10 seconds to transfer funds, it's your money, you pick!
Michelle Neal, Executive Vice President and Head of Markets for the Federal Reserve Bank of New York, better start looking for a new job! Her recent comments at the Singapore FinTech Festival in Singapore represent the most positive comment yet by a Federal reserve employee about CBDCs!
In fact, her comments were so positive that I wonder how they will go down with what I call the “anti-CBDC cabal” of Fed chairman Powell and governors Kashkari and Waller! But, at least fellow CBDC advocate Fed vice-chair Lael Brainard will be pleased!
The Fed has a complete lack of vision regarding CBDCs, and I constantly rail against their inability to conceive of a better payment future for US citizens. A future where banks and credit cards do not take fees out of citizens’ cash transfers and payments are immediate and free. It’s not too much to ask. If China, India, Brazil, and other countries can do it, so can the US!
So imagine my surprise when I read this:
"A U.S. CBDC – a digital form of the U.S. dollar that is a direct liability of the Federal Reserve – has the potential to offer significant benefits. It could enable a payment system that is more efficient, provide a foundation for further technological innovation, and facilitate faster cross-border transactions. It could promote financial inclusion and equity by enabling access for a broad set of consumers and foster economic growth and stability.
I’m delighted to see someone at the Fed who gets it! Michelle Neal has the Fed’s New York Innovation Center (NYIC) under her authority, which is likely why she is sympathetic to CBDCs. She uderstands the good they can do!
Wholesale CBDC and political acceptability
Most of the discussion surrounding CBDC has been around retail CBDCs or rCBDC, which are used for payments by citizens. Retail CBDCs are commonly thought of as “cash replacements,” even though a more accurate way of thinking of them would be as credit card replacements as both are electronic.
Wholesale or wCBDCs are used to carry payments between financial institutions, governments, official institutions, and large nonfinancial companies. WCBDC transactions are at the backbone of our financial system as they allow banks to transfer large volumes between banks and across borders.
They also solve a real problem that has led JP Morgan to issue and use JP Morgan coin a form of tokenized account balance used in wholesale settlements. The implication is that if wholesale transactions are a big enough problem for JP Morgan to solve, a wCBDC would represent a real boon to the entire banking community.
This is where the politics come in. I believe it is much more likely that the US would produce a wCBDC than its retail counterpart. With wCBDCs the Fed is working with the banks, which will mollify their powerful lobbying groups. Compare this with an rCBDC which has every bank in the US already up in arms! So I do believe that this might be the start of something big. Call me an optimist!
What is the problem
The NYIC focused its testing on what it believes is both a large and straightforward problem, foreign exchange (FX) spot trades. They are common with a daily market turnover of $7 trillion and are less efficient than they could be. Currently, it takes two days for an FX spot trade to settle. During this period, senders and recipients are forced to wait for the existing banking systems to process the trade and incur settlement, counterpart, and credit risk during the wait. An immediate or “atomic” settlement that settles nearly instantly would reduce these risks and the burden of waiting for payment.
Astute readers will say that “Real Time Gross Settlement” systems are available with many large institutions or central banks. While this is true to a point, the immediate payment-versus-payment (PVP) or synonymous “atomic” settlement they bring comprises less than 40% of this $7 trillion market. This shows how even in the Fed’s words how there is “potential to drive improvement.”
What is the solution?
Let me clarify that as much as I like Project Cedar, the report was woefully short on any details. This is likely due to the Fed’s desire not to focus on any particular blockchain technology, knowing full well that the design and technology are subject to change. Their goal is to show that a permission blockchain system could work more than to say, “we have tested systems and like this one.”
As much as I like Project Cedar the report was woefully short on any details.
The most significant specification is that the system uses Unspent Transaction Output (UTXO) as ledger data. This means that the system is passing tokenized assets between counterparties and not using an account-based system. This is essentially mandated by the notion of “atomic settlement” as the token is the money.
We can’t know for sure if this indicates their thinking on future systems or was done simply out of ease of testing. That said, my bet is that in order to scale and attain higher performance figures this will be the standard.
Key components of the NYIC’s DLT Solution. The most significant revelation is that the Fed has gone with a tokenized system, not account-based, due to the use of UTXO ledgers. A number of mainstream blockchain protocols including Hyperledger Sawtooth use the Rust programming language. So while we can’t say it was Hyperledger it just may have been!
The results, and why they’re not enough
The NYIC “SIMULATED” an FX spot transaction to demonstrate that payments could by made instantaneously, <30 seconds, and on a PvP basis which means that both legs of a transaction settle simultaneously.
The system’s most interesting feature is that it was set up across “separate homogeneous ledgers that were interoperable.” Imagine each nation and currency ran on a separate DLT ledger. So we aren’t passing tokens on a single blockchain but between separate blockchains. Their goal was to capture performance data to benchmark future projects and figure out what comes next.
The results show that the DLT network performed at roughly 10 seconds per trade with a peak of around 100 swaps per second.
But what does 10 seconds per trade really mean?
Many in the crypto world would simply yawn and they’d be right!
Great says the NYIC! But what does this mean? It’s not at all clear what was attained in the project. Setting up several homogeneous ledgers and passing tokens between them at 100 swaps per second would make most in the crypto world yawn and they’d be right!
There isn’t enough data here to truly ascertain whether this is an astounding feat or dare I say “innovation theater.” That might be a bit strong but without the specifics, we don’t know.
These results are at best interesting. We don’t really have enough data to understand what they mean in the “real world.” Remember it’s not just settlement but all of the systems they connect to that will impact a solution’s ability to be adopted by banks.
Takeaways
Nothing would make me happier than to see the Fed consider adopting a wholesale CBDC.
Project Cedar is perhaps a prelude to the Fed getting serious, but not much more.
The project is neither an indication of intent to build a wCBDC or the underlying technology that they would use.
The project’s major finding was that tokens could be passed between interoperable DLT networks, but crypto already does this what exactly is new here?
I don’t think this is really “innovation theater” but we need more than 11 pages to fully evaluate the significance of this project.
I am genuinely pleased with the effort and am a perpetual optimist that the Fed will find the VISION to build a CBDC and wCBDC is the most likely candidate for now.
One parting thought. If CBDCs are so great for banks, ask Fed governors why retail users shouldn’t have access to the same technology.
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Rich Turrin is the international best-selling author of "Cashless - China's Digital Currency Revolution" and "Innovation Lab Excellence." He is number 4 on Onalytica's prestigious Top 50 Fintech Influencer list and an award-winning executive previously heading fintech teams at IBM following a twenty-year career in investment banking. Living in Shanghai for the last decade, Rich experienced China going cashless first-hand. Rich is an independent consultant whose views on China's astounding fintech developments are widely sought by international media and private clients.
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