Securities Finance Times feature article

Industry experts talk to Sophie Downes about why we need digital currency and what work needs to be done by the industry to implement it

If the shift from credit cards to smart wallets and cryptocurrency tells us anything, it’s that digital forms of money are changing.

Digital currencies are not an entirely new concept; as consumers we pay with digital money all the time. If we forget our credit card, we also have the option of our Apple watches, or smart wallets – transactions that relegate cash to something rather outdated and uncomfortable.

“This generation does not interact or pay like our parents. They do not transact like our parents. So why would they want to make the payments that our parents used?” poses Jovi Overo, director at BaaS, Unlimit.

Yet the impetus in the finance industry is to move beyond that. The new orders of the day are stablecoins, central bank digital currencies (CBDCs), and the possibility of a central bank-backed digital Euro, offering further possibilities for both the retail and wholesale sides of the financial ecosystem.

Amid the buzzwords and excitement, it’s important to ask the question: why do we need these digital currencies, and what work needs to be done within the industry to adopt them?

Possibilities

An obvious advantage to digital currency is its efficiency.

“We are in a global world that moves very quickly,” says Overo. “It also increases the need to make faster payments, to have instant settlements and to increase speed efficiency. It is currently a huge advantage for any organization that can deliver this.”

He is well positioned to comment on this space. Unlimit’s BaaS solution — Overo’s self-proclaimed pride and joy — enables any business or brand to offer financial services to their consumers.

Overo’s role is multifaceted and spans business development, products and marketing. “It’s a challenge,” admits Overo, “and I enjoy it”. His enthusiasm even extends to the t-shirt he wears, emblazoned with ‘Borderless Possibilities’.

The word ‘possibility’ resonates in this discussion, reflecting an industry that is still investigating what forms digital currencies might take.

Such thoughts are central to the work of the Digital Pound Foundation, a trade association that works with banks, non-member firms and other trade associations, to develop an ecosystem and community around digital money.

“There is a perception that money and payments are digital – but what they are not is digital native,” explains Jannah Patchay, head of policy and strategy at the Digital Pound Foundation.

Like Overo, she places a significant focus on the possibilities that digital currency brings to the industry, especially in overcoming the current inefficiencies that traditional financial systems can operate with.

She adds: “It gives us the opportunity to tear down all the assumptions we currently have around restrictions on money and payments, and look at the requirements of what we need in terms of settlements now and in the future.”

Stablecoins and CBDCs

As highlighted by Securities Finance Times coverage of the Digital Assets Forum in April 2024, the various forms of digital currency are subject to much debate and scrutiny.

The forum covered the various use cases of digital money across retail and wholesale centers as well as highlighted inherent challenges in adoption. What quickly became clear was the huge amount of work needed in the industry to make these changes actually happen.

As a participant in one such panel, Overo provoked discussion by advocating the use of stablecoins over CBDCs. Admitting he’s in the minority, he expands on his point in our call: “For me, stablecoins are not just a preference, but a strategic choice.”

He describes how CBDCs are still fundamentally tied to traditional infrastructure and regulatory challenges, while stablecoins offer flexibility and rapid deployment. As the name suggests, they are also a more stable alternative. Since they can be linked to a currency like the US dollar, or to the price of a commodity like gold, they offer more anchored options, especially compared to volatile crypto markets.

Ultimately, though, Overo is strategic. “When looking at the option of CBDCs versus stablecoins, it’s all about using the right tool for the right job – with scalability and adaptability in mind.”

In contrast, Patchay describes the Digital Pound Foundation as “very neutral” in this debate.

“We see both CBDCs and private issues like stablecoin coexisting in the future, alongside signed deposits; all of them will have a role to play in a future ecosystem of digital money,” she says.

She elaborates on the divergent opinions of market players and touches on the politics of digital currency within the financial sphere: “I think that a lot of the arguments are driven by – from all sides – preconceptions and inherent beliefs about the other.”

She explains the potential dynamics at play between market players: stablecoins and CBDCs facing potential skepticism from banks; stablecoin issuers who see banks as adding layers of intermediation and obfuscation; on the retail side, Patchay highlights the genuine concerns consumers have about privacy and control.

“On the wholesale side, there are much stronger and clearer arguments for introducing a CBDC,” argued Patchay, predicting that this could happen in the near to medium term. But, as for the differences in opinion, “it just depends who you talk to”.

Post-trade

Writing for a securities finance magazine, I was curious to see Patchay’s opinion on the impact of digital currencies on the post-trade process.

Her take – it will be profound.

She discusses the impact at various points in the settlement cycle using the example of a bank’s treasury function. “If your business model or function is based on obtaining liquidity, and taking advantage of gaps in the settlement cycle to meet your liquidity needs, instant settlements create significant challenges for that,” she explains. “They will need to have the assets available to trade and settle in real time.”

This can be extended to security financing in particular. With repo and collateralized lending currently operating within a T+2 settlement cycle in Europe, there is a two-day gap where borrowers can find liquidity.

“When you have that immediate settlement, there’s a question of what will happen to those markets?” observes Patchay.

The issue of digital technologies over settlement is not a new discussion. Sir Jon Cunliffe, former governor at the Bank of England, highlighted the benefits of new technologies in a talk entitled ‘Innovation in post-trade services’ at the 2022 AFME conference. This included fewer fees, due to the smaller number of intermediaries, and a shorter and simplified chain structure.

Nevertheless, the focus on regulation was paramount. “Given the range of policy questions – regulatory, supervisory and legal – that these developments raise, market infrastructure regulators will need to step up their involvement,” he said.

Two years later, the industry has seen developments in DLT and blockchain, notably with the Digital Securities Sandbox and the Innovation Hub’s Project Meridian. However, stablecoins and CBDCs remain debated.

However, as Cunliffe somewhat aptly pointed out: “We should not classify new ways of doing things as dangerous simply because they are different.”

Time line

When can we expect these currencies to be realized? The answer lies in the process.

Patchay advocates a careful and unhurried process of adoption. She comically highlights the historical challenges the UK has faced in delivering major infrastructure projects and stresses the need for diligence: “when you do it, you want to get it right.”

“The benefit is not primarily about displacing existing payments and infrastructure,” she continues. “This is about providing a platform for innovation in the future, and the future foundations of financial market infrastructure. It’s not something you want to rush into as a central bank, but it’s something you want to actively investigate.”

To achieve this, Overo agrees, preparation is paramount. “It needs to be interoperable, and there needs to be a very big advance in regulatory clarity, as well as education.” He details the fine balance between regulation and innovation, and emphasizes the need to provide a clear legal framework for operations so that implementation can be possible.

However, it is education that he sees as the fundamental driver of these currencies. “Educating users about the benefits and the operations of digital money is absolutely key to accelerating adoption,” he notes.

“It’s going to be a team effort – and we’ll all play a part.”