For companies large and small and their financial institutions (FIs) navigating operations and trade across borders, foreign exchange (FX) represents a key cost of doing business.
News and research surrounding central bank digital currencies (CBDCs) suggest that the digital offerings may have a place in offsetting volatility in cross-border payments and improving transparency — and by extension, liquidity. Companies buy and sell currencies and keep those funds on the balance sheet for hedging, cash flow management, investment, and buying and selling inventory, among a slew of other activities.
The Bank for International Settlements (BIS), along with the central banks of Singapore, Switzerland and France, announced last month that they had completed a test of wholesale CBDCs (wCBDCs)— with a focus on FX.
Project Mariana tested the cross-border trading and settlement of hypothetical euro, Singapore dollar and Swiss franc wCBDCs between simulated FIs using decentralized finance (DeFi) technology concepts on a public blockchain.
The project helped enable the transfer of the far-flung CBDCs, and automated market makers streamlined the settlement and trading of spot transactions.
In a paper detailing its findings, the BIS and the central banks stated that the benefits of CBDCs “include supporting simple and automated execution of FX transactions, providing options to broaden the range of currencies, eliminating settlement risk and enabling transparency.”
The use of advanced technologies to streamline cross-border activities might help change the dynamics of a massive financial sector that is essential to everyday life.
“Foreign exchange (FX) is the largest financial market in the world, trading about $7.5 trillion a day,” the BIS has estimated in the paper. “It operates 24 hours a day, five and a half days a week. In this market, commercial banks, central banks, brokers, asset managers, corporates and retail investors trade currencies using a range of instruments including spot, outright forwards, swaps and options.”
In detailing Project Mariana, the BIS wrote that it “borrows ideas and concepts from decentralized finance (DeFi)” and said that the smart contracts would draw on a common liquidity pool, with prices determined by a pre-specified algorithm.
PYMNTS Intelligence revealed that 27% of small- to medium-sized businesses (SMBs) see the complexity of cross-border payments as a hindrance to their ability to grow, and just 23% of SMBs found their current cross-border payment solutions to be very or extremely satisfactory. That leaves three-quarters of respondents noting that the solutions they have in place fall short of the mark in terms of what they need to manage their business’ cross-market flows (which would include liquidity).
Private issuers are seeking to digitize currency movement and settlement of transactions across borders, too, through stablecoins.
In one example, J.P. Morgan Chase launched euro-denominated transactions with its blockchain-based JPM Coin in June. The latest launch follows in the footsteps of a dollar-denominated coin that debuted from J.P. Morgan in 2019. The stablecoins can be used by large multinational clients of the banks to transfer funds between (institutional) J.P. Morgan accounts.
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