Introduction
“I believe that technological advancements have the potential to increase efficiency in the financial sector, just as technological innovation has done for centuries. […] The technological innovations stemming from decentralized finance (DeFi) are largely complementary to centralized finance. They have the potential to enhance centralized finance.”
On October 18, 2024, Federal Reserve Governor Christopher Waller delivered these words during the 19th Vienna Macroeconomics Workshop. Just a month earlier, the Bank for International Settlements (BIS), known as the “Central Bank of Central Banks,” announced that over 40 international companies and a group of leading central banks would collaborate “to explore how tokenization can improve wholesale cross-border payments.”
Most international central banks seem interested in tokenization, which, in the long term, could imply transferring much of the current monetary system onto a blockchain. There is a compelling reason why this transition could be advantageous.
The Motivation Behind Fintech Innovations
As highlighted by the Fed Governor, finance has continuously evolved over time, thanks to technological advancements. This evolution began in 1871, when technologies like the telegraph and Morse code were used by Western Union to create the first electronic funds transfer (EFT) in the United States. For the first time, people could pay for goods and services without being physically present during the transaction. The first transatlantic cables extended this capability to intercontinental transactions, marking the origin of globalized financial services.
Later, in the 1970s, finance went digital with the creation of the world’s first digital stock market (NASDAQ) and the birth of SWIFT (Society for Worldwide Interbank Financial Telecommunications), a communication protocol facilitating large volumes of cross-border payments. Online banking spread in the 1980s and boomed in the 1990s, leading to the founding of PayPal in 1998. The growth of online financial services seemed unstoppable, but optimistic forecasts abruptly changed after the 2008 global financial crisis. The following years were marked by a significant loss of trust in financial institutions. It is no coincidence that the first successfully adopted blockchain-based asset, Bitcoin, was created in 2008, following decades of research and numerous failed attempts.
The motivation behind nearly every improvement observed in fintech is the ability to settle transactions faster, cheaper, and more securely. In this sense, blockchain-based solutions have the potential to represent the most revolutionary step in financial history.
How Blockchain Technology Can Serve Central Banks’ Goals
Analyzing the results presented by the BIS in its “Blueprint for the Future Monetary System,” it is evident that most reasons and use cases for adopting blockchain-based currencies can be summarized in one statement: we want to settle multiple phases of a transaction simultaneously and instantly.
In the current monetary system, every claim regarding a sum of money resides in proprietary databases, connected to other databases through third-party messaging systems. Transactions undergo a back-and-forth communication process before being definitively settled. During this process, participants often lack complete visibility of the transaction’s status. Specifically, the beneficiary does not see when the process started, and the payer does not know when it was completed. Beyond the clear disadvantage of excessive communication overload, the current system can sometimes hinder transactions with clear economic logic, particularly due to settlement process uncertainties. International payments can present even greater complexities.
Most transaction overload is eliminated with the transition to cryptocurrencies. A transaction initiated by a user can be settled immediately, without requiring any action from the user’s bank or the beneficiary’s bank, allowing both parties to verify the transaction status at any time. This could also significantly simplify the current “two-tier” monetary system, composed of “regular money” held by individuals and “central bank money” held by banks. With an institutionalized blockchain infrastructure, there would be no need for multiple separate ledgers; these could potentially be unified into a single universal ledger. This type of simplification and efficiency increase has historically driven change in fintech.
In addition to enabling instant and transparent transactions, modern blockchains offer an additional feature that the current financial system lacks: smart contracts. On the blockchain, two or more parties can engage in an economic agreement with rules encoded on the transaction network. These rules form a smart contract, enforced by code rather than by a court. As long as the network operates, the contract will be settled without further communication or negotiation between participants. Consequently, each party can be sure that the other will fulfill their obligations in the right amount and at the right time, enabling more efficient agreements and clearer resource accounting.
Some countries have already made progress toward adopting blockchain-based finance. The Bahamas, Nigeria, and Jamaica have paved the way by launching their own central bank digital currencies in recent years. The United Kingdom continues its research in this direction, following the Britcoin project, which ran from 2011 to 2019. Additionally, interest from the Fed and other central banks grows year after year. However, one question remains: when will this transition happen?
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