The ECB seeks the holy grail of cross-border payments

One of the proposed use cases for cryptocurrency and/or stablecoins is cheaper and faster alternatives to the conventional TradFi payment rails. The argument for the crypto solution as I understand it has two legs

  1. Use of superior technology
  2. Eliminating costs associated with rent seeking intermediaries

The pitches I have seen mostly seem to frame their technology as better than 1970’s based technology that the banking system uses. The problem for me with this argument is that the banking system has not been standing still and Fast Payment Systems (see here and here) are increasingly the benchmark that the crypto alternative needs to improve on, not the 1970’s ACH payment rails. It is true that the USA seems to be lagging the rest of the world in this regard but the Fed is working towards having one in place in the near future. You might still prefer the crypto option on philosophical grounds because you simply do not want to deal with a bank on principle (argument #2 above) but that is a whole different question.

The fast payment systems that have been implemented to date are however domestic payment solutions so maybe crypto has a role to play in cross border payments where high fees and delayed settlement remain a largely unresolved problem. For anyone interested in this area of finance, the European Central Bank (ECB) recently published a working paper titled “Towards the holy grail of cross-border payments”. The ECB first looks at why the “holy grail” cross-border payment solution has proved so elusive and then evaluates a range of solutions to see how close we are to the solution before offering its judgement of where the holy grail is most likely to be found.

The solutions examined are 1) Correspondent banking, 2) FinTechs, 3) Unbacked crypto-assets such as Bitcoin, 4) Global stablecoins, 5) Interlinked instant payment systems with FX conversion layer and 6) Interoperable CBDC with FX conversion layer. The ECB concludes that

  • Options 5 and 6 (Interlinked fast payment and/or CBDC systems) are the most promising alternatives
  • Options 1 and 2 (Correspondent banking and FinTech) have potential to improve on the status quo but are unlikely to achieve the “holy grail” outcome
  • Options 3 and 4 (no surprises crypto and stablecoins) are not ones the ECB wants to get behind

I am pretty sure the true believers will not be convinced by the ECB’s rationale for dismissing crypto and stablecoin solutions. The paper does however highlight the ways in which TradFi players are increasingly adopting improved technology that challenges the first plank of the argument that crypto offers superior technology.

For anyone interested in diving deeper, the paper is 50 odd pages long (excluding references). To give you a sense of whether it is worth the effort I have attached two extracts below – 1) The Abstract and 2) The Conclusion

Tony – From the Outside


The holy grail of cross-border payments is a solution which allows cross-border payments to be (1) immediate, (2) cheap, (3) of universal reach, and (4) settled in a secure settlement medium, such as central bank money. The search for the holy grail has been ongoing for many centuries. In 2020, improving cross-border payments was set as a key priority by the G20: the G20 asked the Financial Stability Board (FSB), working with the Committee on Payments and Market Infrastructures (CPMI) and other standard-setting bodies to co-ordinate a three-stage process to develop a roadmap to enhance cross-border payments. The conclusion that it is time again for forceful measures to improve cross- border payments resulted from several considerations, namely that (i) globalisation and thus volumes of cross-border payments have continued (and indeed are forecasted) to increase; and (ii) the fact that although digitalisation has made instant cross-border communication quasi cost-free, there has not been a striking decline in the costs associated with executing cross-border payments.

This paper argues that after more than thousand years of search, the holy grail of cross-border payments can be found within the next ten years. To this end, section 2 of the paper briefly recalls a few historical elements involving the search for efficient cross-border payments and identifies a number of universal challenges across time. Through a series of financial accounts, the paper then reviews several options for enhancing cross-border payments with a view towards reaching the holy grail. Section 3 covers correspondent banking, both in its current implementation, as well as a modernised version. Section 4 reviews emerging Fintech solutions, which have already delivered in terms of offering cheaper than ever cross-border payments for certain currencies and use cases. Section 5 discusses Bitcoin, which is distinct from the alternatives as it relies on a completely different settlement asset which is not linked to any fiat currency. Section 6 turns to global stablecoins such as the one envisaged initially by Facebook (Libra/Diem). Section 7 unpacks the case of interlinking domestic payment systems through a cross-system and FX conversion layer. Finally, section 8 analyses the case of central bank digital currencies (CBDC), again interlinked cross-border through an FX conversion layer. Each of the arrangements covered in sections 3 to 8 are assessed in terms of their actual or potential efficiency, architectural parsimoniousness, competitiveness and, relating to that, preservation of monetary sovereignty. Section 9 concludes that the interlinking of domestic payment systems and the future interoperability of CBDCs are the most promising avenues, albeit subject to strong progress being made on the AML/CFT compliance side to ensure straight-through-processing (STP) for the large majority of cross-border payments.


The holy grail, whereby cross-border payments can be (1) immediate, (2) cheap, (3) universal in terms of reach, and (4) be settled in a secure settlement medium such as central bank money is in reach for the first time. This is thanks to the rapid decline in the costs of global electronic data transmission and computer processing, new payment system technology (allowing for instant payments), innovative concepts (such as the interlinking of payment systems including a currency conversion layer; or CBDC), and unprecedented political will and global collaboration like the G20 work on enhancing cross-border payments. 

The review of various visions as to how to achieve the holy grail suggests that Bitcoin is least credible; stablecoins, traditional correspondent banking, and cross-border Fintechs take an intermediary place, but may all contribute to improvement over the next years. From a public policy perspective, stablecoins appear somewhat more problematic than the other two options as they aim at deep closed loop solutions, market power and fragmentation. Two solutions – the interlinking of domestic instant payment systems and future CBDCs, both with a competitive FX conversion layer – may have the highest potential to deliver the holy grail for larger cross border payment corridors as they combine (i) technical feasibility; (ii) relative simplicity in their architecture; and (iii) maintaining a competitive and open architecture by avoiding the dominance of a small number of market participants who would eventually exploit their market power. Moreover, (iv) monetary sovereignty is preserved, and (v) the crowding out of local currencies is avoided due to a FX conversion layer at the border (which does not hold for Bitcoin and global stablecoins). Interlinking of domestic payment systems would also perform well in terms of preserving the universal reach of correspondent banking (although of course only for the payment areas that are actually interlinked). However, a number of challenges need to be addressed to set up these solutions, such as: 

  • the organization of an efficient competitive FX conversion layer conducive to narrow bid-ask spreads applying to the FX conversion;
  • the global addressability of accounts;
  • achieving the same degree of legal certainty for interlinked cross-currency payments as for
    domestic payments, including in the case of default of a party;

ECB Working Paper Series No 2693 / August 2022 51 

Finally, all solutions require that strong progress is made on the AML/CFT compliance side to ensure straight-through-processing (STP) for the large majority of cross-border payments. The recognition and the importance of this issue is illustrated by the significant number of building blocks devoted by the G20 to regulatory and compliance issues of cross-border payments, and also the Nexus initiative of the BIS recognizes the importance of such progress particularly for interlinked solutions. 

None of these challenges are unresolvable and for large cross-border payment corridors with significant volumes and sufficient political will, both interlinking solutions should be feasible and efficient. For smaller corridors, fixed set up costs may be too high, or the political or legal preconditions may not be fulfilled. For those, a modernized correspondent banking or solutions relying on Fintechs with presence in both jurisdictions will likely remain good and flexible solutions that can contribute significant improvements. Also, for large corridors, these two solutions may play an important role for the coming years, and the interlinking solutions still need to prove that they can deploy their advantages relative to them. 

Ranking two solutions at the top raises the question whether central banks and the industry should really work on both (i.e. the interlinking of domestic payment systems and future CBDCs), or whether only one should be selected and the other be dismissed to save on investment costs and focus all efforts to implement the holy grail as soon as possible. A number of arguments speak in favor of developing both solutions. First, there are synergies between the two in the sense that organizing competitive FX conversion layers is instrumental for both, as well as solving issues of international addressability of accounts (be it in commercial bank money or CBDC), persons and firms. Second, some FX and cross-border payment corridors are so large that they can easily support two solutions, and the eventual efficiency of cross-border payments will benefit further from the competition between two approaches. Third, for some cross-border payment corridors only one solution may eventually prevail, but this could be one or the other, and in view of the many cross-border corridors, it is favorable to have two fully efficient solutions available who can compete to become the solution for specific smaller corridors. Therefore, forceful work on both should continue, whereby for CBDC much of the energy of central banks will obviously be absorbed first for deploying them for domestic retail payments. Central banks should nevertheless keep in mind that CBDC will eventually be expected to make its contribution to efficient cross-border payments with FX conversion, and discuss at a relatively early stage the related interoperability issues. In the meantime, they should support and co-ordinate the efforts to interlink domestic payment systems for cross-border payments with competitive FX conversion. 

Crypto and credit creation

Matt Levine (“Money Stuff”) neatly captured one of the defining features of the cryptocurrency purist vision for their alternative financial system when he wrote “The basic philosophical difference between the traditional financial system and the cryptocurrency system is that traditional finance is about the extension of credit, and crypto is not”. He acknowledged that this is an exaggeration but argued that it did contain an essential truth about the two systems.

A recent opinion piece by Nic Carter offers another perspective on this philosophical difference arguing that Bitcoin needs to move past this concern with credit creation if it is to have a future. I am a Bitcoin sceptic but I do think Nic offers an interesting (pro Bitcoin) perspective on the problem that Bitcoin maximalists believe they are solving.

Here are a couple of quotes that give you a flavour of Nic’s argument…

Bitcoiners attacking lending institutions are undermining their own interests. Many adherents to the Bitcoin maximalist doctrine maintain a curious disdain for credit. They often follow a Rothbardian ideal, believing fractional reserve banking to be “fraud,” even though the idealized “full reserve banking” generally never emerges in free market conditions.

Maximalists interested in a better managed credit sector won’t achieve anything by bleating to each other about the dangers of crypto lenders. If everything is a scam to them, their warnings contain no information. They cannot extinguish the demand for credit or yield – and entrepreneurs will always emerge to fill this need.

Instead, they should start their own financial institutions, using bitcoin as a neo-gold with superior collateral qualities and setting reasonable underwriting standards. It is a mistake to view bitcoin’s success as trade-off against the creation of credit. Its future depends on it.

I remain unconvinced by the Bitcoin argument but Nic’s defence of the importance of credit creation is I think a reminder that, whatever form the future of finance takes, elasticity of credit will probably be part of that future.

Tony – From the Outside

Izabella Kaminska shares a stablecoin reading list

You may or may not agree with her stance on Bitcoin but this post offers a useful list of what Izabella has identified as the more informed contributions to the debate about stablecoins.

I have read most of these already but it offers a useful reference point for anyone trying to make sense of this corner of the financial universe.

Tony – From the Outside

Bank regulators might be missing something with regard to Bitcoin

The Basel Committee on Banking Supervision (BCBS) released a consultation paper in June 2021 setting out its preliminary thoughts on the prudential treatment of crypto asset exposures in the banking system.

I covered the paper here but the short version is that the BCBS proposes to distinguish between two broad groups: One where the BCBS believes that it can look through the Crypto/DLT packaging and largely apply the existing Basel requirements to the underlying assets (Group 1 crypto assets). And another riskier Group 2 (including Bitcoin) which would be subject to its most conservative treatment (a 1250% risk weight).

At the time I noted that it was not surprising that the BCBS had applied a conservative treatment to the riskier end of the crypto spectrum but focussed on the fact that that bank regulators were seeking to engage with some of the less risky elements.

I concluded with my traditional caveat that I was almost certainly missing something. Caitlin Long (CEO and founder of Avanti Financial Group, Inc) argues that what I missed is the intra-day settlement risk that arises when conventional bank settlement procedures deal with crypto-assets that settle in minutes with irreversibility.

The BCBS could just apply even higher capital requirements but the better option she argues is to create a banking arrangement that is purpose built to deal with and mitigate the risk. I have copied an extract from an opinion piece she wrote that was published in Forbes magazine on 24 June 2021

Thankfully, there is a safe and sound way to integrate bitcoin and other Group 2 cryptoassets into banking systems:

– Conduct all bitcoin activities in a ring-fenced bank that is either stand-alone or is a bankruptcy-remote subsidiary of a traditional (leveraged) bank.

– Use no leverage in the bank. No rehypothecation of bitcoin held in custody. Hypothecation of assets held in custody is fine, but the bank must not permit greater than 1:1 leverage. Remember—bitcoin has no lender of last resort or clearinghouse.

– Take no credit or interest rate risk within the bank. Hold 100% reserves in cash, T-bills or similar short-term, high-quality liquid assets. The bank makes money on fees, which crypto fintechs have successfully done for years due to high transaction volume.

– Pre-fund transactions, so that the bank settles second or simultaneously instead of settling first and thereby avoid “back door” leverage caused by a counterparty failing to deliver.

– Permit no collateral substitution or commingling in prime brokerage.

– Design IT and operational processes for fast settlement with irreversibility, complete with minute-by-minute risk monitoring and reconciliation processes.

If you want a deeper dive Avanti lay out their arguments in more detail in a letter submitted to the Federal Reserve responding to a request for comments on draft guidelines proposed to assist Federal Reserve Banks in responding to what the Fed refers to (emphasis added) as “… an increasing number of inquiries and requests for access to accounts and services from novel institutions“.

It is quite possible that I am still missing something here but the broad argument that Avanti lays out seems plausible to me; i.e. it would seem desirable that a bank that seeks to support payments to settle crypto asset trades should employ a payment process that allows instant payments as opposed to end of day settlement.

Some parting observations:

  1. The Fed is moving towards the implementation of an instant payment system so arguments based on problems with 40 year old payment systems such as the Automated Clearing House (ACH) currently used by the USA would be more compelling if they addressed how they compare to the new systems that have been widely deployed and proven in other jurisdiction.
  2. Notwithstanding, there is still a case for allowing room for alternative payment solutions to be developed by novel institutions. In this regard, Aventi has committed to embrace the level of regulation and supervision that is the price of access to an account at the central bank.
  3. Aventi’s regulatory strategy is very different to the decentralised, permission-less philosophy that drives the original members of the crypto asset community. Seeing how these two competing visions of money play out continues to be fascinating.
  4. I still have a lot to learn in this space.

Tony – From the Outside

The Basle Committee consults on bank cryptoasset exposures

The Basel Committee on Banking Supervision (BCBS) yesterday (10 June 2021) released a consultative document setting out preliminary proposals for the prudential (i.e. capital adequacy) treatment of banks’ cryptoasset exposures. A report I read in the financial press suggested that Basel was applying tough capital requirements to all cryptoassets but when you look at the actual proposals that is not correct (credit to Matt Levine at Bloomberg for picking up on the detail).

The BCBS is actually proposing to split cryptoassets into two broad groups:

  • one which looks through the Crypto/DLT packaging and (largely) applies the existing Basel requirements to the underlying assets with some modifications; and
  • another (including Bitcoin) which is subject to the new conservative prudential treatment you may have read about.
The proposed prudential treatment is based around three general principles
  • Same risk, same activity, same treatment: While the the BCBS does see the “potential” for the growth of cryptoassets “to raise financial stability concerns and increase risks face by banks”, it is attempting to chart a path that is agnostic on the use of specific technologies related to cryptoassets while accounting for any additional risks arising from cryptoasset exposures relative to traditional assets.  
  • Simplicity: Given that cryptoassets are currently a relatively small asset class for banks, the BCBS proposes to start with a simple and cautious treatment that could, in principle, be revisited in the future depending on the evolution of cryptoassets. 
  • Minimum standards: Jurisdictions may apply additional and/or more conservative measures if they deem it desirable including outright prohibitions on their banks from having any exposures to cryptoassets. 
The key element of the proposals is a set of classification conditions used to identify the Group 1 Cryptoassets

In order to qualify for the “equivalent risk-based” capital requirements, a crypto asset must meet ALL of the conditions set out below:

  1. The crypto asset either is a tokenised traditional asset or has a stabilisation mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional asset
  2. All rights obligations and interests arising from crypto asset arrangements that meet the condition above are clearly defined and legally enforceable in jurisdictions where the asset is issued and redeemed. In addition, the applicable legal framework(s) ensure(s) settlement finality.
  3. The functions of the crypotasset and the network on which it operates, including the distributed ledger or similar technology on which it is based, are designed and operated to sufficiently mitigate and manage any material risks.
  4. Entities that execute redemptions, transfers, or settlement finally of the crypto asset are regulated and supervised

Group 1 is further broken down to distinguish “tokenised traditional assets” (Group 1a) and “crypto assets with effective stabilisation mechanisms” (Group 1b). Capital requirements applied to Group 1a are “at least equivalent to those of traditional assets” while Group 1b will be subject to “new guidance of current rules” that is intended to “capture the risks relating to stabilisation mechanisms”. In both cases (Group 1a and 1b), the BCBS reserves the right to apply further “capital add-ons”.

Crypto assets that fail to meet ANY of the conditions above will be classified as Group 2 crypto assets and subject to 1250% risk weight applied to the maximum of long and short positions. Table 1 (page 3) in the BCBS document offers an overview of the new treatment.

Some in the crypto community may not care what the BCBS thinks or proposes given their vision is to create an alternate financial system as far away as possible from the conventional centralised financial system. It remains to be seen how that works out.

There are other paths that may seek to coexist and even co-operate with the traditional financial system. There is also of course the possibility that governments will seek to regulate any parts of the new financial system once they become large enough to impact the economy, consumers and/or investors.

I have no insights on how these scenarios play out but the stance being adopted by the BCBS is part of the puzzle. The fact that the BCBS are clearly staking out parts of the crypto world they want banks to avoid is unremarkable. What is interesting is the extent to which they are open to overlap and engagement with this latest front in the long history of financial innovation.

Very possible that I am missing something here so let me know what it is …

Tony – From the Outside

Joe Wiesenthal contrasts the differing visions represented by Bitcoin and Ethereum

Joe Weisenthal (Bloomberg) wrote an interesting opinion piece discussing the differing visions that Bitcoin and Ethereum offer for the future of finance and money. I am a self declared neophyte in the world of cryptocurrency and DeFi so it may be that the experts in those domains will find fault but I found his thesis interesting. The article is behind the Bloomberg paywall but this is what I took away from it.

  • He starts with the observation that, after a decade since its inception, we seem to have arrived at the consensus that Bitcoin is best thought of as something like a digital version of gold (or “digital gold”).
  • That was not necessarily the original intent and battles have been fought between different factions in the Bitcoin community over differing visions.
  • The most recent example being the “Blocksize War” that played out between 2015 and 2017 where an initiative to increase transaction capacity by expanding the size of each Bitcoin block was defeated by others in the community who saw this as a threat to the network decentralisation they believed to be fundamental to what Bitcoin is.
  • Weisenthal notes that other players in the Crypto/DeFi domain have a different vision – Ethereum is currently one of the dominant architects of this alternative vision (but not the only one).
  • The distinguishing feature of Ethereum in Weisenthal’s thesis is that, in addition to being a cryptocurrency, it is also a “token”
  • He argues that, whereas Bitcoin requires a fundamental act of faith in the integrity of Bitcoin’s vision of the future of money, token’s have a broader set of uses to which you can assign value.
  • Once you introduce tokens the focus shifts to what precisely do you intend to do with them – in Weisenthal’s words “… once you’re in the realm of tokens, you don’t need faith, but you still need a point
  • He notes that we have already seen some dead ends play out – Initial Coin Offerings were a big thing for a while but not any more partly due to many of the projects not stacking up but also because many of them were just another form of IPO that were still unregistered (hence illegal) securities offerings in the eyes of the law.
  • We have also seen some developments like Non Fungible Tokens that are interesting from a social perspective but not necessarily going to shake the foundations of the status quo.
  • A third possibility is that DeFi starts to become a real force that starts to shake up the existing players in the conventional financial system.
  • This third option is the one that Weisenthal (and I) find most interesting but there is still a long way to go.

This is most definitely a topic where I am likely to be missing something but Weisenthal’s article offers an interesting discussion on the contrasting visions, assumptions and objectives of the two currently dominant tribes (Bitcoin and Ethereum). Most importantly it highlights the fact that the vision of DeFi being pursued by Ethereum (or alternatives such as Solana) is radically different to the vision of the future of money being pursued by Bitcoin.

Tony – From the Outside

The Bitcoin energy use debate

Bitcoin’s energy use has been one of the more interesting, and less explored, avenues of the brave new world the crypto community is building. To date I have mostly seen this play out in very simplistic arguments along the lines that Bitcoin is bad because it uses as much energy as whole countries use. On those terms it certainly sounds bad but I came across a more nuanced discussion of the question in this post on the “Principlesandinterest” blog.

Toby lays out some of the counter arguments used to support Bitcoin and in doing so gets into some of the history of how we value things. While my bias remains that Bitcoin’s energy use is a concern, Toby’s post opened my mind up to some of the broader issues associated with the question. Definitely worth reading if you are interested in the question of cryptocurrency and the nature of money.

Tony – From the Outside