A potential future for payments - ubiquitous instant settlement on the blockchain
Technological advancement has revolutionised the payments industry over the past couple of decades, even as far as redefining the forms of money we use. Of all the innovations driving this transformation, blockchain technology is at the forefront, pushing the boundaries of payments as never before, says Lim Soon Chong, Group Head of Global Transaction Services at DBS.
With the onset of the internet and subsequent birth of the smartphone, the business models of some banks and other fiat-based payment service providers have since been upended. Furthermore, fintechs offering disruptive payments capabilities have rapidly gained traction across the globe – encroaching into the domains of many goods and services.
One important factor in fintechs’ arsenal has long been their ability to create onboarding and fulfilment journeys that are easy to use and hyper-personalised, as well as newer payment form factors for end customers, such as contactless near-field-communication payments and “QR scan-and-pay”.
Fintechs have additionally proven more nimble in tapping into alternative processing and blockchain-based clearing infrastructures outside of correspondent banking arrangements. One criticism, however, of some innovations outside the regulated sphere, is that they may not have always met the stringent security and anti-money laundering controls expected by regulators and societies.
The next step in the evolution of payments would be an upgrade to existing interbank clearing arrangements in payment networks and infrastructures, undergirded by distributed ledger technology. This should be ubiquitous for both high-value and low-value payments operating globally, and round-the-clock, while still effectively preventing the illicit use of financial services.
A November 2021 report from Juniper Research suggested that use of blockchain could reduce cross-border settlement costs by over $10 billion a year by 20301 . Additionally noted in the report is that fintech-developed blockchain solutions are already delivering payment efficiencies over legacy systems.
Blockchain’s appeal is due to multiple factors
Blockchain technology can be the catalyst for innovation in next generation payments systems for a few key reasons.
Firstly, data immutability and transparency are fundamental characteristics of the blockchain, which is enforced through its cryptographically enhanced, tamper-proof, and append-only decentralised ledger structure. By providing a single immutable shared source of truth for payer and beneficiary, blockchain minimizes inefficiencies, frauds, or manipulation of financial audit trails, thus ensuring a secure and robust transaction processing infrastructure.
Secondly, blockchain is designed to be decentralised, and rides on top of distributed ledger infrastructure and consensus mechanism to support continuous operations, resulting in its flexibility for network arrangements with or without a central authority or intermediaries. This means that blockchain systems implemented on a wider scale will inherently possess high fault tolerance and redundancy.
For payments, a wholesale blockchain network which is designed to also clear high-value transactions can keep track of all settlements, with near real-time syncing of ledger records of each financial institution. This ensures higher – or even round-the-clock – availability of the payments infrastructure to end customers.
Finally, blockchain-based systems primarily utilise ‘smart contracts’ which are self-executing contracts that automate previously laborious manual operations.
Smart contracts dramatically increase financial transaction efficiency, allowing automatic, condition-based value movement within the blockchain as well as atomic settlements. Inefficiencies (such as manual repair and mismatches in processing windows across multiple parties) are minimized or eliminated.
As a result, blockchain-enabled solutions result in the capability and capacity to process both high-value and low-value payment transactions and finalise settlements much quicker (T+0) and at a lower cost than today, where settlement can be T+2, or longer. As there is almost no reliance on manual processing, these solutions can also operate through weekends and major holidays.
Both blockchain technology and linkages of real-time instant settlement market infrastructures provide the foundation for instant clearing, in both domestic and cross-border payment contexts. The practical way to improve clearing and settlement in payments incrementally, particularly for cross-border payments where there are tens of thousands of pre-existing corridors, would be to utilise a combination of bilateral real-time linkages with application programming interfaces (APIs), linkages of market infrastructures and blockchain-enabled networks.
In the interim, it is likely that linkages of real-time settlement infrastructures for low-value transactions will proliferate in parallel to the growth of blockchain-enabled payment and clearing networks, as the latter requires greater convergence in technology requirements and standards. Ultimately, however, between the two, blockchain-based clearing networks are a more flexible and scalable option for processing a range of high-value wholesale and low-value retail payments.
Multiple emerging blockchain use cases
In recent years, the global banking and financial industry has moved decisively, first to conduct experiments and pilots, and now to embrace blockchain technology. This gives rise to a few key opportunity battlegrounds in the payments landscape that both traditional banks and fintech players are vying for.
One immediate battleground is over burgeoning demand for secure, cost-effective, 24x7 real-time cross-border payments. This demand is directly related to the expansion of e-commerce and remittances, and the need for contactless payments in public transportation and merchant collections from tourists (with behaviours having changed significantly due to the global pandemic).
In addition to payments, the financial industry is actively developing blockchain-based solutions in other areas. The technology is being tested across asset classes and across domains, from equity and debt capital markets, to rights in collective investment vehicles, foreign exchange and derivatives trading, as well as in trade and supply chain finance.
There are several areas where these solutions are having impact, and could be potentially transformative in the coming decade:
- On-demand, cross-border, real-time payments capability – Blockchain-based payment networks offer near instant cross-border payment and settlement capabilities round-the-clock. Juniper Research estimates global e-commerce payment transactions will exceed $7.5 trillion by 2026, up from $4.9 trillion in 20212.
- Tokenised financial assets – Tokenisation is the process whereby an underlying financial asset (tangible or de-materialised) is converted into a digital token that acts as its proxy.
- Cryptocurrency to fiat currency conversions – Crypto exchanges reported more than $14 trillion in trading volume last year according to The Block Research3.
- Stablecoins & Central Bank Digital Currency (CBDC) – The two most popular stablecoins (Tether and USD Coin, both pegged to the US Dollar) recently passed $50 billion and $25 billion in market cap respectively. Another significant development has been CBDCs – digital payment instruments issued by a country’s central bank, akin to physical fiat currency but in digital form recorded on a blockchain.
- GameFi & Metaverse NFTs – GameFi combines the terms ‘game’ and ‘financial’ and refers to play-to-earn blockchain games. A virtual gaming environment is enabled and orchestrated using digital currencies (often cryptocurrencies) and non-fungible tokens (NFTs). Additionally, Gartner estimates that by 2026, 25% of people will spend at least one hour a day in the metaverse for work, shopping, education, socializing or entertainment4.
The need to innovate, connect and collaborate
Global payment networks have always been characterised by some degree of fragmentation and diversity. Payment service providers or financial institutions assemble their propositions through a combination of building, partnering and outsourcing models to access clearing systems and for cost effectiveness.
It is imperative for financial institutions to invest in updating their payment infrastructure beyond traditional fiat-based arrangements and systems to sustain market relevance, capture flows from new business models, and enable other services. An immediate sensible move would be to partner with like-minded financial institutions to connect to blockchain-enabled payment systems which offer near instant cross-border payment capabilities.
Collaboration is key to driving innovation. One such example is the blockchain-based clearing and settlement platform developed by Partior – a joint venture between DBS, J.P. Morgan and Temasek – which aims to revolutionise wholesale cross-border payments.
DBS believes that interoperability across multiple technology platforms and networks is essential to increasing the relevance of the financial industry for both high-value and low-value payment contexts. In turn, this will promote the efficiency and availability of clearing and settlements. We thus continue to leverage blockchain technology even as we increase our linkages to instant settlement infrastructures.
Our approach is informed by the belief that in the future, blockchain will undergird the core of future payment networks, complementing point-to-point connectivity and easy-to-use applications for end users.
Consistent with this approach, we tailor our solutions to allow other banks, financial institutions and large corporations to plug into blockchain platforms with great ease. We do so by using existing connectivity arrangements, bypassing the need for our partners to invest in personnel and technology right away, while simultaneously enabling participation in blockchain-enabled clearing networks to other financial institutions.
At DBS, we would like to think that we are big enough to have the capacity to invest in payment infrastructures and newer technologies, and small enough to be nimble and effective. We readily welcome engagement from the financial community to discover the full extent of the opportunities available as we advance together towards the future of blockchain-enabled financial services.
This article was first published by Euromoney.com in September 2022.