Singapore’s central bank sent a payment to Canada using blockchain technology last week, in a clear signal that the technology has value – as long as you’re realistic about it.
The Monetary Authority of Singapore (MAS) sent $105 Singapore dollars to the Bank of Canada (BoC) in a proof-of-concept project that inches them closer to solving one of banking’s biggest headaches: cross-border payments and settlements.
In a November 2018 report on cross-border interbank payments and settlements, the two organizations and the Bank of England detailed the challenges of settling transactions between banks in different countries. Banks must navigate an array of hurdles including anti-money-laundering and know-your-customer regulations.
If a bank has no presence in the recipient country, it must also rely on another intermediary bank to process the payment on its behalf, in what’s known as the correspondent banking model. All the parties will have their own legacy systems that make it difficult to process the transaction uniformly. It is an expensive process that can take several days, and parties never quite know when the money will arrive.
The biggest problem is counterparty risk – when a bank sends money via an intermediary to buy something, it can‘t be certain that the intermediary will deliver the funds, or that the other bank in the transaction will hold up its end of the bargain.
Reducing counterparty risk :
BoC and MAS wanted to use the blockchain to settle payments while reducing counterparty risk. Each organization already had its own distributed ledger for processing the clearing and settlement of payments and securities domestically. In 2016, BoC created Project Jasper, while MAS created Project Ubin. This latest project brought the two distributed ledger technologies together so they could collaborate on transactions.
The project still needs an intermediary that has a presence in both the sending and receiving countries, because the intermediary is the only party that carries both the sending and receiving banks’ currencies and can process payments in both countries. The difference is that no funds need change hands between this intermediary and the sending and receiving banks before the entire transaction is complete, which reduces the risk.
Instead, the whole multi-step exchange relies on ‘atomicity’, which is a condition where a group of transactions in a chain must all succeed. If one transaction fails, then they all fail, rolling back the exchange of assets to the beginning.