Will CBDCs transform tokenization as we know it?
The collaboration between the Digital Dollar Project (DDP) and the Depository Trust & Clearing Corporation (DTCC) represents a groundbreaking step toward modernizing post-trade securities settlement using Central Bank Digital Currency (CBDC). The project explored how tokenized securities and a simulated CBDC can reshape the settlement landscape, enhancing efficiency, reducing risks, and aligning with the demands of an increasingly digital economy. By leveraging distributed ledger technology (DLT) and a CBDC, the pilot demonstrated the potential to streamline settlement processes, improve transparency, and address long-standing challenges in financial market infrastructure.
In the proposed system, securities and cash settlements occur on two distinct but interconnected DLT networks: DTCC’s Digital Settlement Network for tokenized securities and a simulated Federal Reserve CBDC network for the cash leg. These networks communicate through an orchestrated architecture that guarantees atomic delivery-versus-payment (DvP) settlement. This mechanism ensures that both sides of the transaction—securities and cash—are simultaneously exchanged, or the transaction fails entirely, thus eliminating counterparty risk. The settlement process leverages smart contracts to encumber assets, meaning they are locked until specific conditions are met, providing a secure and automated resolution path.
One of the system’s significant advancements is its ability to achieve real-time settlement. Traditional cash settlement processes rely on end-of-day netting through services like the Federal Reserve’s National Settlement Service (NSS). This approach aggregates cash obligations and settles them in a single batch, creating delays in fund availability and exposing participants to intraday credit risks. The integration of a CBDC enables instantaneous settlement, allowing funds to move as soon as the securities transaction is confirmed. This not only accelerates the settlement process but also improves liquidity management, as participants can access and redeploy funds more efficiently.
The tokenized financial market infrastructure offers several compelling benefits beyond speed. First, transparency is significantly enhanced. DLT systems provide real-time visibility into transactions for participants and regulators, eliminating the need for periodic reporting and enabling immediate compliance checks. Second, tokenized systems support programmability. This allows regulatory requirements such as anti-money laundering (AML) and know-your-customer (KYC) protocols to be embedded directly into the transaction flow, reducing manual oversight and streamlining compliance processes.
Moreover, the use of tokenized securities and CBDCs addresses many inefficiencies in the current system. Today, the movement of securities and cash is managed by multiple intermediaries, each introducing delays, costs, and risks. By tokenizing these assets, the settlement process becomes more direct and less reliant on centralized third parties. However, a neutral entity like DTCC remains essential for ensuring the integrity of cross-network transactions. DTCC’s role includes managing access, orchestrating transactions, and resolving issues arising from network failures or communication errors.
Despite its potential, transitioning to a DLT-based settlement system involves several challenges. One major hurdle is technological investment. Market participants, including settlement banks and broker-dealers, would need to upgrade their systems to integrate with tokenized networks. The interoperability between these networks and traditional systems must also be ensured to avoid disruptions during the transition phase. Furthermore, the design and governance of the CBDC itself present significant questions. The Federal Reserve would need to determine the scope of access to the CBDC network, particularly whether non-bank financial institutions should have direct access. Such decisions could alter the existing banking ecosystem by reducing reliance on settlement banks, which currently act as intermediaries for institutions without Federal Reserve accounts.
Security is another critical area of concern. While DLT provides a secure framework for transactions, it introduces new risks, such as vulnerabilities in smart contracts and the potential for cyberattacks on blockchain infrastructure. The pilot addressed these concerns by employing permissioned networks, where only approved participants can access the system. This approach minimizes the risk of unauthorized transactions but requires robust governance and oversight mechanisms.
The pilot also highlighted the need for comprehensive policy and regulatory frameworks to support the adoption of a CBDC in securities settlement. Regulators would need to ensure that CBDC-based transactions comply with existing financial laws and standards while accommodating the unique characteristics of digital assets. The programmable nature of a CBDC offers opportunities for enhanced monetary policy implementation, but it also requires careful design to maintain neutrality in its application.
Another area of focus is the scalability and performance of DLT networks. While the pilot demonstrated the feasibility of CBDC-based settlement for tokenized securities, the system's scalability under high transaction volumes remains a question. Future studies would need to assess how the system performs during periods of market stress or volatility, as well as the resilience of the CBDC network in such scenarios.
The introduction of real-time gross settlement (RTGS) using a CBDC could also transform market dynamics. Unlike the current system, which relies on netting cycles, RTGS requires participants to have both securities and cash available at the time of the transaction. This ensures settlement finality and reduces systemic risk but imposes higher liquidity requirements on participants. The pilot demonstrated that tokenized systems could support RTGS while maintaining the flexibility to accommodate other settlement models, such as end-of-day netting or intraday cycles, depending on participants' needs.
The business implications of adopting a CBDC for securities settlement are profound. By reducing settlement times and associated risks, market participants could achieve significant cost savings and operational efficiencies. Moreover, the ability to settle transactions in real-time enhances market liquidity, allowing assets to be redeployed more quickly. These efficiencies could encourage broader adoption of tokenized systems, creating a virtuous cycle of innovation and investment in digital financial infrastructure. Subscribe to our blog, at Montes Auri, to stay tuned to the most important developments in the digital banking industry.
