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Introduction
The advent of tokenization has the potential to revolutionize the financial system, particularly in the realm of foreign exchange (FX) markets. Currently, the FX market stands as the largest financial market globally, facilitating approximately $7.5 trillion in daily trades (BIS, 2022) (Chaboud et al, 2023). As we look toward a tokenized future, it prompts us to consider how FX trading and settlement could be transformed.
Foreign exchange markets serve as crucial channels for the global economy. As tokenization approaches, it becomes imperative for market participants, including central banks, to grasp the transformative possibilities it offers.
Project Mariana envisions a future scenario in which central banks have issued wholesale central bank digital currencies (wCBDCs). This project explores innovative avenues for tokenized FX trading and settlement, building upon previous experiments conducted by the Bank for International Settlements (BIS) Innovation Hub and drawing insights from decentralized finance (DeFi) applications.
The project's objective is to assess whether the utilization of automated market-makers (AMMs) employing wCBDCs can enhance the effectiveness, safety, and transparency of FX trading and settlement. By leveraging these technologies, the project aims to mitigate certain risks associated with traditional FX markets. Additionally, it investigates the potential of cross-border interoperability using wCBDCs based on a standardized technical framework, which serves to ensure the future adaptability and resilience of central bank digital currency (CBDC) developments.
Understanding Automated Market Makers
What Are AMMs?
Automated Market Makers are a financial tool unique to Ethereum and decentralized finance. An AMM is a computer program that simplifies trading by automatically exchanging tokenized assets using liquidity pools, without relying on traditional methods like matching buyers and sellers through limit order books. It utilizes smart contracts to facilitate these transactions.
Source: publish0x.com - MikeZillo: DSR - DeFi Secrets Revealed
How Do AMMs Tie In With Cross-Border Payments?
When it comes to cross-border payments, the integration of AMMs with wholesale central bank digital currencies can have significant implications. By incorporating AMMs, cross-border payments can be streamlined and enhanced.
In this context, AMMs enable the automated exchange of tokenized assets, such as wCBDCs, across borders. This eliminates the need for traditional intermediaries and complex matching processes, making cross-border transactions more efficient. AMMs can provide increased liquidity and transparency, while reducing the risks and costs associated with traditional methods.
By leveraging AMMs in cross-border payments involving wCBDCs, the aim is to create a seamless and secure system that fosters faster and more reliable transactions between different countries or regions.
The Need For AMMs?
Cross-border payments in the traditional financial system often face challenges that make them inefficient, costly, and time-consuming to settle. These issues have been widely recognized and documented by various industry sources.
Firstly, the inefficiency stems from the complex network of intermediaries involved in cross-border transactions. Each intermediary adds a layer of processing and documentation, leading to a fragmented and cumbersome process. The involvement of multiple banks, correspondent banks, and clearing systems can result in delays and increased operational costs (World Bank, 2020).
Secondly, the cost of cross-border payments can be substantial. Fees charged by intermediary banks, foreign exchange conversion fees, and additional charges for compliance with anti-money laundering and other regulations can accumulate, eroding the value of the transferred amount (McKinsey & Company, 2019). It has been estimated that cross-border payment fees can reach an average of 6-10% of the total transaction amount (World Bank, 2021).
Furthermore, the settlement time for cross-border payments is often protracted. The process involves multiple parties and manual verification steps, which can introduce delays. Additionally, differences in time zones and banking hours across countries can further prolong the settlement time (Deloitte, 2021).
Failures or errors in cross-border payments are not uncommon either. These can range from data entry mistakes to compliance-related issues, leading to rejected or delayed transactions. Such failures can create frustration for individuals and businesses alike, impacting their ability to conduct international trade smoothly (Accenture, 2020).
BIS - Project Mariana
Source: bis.org
The BIS has launched an exploratory project called Project Mariana to tackle the challenges associated with cross-border payments. The project aims to facilitate the exchange of wholesale central bank digital currencies through the use of automated market-makers.
Project Mariana envisions a future where central banks have issued wCBDCs and seeks to explore innovative solutions for tokenized foreign exchange trading and settlement. The primary objective is to assess whether AMMs utilizing wCBDCs can enhance the effectiveness, safety, and transparency of FX trading and settlement, while mitigating risks prevalent in traditional FX markets.
Notably, Project Mariana is an exceptional initiative as it represents the first cross-centre project of the BIS Innovation Hub. It brings together the Switzerland, Singapore, and Eurosystem Centres, in collaboration with the Bank of France, the Monetary Authority of Singapore, and the Swiss National Bank. This collective effort demonstrates a global commitment to addressing the challenges in cross-border payments and advancing the potential of wholesale CBDCs in a collaborative manner.
By combining expertise and resources from multiple institutions, Project Mariana aims to foster innovation and explore new avenues for cross-border payments using wCBDCs. Through the integration of AMMs, the project seeks to improve the efficiency, security, and transparency of FX trading and settlement processes, ultimately paving the way for a more seamless and robust cross-border payment ecosystem.
Objectives Of Project Mariana
Source: bis.org - Project Mariana
Project Mariana is an experimental initiative conducted by the BIS Innovation Hub, Bank of France, Monetary Authority of Singapore, and Swiss National Bank. Its objective is threefold:
Explore joint trading and settlement in wholesale central bank digital currencies using automated market-makers. AMMs employ smart contracts and liquidity pools to automatically exchange tokenized assets, simplifying the process compared to traditional buyer-seller matching.
Test a standardized framework for fungible wCBDC tokens, ensuring interoperability within the same protocol and enabling governance at the token level without relying on a third party or platform operator.
Investigate asset mobility between different blockchain-based networks using bridges, allowing for seamless and secure transfers of wCBDCs. Bridges utilize on-chain governance and robust off-chain communication to facilitate cross-network transactions.
BIS stated that Project Mariana serves as a joint proof of concept and is purely experimental, with no indication of the involved central banks intending to issue CBDCs or endorse specific technological solutions or decentralized finance (DeFi) approaches. It represents a collaborative effort to explore innovations in wholesale CBDCs and their potential applications.
Technology Solution - Ethereum
Source: ethereum.org
The BIS is actively exploring the utilization of Ethereum, a popular blockchain platform, for international settlements. In their report, BIS specifically mentions their choice of Curve V2, a major DeFi protocol on Ethereum, for Project Mariana, which focuses on developing a hybrid function market-maker (HFMM). This decision sheds light on BIS's interest in Ethereum and the significance of DeFi protocols like Curve V2 in the context of international settlements.
International Network - Testing on Sepolia Testnet:
To assess the viability of Ethereum for international settlements, BIS has conducted tests on the Sepolia testnet, a public Ethereum test network. Sepolia replicates the functionality of the Ethereum mainnet in a controlled environment, allowing developers to test their applications before deploying them on the live Ethereum blockchain. The choice to test on Sepolia indicates BIS's intention to explore the potential of launching an international settlement network on a public Ethereum blockchain.
The Role of Curve Finance:
Source: resources.curve.fi
Curve is a prominent DeFi protocol on Ethereum, has been selected as the HFMM for Project Mariana. Curve V2 specializes in efficient and low-slippage trading of stablecoins. By integrating Curve V2 into Project Mariana, BIS acknowledges the value and innovation that DeFi protocols bring to international settlements. The utilization of Curve V2 as the HFMM underscores BIS's recognition of the potential benefits that DeFi can offer in terms of liquidity provision and advanced trading mechanisms.
Implications for BIS:
The inclusion of Curve in Project Mariana and the testing on the Sepolia testnet indicate BIS's serious consideration of Ethereum and DeFi for international settlements. Ethereum's smart contract capabilities, extensive developer community, and interoperability potential align with BIS's goals of enhancing efficiency, transparency, and security in cross-border transactions. By leveraging Ethereum and DeFi protocols like Curve, BIS aims to explore new avenues for transforming the landscape of international settlements.
BIS's selection of Curve and the testing on the Sepolia testnet reflect their strategic exploration of Ethereum and DeFi for international settlements. This signifies BIS's recognition of the value and potential offered by Ethereum's infrastructure and the innovation within the DeFi ecosystem. As BIS continues its research and development efforts, the adoption of Ethereum and integration with DeFi protocols could herald a significant milestone in reshaping global financial systems, making them more efficient, secure, and accessible.
Overview With Use Cases
Source: bis.org - Project Mariana
The solution design for the project can be visualized in a diagram, which includes the following elements:
Three domestic platforms, each associated with a central bank.
Three commercial banks, representing different jurisdictions.
Bridges that facilitate the transfer of assets, including bridge accounts, whitelists, and relayers (nodes in a blockchain that help transfer information).
An international network featuring a three-currency automated market-maker.
In the diagram, the commercial banks are depicted on both their respective domestic platforms and the international network. All three commercial banks are whitelisted for their corresponding bridges. For example, the Swiss commercial bank is whitelisted for the bridge connecting Switzerland's domestic platform to the international network.
In this illustration, the Swiss commercial bank has access to the Swiss franc wholesale central bank digital currency, the Euro area commercial bank has access to the euro (EUR) wCBDC and the Singapore dollar (SGD) wCBDC, and the Singaporean commercial bank has access to the SGD wCBDC. The ability to access these wCBDCs is determined by the whitelists managed by the respective central banks.
Use Cases
Let's explore two use cases that demonstrate the practical applications of wCBDC in facilitating cross-border payments and liquidity provision.
Use Case 1: Cross-Border Payments
In this scenario, we have the euro area commercial bank and the Singaporean commercial bank involved in executing a cross-border payment from the euro area to Singapore. Here's how the process unfolds:
The euro area commercial bank requests the issuance of EUR wCBDC (Step 1).
It transfers the EUR wCBDC to the international network using a bridge (Step 2).
On the international network, the euro area commercial bank performs the FX transaction by exchanging EUR wCBDC for SGD wCBDC using the AMM (Step 4).
As part of the FX transaction, the euro area commercial bank pays the SGD wCBDC to the Singaporean bank (Step 5).
The Singaporean bank transfers the received SGD wCBDC to the Singaporean platform (Step 2).
Finally, the Singaporean bank redeems the wCBDC, completing the process (Step 6).
Use Case 2: Liquidity Provision
In this case, we focus on the Swiss commercial bank providing liquidity using CHF wCBDC. Here's how it unfolds:
The Swiss commercial bank requests the issuance of CHF wCBDC on the domestic platform (Step 1).
It transfers the CHF wCBDC to the international network using a bridge (Step 2).
On the international network, the Swiss commercial bank contributes liquidity to the AMM by exchanging CHF wCBDC for LP tokens (Step 3).
By becoming a liquidity provider, the Swiss commercial bank earns the opportunity to receive fees or yield in return. These rewards are based on the trading fees generated by the AMM or other mechanisms within the system.
These use cases demonstrate how wCBDC can be utilized for seamless cross-border payments and how commercial banks can provide liquidity to the AMM, promoting efficient and effective financial transactions.
Conclusion
Project Mariana, a collaborative initiative led by the BIS Innovation Hub in partnership with the Bank of France, Monetary Authority of Singapore, and Swiss National Bank, aims to investigate the potential advantages of integrating AMMs and wholesale CBDCs in the foreign exchange trading and settlement domain.
The project's primary goal is to enhance the efficiency, security, and transparency of FX markets by harnessing the transformative capabilities of tokenization and DeFi applications. By leveraging AMMs and standardized technical frameworks, it seeks to mitigate risks commonly associated with traditional FX markets and ensure seamless cross-border interoperability of wCBDCs.
While Project Mariana is primarily a proof of concept (PoC) and remains in the experimental phase, it holds immense potential for revolutionizing the financial landscape. Successful implementation of AMMs and wCBDCs could yield benefits such as streamlined trading processes, improved transparency, and increased liquidity. Moreover, the exploration of asset mobility between different blockchain networks using bridges has the potential to enable secure and frictionless transfers of wCBDCs.
Nevertheless, it is crucial to acknowledge the potential drawbacks and challenges inherent in such experimental endeavors. Privacy concerns are a pertinent issue, and there are considerations regarding the centralization of power, which can raise concerns about transparency, accountability, and the potential for abuse of authority. These challenges necessitate careful evaluation and robust measures to ensure a balanced and inclusive implementation of the project.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.