Explainer | What is wCBDC and why is it important for Hong Kong?
- The HKMA’s wholesale central bank digital currency project aims to enhance interbank settlements for tokenised money
- A planned sandbox will test tokenisation use cases that include settlement of tokenised real-world assets
The Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, has launched a wholesale central bank digital currency (wCBDC) pilot to facilitate instantaneous, large-value interbank settlements of tokenised money.
One of the world’s first such platforms, the initiative, dubbed Project Ensemble, is key to the HKMA’s ambition to be a reference for the latest developments in digital currencies.
As part of the initiative, the HKMA will launch a sandbox by June for a select group of participants to test their innovations – from concepts to trading and settlement on the blockchain – in a closed loop.
The HKMA will also develop common standards by forming an “architecture community”, which has already attracted interest from some of the largest banks and technology companies, such as HSBC, Standard Chartered, Bank of China (Hong Kong), Ant Group, Microsoft and Hashkey Group.
Here are some of the details about the project:
What is a wCBDC, and how does it work?
A wCBDC is a digital currency issued by a central bank that is used exclusively by central banks, commercial banks or other financial institutions to settle interbank transactions. It is unlike a retail CBDC, which caters to individuals and companies and facilitates everyday transactions.
As a wCBDC is issued by a central bank, it will enable instant processing of payments in the digital asset market while providing confidence and added functionalities enabled by tokenisation. Otherwise, digital-asset exchanges and banks would need to establish one-to-one connections to enable transactions.
“Interbank transfers need to move through clearing systems before they are credited to accounts, and they take even longer if one wants to transact outside banking hours,” said Ben Hammond, financial regulatory partner and Hong Kong managing partner at law firm Ashurst.
“The wCBDC promises to remove, or at least lubricate, this friction as well as support other payment solutions such as tokenised deposits.”
04:14
Blockchain in Asia: Digital Dragons & Digital Dollars
How different are tokenised deposits, CBDCs and stablecoins from each other? How are they related to wCBDC?
In any transaction, payment must be made in exchange for goods or services. Digital money is being created as a monetary unit and means of payment to buy digital assets.
Tokenised deposits, which will be the first to be tested under Project Ensemble, are digital representations of deposits issued by licensed commercial banks. They differ from stablecoins, which are cryptocurrency assets issued by private entities against a portfolio of traditional financial assets, such as fiat currencies or government bonds.
For example, through the use of HKMA’s wCBDC, payments could be settled at par value in the sovereign unit issued by the HKMA, even if they are in different forms such as tokenised deposits or stablecoins.
Even retail payments made via e-HKD and digital wallets such as Alipay or WeChat Pay could technically be settled by wCBDC.
“We see strong potential in tokenised deposits as a regulated, safe and accessible form of digital money with additional features such as programmability,” said Lewis Sun, global head of domestic and emerging payments at HSBC’s global payments solutions.
“It can work seamlessly with wholesale CBDC to establish a solid interoperable infrastructure to support payments and settlements of digital assets.”
Why are central banks looking at wCBDC?
Currently, 134 countries are exploring their own versions of CBDCs, representing 98 per cent of the global gross domestic product, up from 35 in 2020, according to the US think tank Atlantic Council.
By building resilient and efficient financial infrastructures, central banks can support the financial industry tap the opportunities and benefits brought by digital assets, which could reach US$16 trillion by 2030, according to an estimate by consulting firm BCG and Singapore-based digital securities exchange ADDX.
The moves also align with the “unified ledger” vision that the Bank for International Settlements (BIS) outlined last June.
A unified ledger combines central bank and commercial bank money with other assets in common digital infrastructures, making it possible to instantly pay, clear and settle any transaction through tokenisation, smart contracts and programmability.
“For example, funding an account could be done in milliseconds versus the process today, which typically starts with a bank receiving instructions from the customer or another correspondent bank to credit their nostro account, and these instructions may go through various layers,” said Julia Demidova, head of CBDC product and strategy at FIS, a US-based fintech firm. Nostro refers to an account that a bank holds in a foreign currency in another country.
How are other countries doing in the wCBDC space?
The Monetary Authority of Singapore said in November it would pilot a wCBDC this year, without providing details. The first pilot will involve using wCBDC to settle retail payments between commercial banks. Future pilots could include using wCBDC to settle cross-border securities trade.
Bank of Korea is also planning wCBDC trials this year for interbank transactions and for issuing tokenised deposits. Some of the trials will also involve the participation of the general public.
In January, the central bank of the United Arab Emirates made the first cross-border digital payment of 50 million dirhams (US$14 million) to China using the “mBridge” multi-country CBDC platform that also includes the central banks of China, Hong Kong and Thailand. Transactions via mBridge can be completed as quickly as seven seconds and cut costs by 50 per cent, according to Di Gang, deputy director of the Digital Currency Institute of the People’s Bank of China.
Brazil and the European Central Bank are also said to be in advanced stages with their wCBDCs.
How significant is Project Ensemble to Hong Kong?
Project Ensemble complements Hong Kong’s other initiatives to develop the tokenisation market. These include testing a retail CBDC called the e-HKD since May and the mBridge project to cut costs and time for cross-border settlements.
“The development of tokenised deposits and wholesale CBDC presents a significant leap forward for Hong Kong as an international financial centre, heralding a new era in the speed and efficiency of financial transactions,” said HSBC’s Sun.
Leveraging tokenised deposits and wCBDCs could enhance speed and reduce costs for settlement of real-world assets, “potentially transforming the capital market landscape”, he added.
Failing to pursue these developments could pose a threat to the Hong Kong dollar.
“Market participants will choose to use the Hong Kong dollar only if it continues to be functional and efficient as a medium of exchange,” said Ashurst’s Hammond. “With the market becoming digitalised, the Hong Kong dollar needs to digitalise.”
02:59
BIS head Carstens: China’s clearing and settlement service is no substitute for global Swift system
How can companies take part in Project Ensemble and test the wCBDC?
Many participants are interested in joining the project, but concrete use cases are being developed and few details are known.
Project Ensemble will build on the HKMA’s experiment last year on tokenised deposits with HSBC, Hang Seng Bank and Ant Group. HSBC trialled tokenised deposits to enable a corporate client to move money between multiple HSBC accounts in real time and even outside banking hours using Ant Group’s blockchain platform.
The HKMA envisages several use cases for the wCBDC to resolve pain points in current payment systems. For example, tokenised electronic bills of lading, which use blockchain to provide real-time and reliable cargo data, could improve efficiency and mitigate the risk of fraud.
Another use could be investments in tokenised electric vehicle charging stations, which can be broken down into bite-size tokens to improve their appeal.
What are the challenges and risks in launching a wCBDC and the blockchain ecosystem it creates?
Agustin Carstens, the general manager of BIS, flagged several challenges, chiefly legal and regulatory frameworks, governance, and communications protocol, as well as the need for a solid digital infrastructure.
“It is likely to be a long road that requires careful experiments, learning and recalibration and further exploration,” Carstens said.
The same practical issues were brought up by HSBC’s Sun. “For tokenised deposit-based payment and settlement to scale, other than the established technical factors, the industry would need to agree on a common set of regulatory, legal and operational standards so that market infrastructure can be built to support interbank settlement,” he said.
Meanwhile, the HKMA said it was proceeding cautiously with the sandbox.
“We need to be especially cautious about whether there’s any cybersecurity risks or even technology risks that we’re not aware of that might lead to failed settlement, for example,” the HKMA’s Yue said.
