Last week, the IMF published a paper on XC, a platform for cross-border payments, co-authored by the IMF and members of the MIT Digital Currency Initiative.

The solution proposes a global centralized ledger for cross-border payments involving central banks, banks and payment providers. An XC platform would not only centralize payments and settlement, but also provide a foreign exchange (FX) market, hedging and fulfillment.

On a technical level, XC can use a centralized database or a distributed ledger (DLT), but either way, it relies on smart contracts to automate significant amounts of functionality and encryption for privacy.

The need to reduce friction in cross-border payments has been widely discussed. Too many intermediaries make payments slow and expensive. And in emerging markets, foreign exchange costs are high.

Arguably, the introduction of the Libra multi-currency stablecoin on Facebook created additional urgency. A year after Libra was unveiled, the BIS and the G20 unveiled a set of building blocks to address payments frictions.

Two years later, an updated report shows the challenges in achieving the goal, even with cross-border CBDCs. The BIS Committee on Payments and Market Infrastructures (CPMI) also highlighted the decline in the use of lower-risk payment versus payment (PvP) in foreign exchange transactions.

No need for multi-CBDC cross-border projects?

Instead of central bank digital currency (CBDC), central banks would provide Certificates of Escrow (CE) for use on the XC platform. These have similarities to CBDCs, but are limited to the XC platform and can only be redeemed by banks for central bank reserves.

Because these central bank-issued CEs are the only instruments on the platform, there is no usual counterparty risk. And unlike SWIFT, which is purely a messaging system, XC integrates the message with the movement of money, like most digital currency projects.

One of the benefits of the CE concept is that CBDC projects can focus on domestic use cases.

Blockchain-inspired features

XC will use blockchain-like foundations to reduce the need for intermediaries, automating most functions with smart contracts.

Encryption and credentials will play an important role. XC participants, such as banks and payment providers, will receive anonymous credentials from credential providers. This allows participants’ identities to be examined outside of the ledger, but any restrictions on their credential, such as transaction limits, can be verified on the platform.

Privacy also applies to the end customer making the payment. Instead of sharing KYC data with foreign counterparties of unknown reliability, the customer’s identity can be compared to off-ledger sanctions lists and cryptographic proof is stored verifying that they have been investigated. However, this involves relying on external data and the parties conducting the investigation.

A centralized forex market

The XC concept aims to reduce currency spreads, address the fragmentation of currency markets and the dominance of the largest players by creating a centralized exchange. One implementation would include a centralized FX order book open to all dealers, where participants must honor the quotes they list. The challenge with this approach is that distributors will not be willing to commit to larger volumes.

Therefore, another suggested route is a centralized multi-currency auction where the privacy of the bidding is preserved. This could use prevalent technologies in the blockchain world that allow calculations to be performed on the data while hiding input data, such as FX deals. Concepts include multipart computing (MPC) and fully homomorphic encryption (FHE).

XC: A great idea

XC is a great idea inspired by a wide variety of contemporary work, including cross-border CBDC projects like MBridge and its predecessor, Project Inthanon-LionRock. It also borrows ideas from private initiatives such as Citi’s concept of a Regulated Accountability Network and Partior, the multi-currency payment system backed by JP Morgan, DBS Bank and Temasek. And it incorporates technical designs from the MIT Digital Currency Initiative. The list of inspirations is long.

The purpose of the document is to encourage consideration of the design of multi-party platforms and stimulate the creation of infrastructure and public goods.

A couple of times in passing, the XC document mentions the elephant in the room: geopolitical fragmentation. Centralized platforms such as SWIFT have been used to enforce sanctions. “More work is needed to ensure regional platforms are interoperable,” the report says, to help counter geopolitical fragmentation.