The New York Federal Reserve (NY Fed) and the BIS Innovation Hub have been exploring whether a wholesale central bank digital currency (CBDC) could improve settlement times for foreign exchange (FX) transactions that normally take two days. The Cedar Project, the first project of the New York Innovation Center, discovered that atomic settlement of foreign exchange transactions using distributed ledger technology (DLT) can occur in ten seconds or less, significantly reducing risk.

In addition to faster and atomic settlement, the DLT experiment supports 24/7/365 payments. The lack of overlapping opening hours between jurisdictions is one of the current frictions in foreign exchange transactions.

This is the first of a multi-phase effort to develop a technical design for a wholesale CBDC, although the US has made no decision on issuing a digital Fed dollar.

The importance of shortening FX settlement times

In July, the BIS Committee on Payments and Market Infrastructures (CPMI) published a report and launched a consultation on the issue of payment versus payment (PvP) in foreign exchange transactions, similar to the topic explored by Cedar. One survey found that up to $8.9 trillion may be at risk daily, with a potential loss of up to $2.8 trillion.

Additionally, the proportion of FX transactions settled via PvP decreased from 50% in 2006 to 40% in 2019. In some jurisdictions, potential losses exceed bank supervisory capital, and the risk is particularly acute in the UK, which is the center of world currency markets.

“The Cedar Phase I Project revealed promising applications of blockchain technology in modernizing critical payment infrastructure, and our inaugural experiment provides a strategic launchpad for further research and development on the future of money and payments from a global perspective. from the US,” said Per von Zelowitz, director. of the New York Innovation Center.

cedar project

Phase 1 of the CBDC project explored the simulation of multiple homogeneous ledgers, each with a different currency for CBDC operations. Issues like scalability, privacy, and programmability were out of scope at this stage.

The NYIC developed a bespoke DLT for testing, a permissioned blockchain that uses UTXO for transactions instead of accounts, powered by the Rust language. The Interledger transfer used hash time lock contracts.

It is not the only one that develops a custom ledger. Hong Kong’s MBridge multi-CBDC project has also done so.

Existing DLTs are arguably faster to deploy and test from a development and security perspective. Potential partners will also be familiar with them. However, when one considers using blockchain, performance in terms of throughput and scalability is usually mentioned as one of its disadvantages. Even the best performing DLTs are sometimes considered not scalable enough. Hence the desire to create a custom one.

The next phase of the project will further explore ledger design and investigate interoperability between different types of ledgers.

The NYIC does not consider Project Cedar to indicate any particular future direction in politics or technology.

Meanwhile, various jurisdictions and private sector entities are exploring the efficiency of cross-border payments using blockchain. This week, the BIS announced that the Mariana Project would investigate the use of DeFi for 24/7 foreign exchange trading with the central banks of Singapore, France, and Switzerland. There are several multi-CBDC projects including MBridge, Dunbar and Jura. And bank-backed initiatives include Fnality and Partior.