Inside Jackson Hole's Big Question: Can Central Banks Modernize Tokenized Markets? — Barrons.com

By Megan LeonhardtCentral banks may hold the key to unlocking swifter, cheaper markets access.This year's theme of the Jackson Hole Economic Policy Symposium was "Financial Innovation: Implications for Payments and Policy" and the academic research presented reflected that idea. One of the more discussed papers amongst attendees was the "Tokenized finance and the perimeter of central banking" by Darrell Duffie, professor of management and finance at Stanford University's graduate school of business.For the uninitiated, tokenized finance is the process of converting assets, such as stocks and bonds, into digital "tokens" that can be traded using blockchain-like digital ledgers instantly and constantly.One of the biggest advantages of tokenized finance is that it promises to boost liquidity. Markets would not have to close, which could make it easier for banks to move assets and borrow money with little notice. Currently, a stock trade settles one business day after it's executed. A tokenized type of financial system, in theory, could make it swifter, easier and cheaper to buy, sell and trade.Crypto firms have already tested tokenized stock offerings, but they've been largely prevented from offering them to U.S. investors so far. The Securities and Exchange Commission has been considering a rule proposal around allowing trading of assets like stocks via blockchain technology.But the big hurdle with all of this is that big multi-trillion-dollar trades require completely "safe cash" to settle the transaction. Stablecoins, for example, are growing in use in the U.S. on crypto exchanges and some cross-border payments, but are currently deemed unsuitable for multi-trillion-dollar core-market infrastructure applications such as clearinghouse margin payments and financing government securities, Duffie's paper notes.Moreover, central banks, which could provide the safest funds to settle these trades, can only transfer money to commercial banks-leaving a lot of the emerging non-bank space out in the cold.Duffie contends in his latest paper that central banks can fill this gap-though given the complexities, some could delegate this process to the private sector, at least in the near term.But that, he wrote, could lead to greater fragmentation as money is split across separate payment networks that may not work together smoothly. That would force financial firms to backstop trades by having more cash on hand across different systems to cover the trades-and likely increase funding costs.For tokenized finance to succeed, networks will need to be compatible with each other and traditional funding systems, Duffie wrote. Central banks could play a role in easing these complexities by expanding their operating hours and potentially upgrade their legacy payment systems."Central banks should mitigate the costs of fragmentation by supplying additional reserves, so that a scarcity of settlement balances is not an impediment to trade and does not interfere with market interest rates and monetary policy implementation," Duffie's paper notes."Today, one big question in front of us is whether private sector financial innovation-notably, distributed ledger technology-can help us achieve a systemic transformation of cross-border payments on a global scale," Kristalina Georgieva, IMF Managing Director, said in remarks regarding Duffie's paper.Yet she noted that blockchain is still a small experiment in a vast global payments ecosystem. It is certainly possible that tokenization and stablecoins could make cross-border payments cheaper and faster, but their broader use demands an internationally coordinated regulatory policy response, Georgieva said. That, she added, would be a "heavy lift" given the current geopolitical fragmentation.In response to the paper, Isabel Schnabel, a German economist and a member of the executive board of the European Central Bank, said in a statement that she was in favor of central banks getting involved, saying that tokenization has the potential to fundamentally reshape wholesale financial markets, particularly in the eurozone.But private markets cannot unlock the full potential of tokenization on their own, Schnabel said, adding that safe and scalable settlement assets are needed, which is why central banks are a critical component of the success."Central banks should embrace [distributed ledger technology] and go on-chain themselves," Schnabel said. "Bringing central bank money on-chain would not only preserve its role as the foundation of settlement - it would also enable central banks to leverage the programmability of distributed ledgers to modernise monetary policy implementation, collateral management and liquidity provision, thereby also fostering financial stability."She pointed out that the ECB is already working towards this. The Pontes project is a pilot that is set to launch in September and aims to link distributed ledger technology platforms and the payment services operated by the central banking system of the eurozone. Additionally, the ECB is also working on the Appia project, which is focused on developing a scalable European shared ledger network."In cross-border payments, we have yet to see the sweeping transformation. But given the economic logic, I am confident we will get there-let's make sure we put in place the right conditions to allow us to reap the benefits and manage the risks," Georgieva said.Write to Megan Leonhardt at [email protected] content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.