Navigating the evolving future of payments (part two)

Digital currencies could change the future of payments, revolutionising how we look at settlement speed, liquidity, reconciliation, and risk.

Banks are increasingly leveraging emerging technologies to make domestic and cross-border transactions faster, more frictionless, efficient, and cost-effective. As a result, the payments industry is moving ever-closer towards a 24/7/365, instant, and fully transparent future. Yet, with a range of innovations occurring at pace, there seems to be no single solution or fixed route to arriving at this destination. 

Digital currencies represent one part of this journey – and ultimately have the potential to transform the entire payments landscape, not least because of their extensive application.

Due to its token-based nature, it can be held in a transaction and be transferred directly, instantly and on a peer-to-peer (P2P) basis, irrespective of the value. The attraction comes from the ability to settle payments without the involvement of any third-party intermediaries, creating an entirely new processing model for payments. There are also implications for risk management, liquidity management and correspondent banking strategies.

So, what does the road ahead look like for digital currencies, and how will banks adopt them into their wider offering of solutions? 

A new world

Digital currencies, which are built on distributed ledger technology (DLT), can be split into three distinct categories: cryptocurrencies, central bank digital currencies (CBDCs) and stablecoins. 

Cryptocurrencies – including Bitcoin and Ethereum – have gained public traction in recent years. Most governments, central banks and financial institutions (FIs) are, however, wary. While the potential of cryptocurrencies is undeniable, their highly volatile prices, limited scalability, complicated user interfaces and issues with governance and regulation (since their supply is not linked to a central bank) challenges their stability in the long-term. 

CBDCs are digital fiat currencies issued and monitored by the central bank of a region or country. They bring improved security and visibility through DLT technology, and as well as enabling faster payments and enhanced monetary control. Despite these benefits, the implementation of most CBDCs remains a long way off, not least because several fundamental questions, including how they might impact monetary policy and traditional banking business models, are yet to be answered.

Stablecoins are something of a mix between cryptocurrencies and CBDCs. Sharing many features of cryptocurrencies, but without their high levels of volatility as they are linked to a pool of assets. This makes stablecoin more inviting as a method of payment and source of value and, as a result, it is growing in popularity.

Many central banks, FIs, and fintechs are involved in various digital currency projects, with the industry working towards a common goal: to create financial market infrastructures (FMI) centred on DLT. 

A potential path

The future of payments will involve some – or multiple – forms of digital currency and stablecoins could be the first digital currency to revolutionise the payments space. Certainly, stablecoins could play an important role in cross-currency FX swaps, securities settlement and even cross-border payments.

With businesses increasingly expecting faster payments, digital tokens could allow cross-border FX payments to be made in real-time, 24/7/365, and increasingly make cut-off times a thing of the past. By settling transactions instantly, banks can avoid having unsettled overnight trade and free up capital that is held for assurance. The real-time nature of these transactions could also reduce FX fees and increase transparency.

In addition, stablecoins could re-write existing securities settlement processes due to the fact that they can be applied to the payment leg in a delivery-versus-payment (DvP) digital asset settlement. At the moment, such transactions call for various parties to coordinate the transfer of securities and the transfer of funds on two separate platforms. Stablecoins could tokenise the entire process and allow the transaction to be completed instantly – with the buyer and seller receiving their asset and payment in unison. This would also eliminate the need for third parties, reducing risk and costs. 

Looking to the future, if stablecoins are readily accepted into transaction banking, it could potentially impact the way cross-border transactions are processed. While these transactions currently use a correspondent banking model with multiple parties involved, tokenised cash could allow the immediate and secure settlement of transactions, reducing counterparty and institutional risk. In this respect, digitalised currencies represent an opportunity to completely transform cross-border payments. 

A model for the future

Digital currencies have the potential to transform the existing payments ecosystem – impacting settlement speed, risk mitigation, reconciliation and liquidity management, as well as the traditional role of correspondent banking and intermediaries in the settlement process.

As digital currencies edge closer to becoming a reality, there are implications for stakeholders across the industry, including considerations for corporates. Banks will need to adapt to the evolving landscape, meeting the unique needs of their clients. Indeed, there is not one technology for improving payments, rather it is a combination of solutions that will enable the future of payments. This means investing in a broad range of industry initiatives, including SWIFT gpi, artificial intelligence (AI) and real-time capabilities, as well as digital currencies. 

This is truly an exciting time for payments. It presents an opportunity for banks to provide improved digital services to clients, with greater levels of security, ease and efficiency than ever before. 

To find out more, including the implications of digital currencies for liquidity management and correspondent banking strategies, read BNY Mellon’s new two-part whitepaper Innovation in Payments

The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute Treasury Services advice, or any other business or legal advice, and it should not be relied upon as such.

About Vivek Kohli

Vivek Kohli is Emerging Technology Head, Treasury Services Digital Office, BNY Mellon.

About BNY Mellon

BNY Mellon is a global investments company dedicated to helping its clients manage and service their financial assets throughout the investment lifecycle. Whether providing financial services for institutions, corporations or individual investors, BNY Mellon delivers informed investment and wealth management and investment services in 35 countries.