Editor's note: Darko Pilav is Digital Asset's Director of CBDC and Payments Technology

Central bank digital currency (CBDC) is entering a new stage of maturity, with the majority of central banks exploring and testing its potential. Major global institutions including the Bank of International Settlements and the International Monetary Fund, as well as agencies of the United Nations, have dedicated teams researching solutions to achieve faster, cheaper, and more transparent forms of payment and currency. But with exception of that of China, central banks still have a number of choices to make concerning CBDC design and technology, as well as policy and legal questions to resolve¹ before they make digital currency available to users. While there are many more steps to take on the journey to CBDC, the conversation is expanding and now includes substantive industry discussion in the regulated private sector.

What is the Regulated Liability Network?

In parallel with the evaluation of CBDC by various central banks, a number of commercial banks and payment service providers have proposed a Regulated Liability Network (RLN) that could capture and catalyze some of the promises of digital currency today, using current rules, regulations, and arrangements. This plan leverages existing public-private sector arrangements for regulated payment networks in place between central and commercial banks, but it improves on these arrangements to capture some of the key attributes of CBDC.

The RLN founders recognize that mainstream financial institutions all operate on clear but distinct rulebooks. There are rules for central banks, other rules for commercial banks, and still others for payment processors. The liabilities of these institutions reflect the varying risk factors:

• As a liability of a central bank, cash carries almost no risk. Similarly, cash-based transactions are also riskless: When a consumer pays for a product with cash, the transaction is immediate and final.

• Commercial banks must manage a variety of risk factors, including the liability associated with bank deposits (and the need to hold reserves against them), regulatory compliance (including KYC requirements), and the need to remain competitive with related banking services. Traditional banking payments and transfers are not as riskless or as quick as cash or emerging peer-to-peer payment and transfer structures. E-money transactions still rely on traditional bank payment rails, and international transactions take several days to be ‘final’ as credit risk is checked and regulatory compliance is performed. 

As proposed by the team behind the initiative, the RLN could play a major role in de-risking and accelerating commercial bank payments. Citi’s concept paper demonstrates how RLN would connect the liabilities of all mainstream finance players involved in transactions. One of the most important elements of this plan is that it does not require new rules or functionality for any of the actors in the payment process. The legal certainty around the payment system and liabilities is maintained. Only the technology changes—but that does change many aspects.

With central banks, commercial banks, and payment processors all sharing a technology framework to conduct business, the time to finalize transactions and the risk factors involved in payments could be significantly minimized. 

"To further increase the system's efficiency, all financial claims (including claims on volatility) will be in book entry form, and ownership of all these claims will be transferable instantly anywhere around the globe via 24-hour multicurrency payment systems. Settlement risk will be eliminated and with it a major bottleneck to transaction flows. This has enormous implications for releasing capital and lowering transaction costs."

-Charles Sanford, 1994

The current state of the Regulated Liability Network

The RLN effectively replicates the existing two-tiered banking system with the creation of a network that supports a common way to represent the liabilities of different regulated institutions.

Implementing the RLN requires the ability to create and manage workflows across multiple organizations, with clearly defined roles and permissions and the necessary supervisory oversight. Smart contract functionality would establish and enforce rules with rights that can be set at a granular level. And, with the right underlying technology, smart contract-driven transactions can extend across organizations and incorporate additional asset classes, while delivering significant benefits, including: 

• Ensuring the entire transaction completes if, and only if, every leg of the transaction is successful. This creates a streamlined, efficient settlement process that provides surety and completely eliminates counter-party risk. 

• Preserving privacy, even in transactions that span multiple platforms, by restricting access to transaction data and status on a need-to-know basis.

• Providing extensibility to allow different organizations to participate and facilitate the development of new use cases that leverage the tokenized assets, beyond the proposed levels of API integration. 

To achieve these benefits, the underlying technology will need to be both interoperable and extensible, enabling a network of networks that not only supports today’s requirements but also is flexible enough to accommodate opportunities and connect participants that are yet to be identified.

Finally, while the RLN can drive important efficiencies and support industry innovation, the tokenized assets created will be commercial bank liabilities, leaving the owner to face the same depository risks that exist today. The introduction of central bank-issued CBDC, in combination with the RLN, would create a ‘best of both worlds’ scenario. As a liability of a central bank, CBDC would remove that depository risk. Ultimately, the parallel existence of the RLN and CBDC would give consumers greater transparency into the risk exposure of their assets, whether held by a central bank or as part of the RLN. 

A path to implementation

Digital Asset is deeply engaged with central banks as they explore CBDC approaches and implementation strategies, and we are pleased to be working with the industry partners that have proposed the RLN.

Since the RLN aims to be broadly inclusive of regulated financial institutions, the ability to connect to current banking technology is essential. Furthermore, the technology should also be flexible enough to accommodate both token- and account-based (or digitized) methods for executing transactions. 

This is where Daml comes in. Our multi-party application framework leverages the benefits of distributed ledger and smart contracts and can establish a strong foundation for a successful RLN:

• Assure and protect the privacy rights of each financial institution and its clients. Daml-driven smart contracts allow privacy rights to be set so that the parties are authorized to see only the parts of a transaction they need to perform their duties. Confidential information resides with its owner (regardless of whether blockchain or traditional databases are used), and rights and permissions are set at a granular level to protect the ‘need to know’ principle. This model allows a single transaction to govern the atomic updates needed to complete a cross-bank funds transfer, simultaneously updating the ledgers of all three banks (originating, receiving, and central) and providing each entity with only the data necessary to verify the correctness of execution.

• Enhance settlement and transparency. By using a common data model within or across markets, automating lifecycle events, and mutualizing workflows across parties can increase settlement transparency and lower both operating cost and risk. Real-time access to accurate information and asynchronous processing can expedite workflows, particularly across different time zones or markets.

• Create scalability and improve efficiency with interoperability. Ensuring all banks and payment processors have access to the RLN will be critical to adoption. This requires a technology that can connect to existing infrastructures and the most sophisticated emerging ledger solutions. Digital Asset has developed a uniquely interoperable solution that works across platforms and ledgers, enabling multi-party workflows that span organizational boundaries. Interoperability is the key to RLN: By alleviating the friction resulting from data silos within financial organizations, customer experience improves and innovation and competition can thrive.

• Reduce risk with atomicity. Smart contracts designed for atomic transactions ensure that if one leg of a transaction fails, all legs fail. This enables systems to achieve payment versus payment (PvP) and delivery versus payment (DvP) without the risk of handing over goods when the payment leg fails and removes the need for a depository institution or a central bank to act as an escrow. Daml-based CBDC experiments with Banque de France and the Daml-driven repo market platform in production in the US have demonstrated the ability to improve DvP and PvP with smart contracts and a shared, immutable ledger. In the case of the RLN, this may allow for the liabilities of commercial banks and payment processors to be fungible with those of central bank liabilities.

• Build new solutions or expand the network with extensibility. Since it is impossible to identify all potential use cases up front, it must be easy to build new applications or add connections to other networks in order to support the adoption and expansion of the RLN. Importantly, new use cases must not require changes to the initial implementation, and future use cases must be tightly integrated to ensure frictionless transactions between parties. Daml is agnostic to ledgers and platforms, and extensibility is a fundamental characteristic. Each new application relies on the same core code, reducing rework and time-to-market while ensuring integrity, and all applications can be easily integrated with additional providers and data sources. 

Daml not only supports the future-proofing of a new RLN but also opens opportunities on a global scale for all end-users on the network. This leverages the strength of the founders’ vision and creates the potential for new asset classes to be introduced onto the RLN — and hence into mainstream financial institutions. Read more about CBDC implementation.

The Regulated Liability Network and CBDC

In summary, there are substantive, attainable benefits to the Regulated Liability Network in both the short and medium terms. Since the liabilities in question are based on the existing legal framework, the creation of new assets is not required. Furthermore, the RLN addresses the problem of shrinking balance sheets for commercial banks, which hinders their ability to extend loans. Finally, the usage of new technology for the RLN’s underlying infrastructure allows for future capabilities like programmable money, increased transparency, and instant, cross-organization, and cross-border settlements. With a Daml-based implementation, the use of liabilities on the RLN can even be extended to improve the efficiency of other types of transactions—for example, the cash leg of a securities transaction—while providing atomicity and privacy guarantees.

It’s important to note that while the RLN is not CBDC, it could exist in parallel with a digital currency issued by a central bank. We believe the RLN is a significant step on the journey towards realizing the full promise of CBDC. The initiative and collaboration demonstrated by its industry proponents can accelerate change and simplify the existing infrastructure to deliver substantial, near-term benefits, while central banks continue their exploration and analysis of CBDC, including how depository risk can be reduced or eliminated and financial inclusion can be expanded. 

A robust and interoperable Regulated Liability Network would be able to plug into CBDCs as they are developed and deployed, extending benefits more broadly and driving continued financial market innovation.

¹For example, in an IMF Survey, only 23% of central banks (approximately 40 jurisdictions) had clear mandates to issue CBDC. https://www.imf.org/en/Publications/WP/Issues/2020/11/20/Legal-Aspects-of-Central-Bank-Digital-Currency-Central-Bank-and-Monetary-Law-Considerations-49827