Bankers are designing a new blockchain that works like bitcoin – but it’s regulated

A team of technology experts from banks and technology companies have designed an anti-bitcoin. It is the architectural blueprint for a distributed ledger that borrows many of the concepts behind bitcoin. But instead of existing outside the government and the current banking system, as bitcoin and many other cryptocurrencies do, this version will be used by central banks, traditional banks and some fintechs – and fully regulated.

The idea is to counter the rapid rise of unregulated digital currencies with an approved and monitored form of digital dollar, and along the way help modernize many outdated payment rails and other technological platforms used in financial services.

– The impetus for this was that the debate about the future of the digital dollar seemed to resolve itself into a kind of ping-pong match between central banks’ digital currencies and stablecoins, says Tony McLaughlin, managing director, emerging payments and business development at Citi Treasury & Trade Solutions. “As if the choice is really between centralizing things with the central bank or having unregulated wildcat stablecoins. And that seemed to be a false choice.”

McLaughlin and several counterparties at other banks, including TD, Wells Fargo and US Bank, have designed a shared ledger scheme where government-issued digital dollars can coexist with digital dollars issued by banks and private companies such as PayPal and Square. The group has published a white paper which describes the system, which they call the Regulated Liability Network.

It starts with first principles, McLaughlin said: Is a dollar just the dollar or the coin in your pocket? Or is it a deposit in a bank or a balance on a fintech wallet?

“The concept of the regulated liability network is to say, yes, let’s have a programmable digital dollar, but not limit it to central bank money,” McLaughlin said.

Public blockchains like Ethereum operate 24/7, and they are programmable and multi-active. Bankers would like to see these virtues applied in the regulated financial system through the use of shared financial technology.

“We cannot try to ignore or hold back this technology,” said Jon Prendergast, head of US payments strategy for TD Enterprise Payments and a contributor to the Regulated Liability Network white paper. “Blockchain is one of the most revolutionary, brilliant technologies to come around in centuries. But to use it in a way that tries to avoid regulatory oversight by a sovereign government, that’s just a non-starter. The government ultimately comes not to agree that this technology should be used outside its sphere of influence.”

On the other hand, the group wants to limit digital dollars to regulated entities.

“If allowed to develop outside of regulation, cryptocurrencies and stablecoins could replace sovereign money,” the white paper said. “They can reduce an important instrument of national self-determination and negatively affect financial stability.”

Outside experts see promise in the idea.

“This is an idea that is very interesting and deserves exploration,” said Timothy Massad, a fellow at the Harvard Kennedy School Mossavar-Rahmani Center for Business and Government. “What’s interesting about it is that it’s trying to bring together shared ledger technology with sovereign currencies and with what I would call the regulated financial system. It’s basically saying, look, if shared financial technology has benefits, why can’t it used for sovereign currencies and other traditional assets?”

Like the bankers involved, Massad said a shared ledger of this kind could make the U.S. financial system more efficient.

“One of the things that is true about our financial system is that multiple entities spend a lot of time reconciling the same sets of data and shared financial technology,” he said. “It’s conceivable that this is a way to reduce the cost of that, to create a golden record of information. If it can be that plus a transmission mechanism, that’s a promising approach.”

Prendergast also sees this work as part of work towards modernization of the financial system.

“Most of the systems that support payments have been around for generations,” he said. “If you think about the card rails, if you think about wires, they’ve been around for generations, but nothing lasts forever. And so either it’s the real-time systems that have recently come up with the ISO 20022 format, or it’s systems like this that are based on distributed ledger, there will be new platforms that evolve and become dominant in money movement and value transfer.”

Prendergast and TD want to “make sure that we’re engaged in these new forms of money and these new platforms, and that we’re able to inform how they’re built and structured, but also how we can make sure we’re not left behind .”

RLN can operate 24/7 and enable near-instant movement of value between entities or within large companies across national borders, he said.

“There are aspects of this concept that can solve problems for our customers, and that’s why we want to do that,” Prendergast said.

Give the government a role

Banks already use shared distributed ledgers in a few cases. In October, Tassat reported it three banks had started using the distributed ledger for business payments including: Cogent Bank, Customers Bank and Western Alliance Bank. The Provenance Blockchain Foundationwhich was started by Figure Technologies, has 50 bank members who use shared distributed ledgers to buy and sell mortgages and settle corporate customers’ transactions among themselves.

The main difference between the regulated liability network and this existing effort is the participation of a government entity.

“We wouldn’t have engaged in this if it wasn’t regulated, because at the end of the day it just doesn’t end well,” Prendergast said. “To further the proper use of technology to streamline and make more efficient money movement and transactions for customers, within a proper regulatory framework, that was the goal. It’s the opportunity to use what bitcoin did in a test-tube environment and make it applicable to a much wider and much more stable financial environment.”

Strongest use cases

Another priority for this initiative was that it had to solve a problem, Prendergast said. But consumer payments don’t seem to have a problem that needs a new digital solution.

“Do I need another solution to buy a coffee?” McLaughlin said. “I don’t.”

Trying to use this ledger to create digital dollars that go directly into a consumer’s wallet could be troublesome from a privacy standpoint, as ledger owners may be able to see exactly where consumers’ money is going, Prendergast pointed out.

The main use case for RLN may be cash management for large companies.

“Corporate cash management is a prominent use case because it’s a place where programmable dollars can be extremely powerful, but it’s not a use case that can be easily supported by CBDC or stablecoins,” McLaughlin said.

American companies have about $2 trillion offshore, he said, money that often has to be moved around between subsidiaries.

“For example, today if a multinational company wants to move dollars from a Hong Kong-based subsidiary to an Australian-based subsidiary, it cannot do so on a 24/7 basis between different banks,” McLaughlin said.

A CBDC would not suit this purpose because to do corporate cash management with CBDCs would require all corporate cash to be moved into the Fed and out of commercial bank balance sheets.

Stablecoins also do not work for this purpose because they are not regulated and not all are equivalent to cash.

RLN can be used for other things later, potentially.

“We’ll see how it develops as the white paper is read and people start thinking about this,” Prendergast said. “The first thing for us as US banks is to at some point test this and make the case that we think there is value here. And then develop it and grow it from there.”

How the RLN would work

The Regulated Liability Network is technology neutral, McLaughlin said.

“It’s not specifically pushing blockchain or distributed ledger technology,” he said. “But that is, are there attributes of shared accounting that might be valuable to import into the traditional financial system?”

Multiple forms of digital dollars will coexist on the same ledger.

One type is central bank money, digital versions of dollar bills and coins. In the US, this is owed to the Federal Reserve Bank. Consumers and businesses cannot have accounts with the Fed at this time, but banks can.

The second type is money deposited in commercial banks.

“At the moment, it’s the dominant form of digital money,” McLaughlin said.

The third type is what McLaughlin calls “e-money” issued by regulated fintechs — such as PayPal balances and Square Cash balances.

All of these are promises to pay from different institutions: a central bank, a commercial bank or a regulated non-bank. They can all reside on the RLN and be interoperable.

Then there is non-sovereign money like bitcoin, which lives on the bitcoin blockchain and would not be interoperable with RLN.

“The ideology of bitcoin is that money does not belong to the nation-state,” McLaughlin said.

And there are unregulated stablecoins. These would also not exist on RLN, for now. If stablecoins are regulated, they can also live on the network, McLaughlin said.

This ledger will be operated by a financial market utility, a regulated entity formed as part of a public-private partnership, he said. It will be similar to CLS Group in New York, which is monitored by regulators around the world and can achieve final settlement, meaning that the transfers in CLS and the transfers in RLN will be final from a legal perspective.

RLN disarms some of the potential downsides of CBDC, McLaughlin said.

“What people don’t like about CBDC is deposits and transactions moving into the central bank, as this can affect credit creation,” he said. “The RLN construct solves that problem by keeping the money on the private balance sheets where it can support lending to the economy.”

In RLN, central banks’ digital currencies act as means of settlement. If a person or company that banks with Wells Fargo makes a payment to another person or company that banks with Citi, “you would instruct your bank to make a payment using your tokens, in other words another form factor for your bank balance.” McLaughlin said. “That means it should be subject to FDIC insurance, it’s protected by banking regulations, and it’s protected by the capital that the commercial bank must hold.”

To facilitate a $100 payment, RLN would extinguish the Wells Fargo token and mint a new Citi token, meaning Citi owes the payee $100. And then it would move a wholesale CBDC from Wells Fargo to Citi, because Citi will only accept the new liability if it receives a matching asset.

This new network could affect the future of the US dollar, advocates say.

“We don’t want to have a situation where other currencies are easier to trade in than the U.S. dollar,” McLaughlin said.