Tokenization: Swiss central bank sees Big Bang migration to blockchain as unrealistic – Ledger Insights

Last week, Benjamin Müller of the Swiss National Bank (SNB) observed that the transition of financial markets to blockchain would be an evolution. “We do not want to see a Big Bang migration to blockchain and DLT. We believe this is not realistic and probably not good practice for regulated financial institutions,” he said during a panel discussion at the OMFIF Digital Money Symposium.

In 1986, the London markets had an event referred to as the “Big Bang” which involved a series of regulatory changes to increase financial market competition. They were all implemented in a single day. It catapulted London from a laggard to a leader. And it might be worth studying some takeaways from 1986 to inform the approach to DLT. But more on that later.

Switzerland is considered to be one of the leaders in regulatory reforms for cryptoassets and DLT. And the SNB has been at the forefront of wholesale central bank digital currency (CBDC) research, driven in part by the desire to have a CBDC for DLT settlement by SIX Digital Exchange (SDX) – the first fully regulated financial market infrastructure for digital securities.

It has also worked on cross-border and DeFi experiments with the Banque de France. The French central bank’s Claudine Hurman, a fellow panelist, spoke about the benefits of tokenization. These include the ability to settle atomically, longer operating hours that can be 24/7, transparency, and the promise of DeFi efficiency.

SNB’s Müller doubled down on other panel members’ comments about nuclear settlements. The opportunity to exchange the asset for the money, delivery for payment, does not have to be immediate. It may be later the same day or the next day, but the fact that both sides of the transaction exchange reduces counterparty risk at the same time.

The cost of running two systems in parallel

Circling back to the evolutionary approach, he warned that this is relatively expensive. Not only is there a need to invest in DLT infrastructure, but it needs to run in parallel with existing systems. And because two systems are in operation, the targeted efficiency gains are not taken into account.

While Müller didn’t mention it, SDX is an example of running two systems in parallel. UBS issued a blockchain bond that is naturally registered in the SDX Central Securities Depository (CSD). But it was linked to the conventional SIX CSD to enable greater liquidity, opening it up to investors who are not yet ready to store blockchain keys.

The Swiss central banker talked about different approaches to settling DLT transactions. The latest Swiss wholesale CBDC trials involve the issuance of a genuine wholesale CBDC on the SIX Digital Exchange. Currently, SDX uses tokenized cash backed by central bank reserves.

Müller also mentioned that another yet-to-be-launched DLT-based exchange will settle transactions through a link to its real-time gross settlement system (RTGS), SIC. We’re guessing this is Boerse Stuttgart-owned BX Swiss which conducted a test transaction in late 2022 with Credit Suisse, Pictet and Vontobel. That test also included a bridge to SIC.

Another topic that was raised was interoperability. The focus is always on interoperability (or lack thereof) between different blockchains used to issue securities. Clifford Chance addressed the issue of legal interoperability. And the Swiss National Bank’s Müller talked about interoperability enabling the uniformity of money. Today, people are often unaware of the differentiation between commercial bank and central bank money.

Central bankers tend to quickly zoom into fragmentation when talking about digital currency. “Would we enter a stage where you could potentially risk that uniformity of money? Where you have a Swiss franc stablecoin or a Swiss franc CBDC on one ledger, it’s not necessarily exchanged at a 1:1 exchange rate,” Müller said. “I believe interoperability can be the solution to ensure uniformity.”

Why not the Big Bang?

Meanwhile, the early mention of London’s Big Bang begs the question, why not have a mass switch to DLT? An article reviewing the lessons after 20 years offers some useful takeaways by former UK Chancellor Nigel Lawson.

The Big Bang legislation was one of the first times there was broad industry consultation. This resulted in more bureaucracy than was optimal. “Paradoxically, the involvement of practitioners in the regulatory process, which was intended to avoid this, probably exacerbated it,” he wrote, then observed that poachers make overzealous gamekeepers.

Another observation concerns crypto and tokenized securities. “In general, openness is always preferable to regulation as a means of protecting the public; but openness is not always the athletes’ first choice.”

And finally, one of the things we hear repeatedly is a desire to avoid regulatory arbitrage. Lawson disagreed. “It is not sufficiently recognized that healthy competition in regulatory systems is as beneficial as it is elsewhere,” Lawson wrote.

He opined about the speed needed in 1986 to get real reform to attract capital to Britain. Although the EU’s DLT pilot regime should be applauded, it will last three to six years and be relatively small scale. If the tokenization is to take off, the established operators must work within the current laws to show a timely return on investment.

DLT offers the opportunity to radically transform markets to significantly cut costs and enable new business models. Perhaps there is a need for more regulatory competition and a Big Bang approach.