Tokenization and unified ledgers: shaping the future of finance

This analysis explores the BIS article 'Finternet: the financial system for the future' by Agustín Carstens and Nandan Nilekani. It covers payment systems, financial intermediaries, currency, and tokenization, among other topics.

Introduction and vision

The article introduces the "Finternet," a concept for a global financial system similar to the Internet. It underscores the limitations of the current financial system regarding outdated processes, lack of interconnectedness, and insufficient access to financial services in emerging markets and developing economies.?

After buying and selling securities, financial market participants must deal with multiple interfaces and reconciliation procedures with financial infrastructures and wait for transaction settlement. This process could be more efficient, less expensive, and less complex.

Finternet is a digital platform that uses tokenization to enable immediate global financial transactions across devices. It promotes financial inclusion, risk management, and reduced transaction costs.

Unified ledgers and technological advancements

Central to the Finternet are "unified ledgers," digital platforms that consolidate multiple financial assets markets, such as tokenized central bank money, commercial bank deposits, and other financial assets (shares, bonds, real estate), on a common programmable platform driven by smart contracts. This system would dramatically reduce reliance on external verification processes and messaging systems that contribute to inefficiencies in the current financial system. It promises immediate, safe, secure asset transfers, fostering a more inclusive and efficient financial ecosystem.

The article underlines technological innovations such as AI and blockchain as critical enablers. AI could streamline back-office operations and enhance compliance procedures, while blockchain-based tokenization of assets allows for more efficient transactions and new forms of financial products.

Design principles and implementation strategy

The Finternet is built on a foundation of user-centric design, ensuring that financial services are accessible, reliable, and secure. Fundamental design principles include

• Interoperability, allowing for seamless functionality across different financial systems.
• Scalability to accommodate growth.
• Robust security measures to protect data and ensure privacy.

The rest of the principles are

• User-centric approach. Users' needs and wants should guide technological and regulatory choices.
• Evolvability. It should support future tech while staying compatible with existing systems, allowing for continuous improvement;
• Modularity. The architecture should have modifiable layers to minimize disruption and allow users to customize functionalities;
• Public and private sectors. The public provides infrastructure, rules, and regulations while promoting competition among private actors through open platforms.
• Inclusiveness and accessibility. The architecture must prioritize inclusive, affordable, and accessible financial activities while respecting legal norms and catering to diverse sectors, devices, and purposes.

The paper outlines a strategic implementation plan emphasizing the necessity of unified ledgers for transformation. It calls for a phased approach, beginning with pilot projects that leverage existing systems to demonstrate benefits and build stakeholder support. This approach would address potential technical and regulatory challenges by fostering an environment conducive to iterative testing and adaptation.

Architecture

The Finternet represents a revolutionary approach to providing universal access to high-quality financial services by placing users—individuals and businesses—at the center of its design. It leverages existing legal frameworks and infrastructure to create a compliant, secure, and user-centric financial ecosystem.

At the core of the Finternet are?unified ledgers, which serve as the system's backbone. These immutable ledgers ensure that all transactions are secure, irreversible, and transparent. Users can create and manage multiple accounts linked to a globally resolvable virtual address. It allows for unparalleled control over assets, enabling users to tailor their authentication and authorization protocols for each account and engage in various transactions.

Digital tokens?are a fundamental component of the unified ledgers. They represent various assets, from tangible ones like real estate to intangible ones like intellectual property.?Tokenization, managed by central and commercial banks, ensures assets' secure and compliantly digital representation. These tokens encapsulate ownership, value, and regulatory compliance, allowing seamless transitions between digital and traditional economies.

The?unified interledger protocol?is a crucial mechanism that ensures seamless interoperability across different ledgers. This protocol allows users to open accounts in any ledger and facilitate transactions between them, guaranteeing the integrity and consistency of transactions. This interoperability provides security and irreversibility guarantees of the transaction's completeness.

User onboarding?in the Finternet is straightforward and secure. Users can easily create accounts on any unified ledger and manage their assets.?Trusted digital identities?play a vital role in this system, ensuring verifiability, portability, and permanence. These identities are central to enforcing rules and policies, making the system inclusive and compliant.

Trusted data?is paramount on the Finternet. It ensures that transactional information is transparent, immutable, and directly verifiable. This high level of data reliability supports regulatory compliance, fraud prevention, and the development of predictive analytics and risk management tools. The system also supports dynamic contracting, automating the execution of agreements and enhancing efficiency and trust within the ecosystem.

A diverse?ecosystem of applications?enriches the Finternet, allowing users to seamlessly manage banking, investments, insurance, and other financial aspects. These applications, driven by AI insights, enable personalized financial planning and optimizing investment strategies, insurance coverage, and savings plans. Businesses benefit from applications that streamline financial operations, manage cash flows, and facilitate B2B transactions, contributing to a dynamic economic environment.

Developers and entrepreneurs?are encouraged to innovate within the Finternet, creating tailored solutions for various user segments. It fosters a vibrant ecosystem where financial management is simplified, and custom solutions enhance efficiency and decision-making.

Unified ledgers on the Finternet manage a broad spectrum of assets, each with distinct legal statuses, market behaviors, and security levels. The system differentiates between regulated and unregulated assets, ensuring investor protection and market integrity. This comprehensive approach allows for robust regulatory frameworks that leverage the benefits of tokenization while mitigating inherent risks.

Challenges and critical analysis

While the Finternet presents a transformative vision, the article acknowledges potential challenges such as resistance from existing financial institutions, the need for significant regulatory changes, and the technological disparities between countries. It suggests that addressing these challenges requires comprehensive stakeholder engagement, including policymakers, financial institutions, and technology providers, to develop and refine the legal and regulatory frameworks collaboratively.

Conclusion and call to action

The article concludes with a solid call to action for public authorities and private institutions to take the lead in realizing the Finternet vision. It highlights the need for international cooperation to ensure that the system meets diverse regulatory standards and can address the unique needs of different jurisdictions. The paper positions the Finternet as a technological innovation and a crucial step toward a more inclusive, efficient, and future-ready global financial system.