Opportunities and Challenges of Financial Tokenization
Event of the European and American Chamber of Commerce
Opportunities and Challenges of Financial Tokenization
Tuesday, January 17, 2023, New York
Introductory statement by Chief Deputy Governor Denis Beau
Digitization is far from new in the financial sector, but tokenization based on distributed ledger technologies (Distributed Ledger Technologies – DLT) may be a new turning point. In my introduction, I would like to explain why we at Banque de France and ACPR are interested in the development of tokenized finance in terms of our financial stability mandate and how this affects the tools we use. to fulfill our mandate.
I/ Tokenization of finance is of great interest for two main reasons:
1/ It is one of the main driving forces behind the transformation of our financial landscape
In fact, digital technologies are profoundly changing finance and a wave of new players At the intersection of IT and finance,digital assets, in their new, tokenized form, are commonly referred to as crypto-assetsfor investment and settlement and new exchange and settlement infrastructures. Their combination results in activities and services that first touched the field of payments and are now expanding more broadly.
Among them, decentralized finance, DeFi, is emerging as one an alternative to traditional finance based on crypto-assets that service delivery is seamless and management is decentralized; was especially possible thanks to blockchains disallowed, automatically executing clauses (smart contracts) and decentralized applications (Dapps).
For now, the crypto-asset ecosystem is not large enough to threaten the dominant role of traditional finance. However, looking beyond the sector’s current challenges, this may change in the future. For this reason, we believe it is important to be vigilant.
2/ This is the second reason for our interest the uncertain impact that the tokenization of finance could have on the performance of our financial system, both in terms of efficiency and stability
In terms of efficiency, the use of DLT, which underpins the development of tokenized finance, is a good example. In addition to its widely recognized potential to increase transparency through better monitoring of transactions and property rights, DLT also has a good feature. cost-effectiveness and affordability 24 hours a day. But there is also a risk fragmentation of processes, if the blockchains supporting it are not interoperable and cannot interact smoothly with existing centralized clearing, settlement and payment systems. This interoperability must be guaranteed for now.
In terms of stabilityIt is clear that currently the crypto-asset ecosystem is not large and interconnected enough to threaten the stability of the entire financial system, as demonstrated by the limited impact on traditional finance, following the crypto-asset market disruption last May and the June Terra-Luna collapse and more recently after the collapse of crypto-asset conglomerate FTX.
However, let me first point out that these crashes have significant negative contagion effects on the crypto-asset ecosystem, and secondly, by attempting to replicate some of the functions provided by the traditional financial system, the crypto-asset ecosystem inherits weaknesses from the latter and can amplify them. For example, tokenization is on the rise operational risks, especially cyber risks. Cyber risk is the number one operational risk for financial players today and has the potential to destabilize the financial system as a whole. In this context, the tokenization of finance arises new vulnerabilities : I will mention it as an example bridges (bridges) between blockchains or the priests (database management systems) feed data to blockchains. In addition, public DLT infrastructure management issues, which strongly contribute to the risk of hacking, are still unresolved.
II) Impact on our role and activities
In response to these transformations, we believe that our role is two-fold: as the body responsible for financial stability, it involves helping to integrate tokenized finance into a regulatory framework that allows us to take advantage of its advantages while also controlling its risks. an appropriate way to maintain financial stability and therefore confidence. But we also believe that we are part of an innovative ecosystem with the aim of acting as a facilitator and catalyst. through our operational role as a provider of central banking services.
1/ Contribute to a regulatory framework that builds trust
It is basically unchanged in the financial sector the the need for trust. Consumers of financial services should be sure of: security of transactions, protection of their assets and freedom of choice. The players in the sector must also trust each other, as they remain interdependent and rely on the rules of the game, the regulatory framework within which they operate.
As authorities responsible for financial stability, central banks and supervisory authorities must play a role in maintaining this confidence in all the forms I mentioned above.
In this regard, I would like to share with you three conclusions:
– First, The traditional pillars of trust, including trusted third parties, central banks and supervisors, cannot be replaced by trust. “algorithmic”, that is, with rules of the game to be codified once and for all to be respected by algorithms, even if integrated into “smart contracts”… eliminate financially unbalanced relationships? Or failed governance mechanisms, concentration of operational risks and cyber-attacks? I think the answer is no. Therefore, trusted third parties, central banks and supervisory authorities remain necessary and, in my view, are not about to disappear…
– secondly, and this is a consequence of my first point, trust assumes that central bank money remains the anchor of the system finance ;
– finally trust requires a clear, fair (“same activity, same risk, same rule”) and balanced regulatory framework.that is, promoting innovation, adequately protecting consumers, and maintaining the stability of our financial system.
The crisis of confidence caused by the upheaval and collapse of the cryptoasset ecosystem clearly shows that from our perspective as a financial stability authority, we state that the implementation of such a confidence-building regulatory framework is an urgent imperative. Europe has led the way in this area by defining a new regulatory framework called MiCA –Markets in the Regulation of Crypto Assets– (regulation of crypto-asset markets). It is important that its implementation takes place as soon as possible within a broader international effort based on the high-level recommendations developed by the CSF-Financial Stability Board.
2/ In addition to supporting the development and adoption of a trust-building regulatory framework, we too, as a central bank, can play a positive operational role by rethinking the central bank money services we provide to align with the digital age and the possible development of tokenized finance.
For this reason in 2020 Banque de France has launched a large-scale internship program at MNBC wholesale, with several market players. This program has given us the opportunity to better understand how DLTs work and their potential benefits and risks for financial markets.
Our main motivation is to extend the trust that exists in our infrastructure and settlement assets to transactions performed in DLT. Settlement of these transactions in central bank money appears essential to protect participants in these markets from the counterparty risks inherent in other private tokenized settlement assets. The new European pilot scheme for DLT, which will come into effect in March this year, will allow us to continue our experiments in a simplified regulatory framework.
At the same time, Banque de France is helping to reflect the feasibility of retail MNBC. : The central banks of the Eurosystem are currently engaged in this project under the auspices of the ECB, and the research phase for the digital euro is ongoing. The changing payment landscape has us thinking about the tools citizens can use to access central bank money, including in the digital world.
In conclusion, I would say that tokenization can be a blessing or a curse for the functioning of the financial system. I am confident that we can collectively make the most of it if we ensure that its development takes place within a framework of trust in which good regulation plays an important role.
