JP Morgan estimates that global corporates move nearly US$23.5 trillion across countries each year, equivalent to roughly 25% of global GDP. Because they rely on what the bank calls “sub-optimal wholesale cross-border payment processes,” annual transaction costs for the companies have reached US$120 billion.
The case for atomic settlement
There is thus strong demand among businesses for faster, more-efficient and cheaper cross-border payments, and this is where atomic settlement comes in. Defined as the instant exchange of two assets that are linked, such that the transfer of one occurs only upon transfer of the other, atomic settlement breaks each complex transaction into its atomic components and settles them all simultaneously. All conditions must be satisfied before the transaction can complete. In other words, both payment and delivery must take place per terms set in the smart contract for settlement to occur.
Atomic settlement is important for businesses for several reasons. First, it reduces transaction time to a matter of seconds or minutes, rather than the days that may be required for traditional methods. For firms that make frequent and/or large cross-border payments, the value of these speedier transactions is significant.
At the same time, atomic settlement is less expensive than traditional correspondent banking due to the involvement of fewer intermediaries – and thus fewer parties collecting fees. This can be especially useful for smaller businesses or individuals who may not have the resources to pay the higher fees associated with conventional methods.
Additionally, atomic settlement also has the potential of reducing liquidity issues for banks – though this remains to be seen.
In the Asia-Pacific region, which globally stands at the forefront of digital payments innovation, atomic settlement is already being adopted by a number of different entities.
Atomic settlement with CBDCs
In Asia, several atomic settlement initiatives using central bank digital currencies (CBDC) are underway. For example, the multi-CBDC m-Bridge project jointly launched by the Bank of International Settlement (BIS) Innovation Hub and the central banks of mainland China, Hong Kong, Thailand and the UAE conducted a five-week pilot in the fall of 2022 in which US$12 million in currency was issued US$22 million in trade transactions were executed. M-Bridge aims to ultimately build a common platform for efficient, low-cost digital payments in support of global trade.
M-Bridge is significant in that it is among the first multi-CBDC projects to settle real-value, cross-border transactions on behalf of corporates. 20 of the region’s largest commercial banks participated in the pilot.
For its part, the Monetary Authority of Singapore (MAS) in November 2022 launched Ubin+, an expanded collaboration with global partners on cross-border foreign exchange (FX) settlement using wholesale CBDC. MAS reckons that atomic settlement based on digital currencies can boost efficiencies and reduce settlement risks compared to existing payment and settlement rails.
“Interoperable wholesale digital currencies offer efficiency gains through a growing range of cross-border use cases,” said Sopnendu Mohanty, Chief FinTech Officer of MAS, said in a statement.
Singapore also led Project Dunbar, which also included participation from the central banks of Malaysia, South Africa and Australia. Completed in March 2022, the project found that financial institutions could use CBDCs issued by participating central banks to transact directly with each other on a shared platform, potentially reducing reliance on intermediaries and thus the costs and time taken to process cross-border transactions
Singapore-based Partior is a prominent startup backed by Temasek, DBS and JPMorgan focused on developing atomic settlement solutions for cross-border payments. The firm sees itself as a network though, not a payment or settlement system. It aims to improve the efficiency, reliability and security of digital clearing and settlement for financial institutions.
“Our network provides transfer of value atomically,” CEO Jason Thompson told DigFin in a May 2022. “Which means we could clear and settle a currency and a liability at the same time.”
One of Partior’s main products is “Atom,” which is designed to facilitate the atomic settlement of transactions between banks and other financial institutions. Atom uses blockchain technology and smart contracts to enable the rapid exchange of assets between parties.
Finality International is another private-sector project that uses atomic settlement. It is a consortium made up of 17 members including BNY Mellon, Barclays, Credit Suisse, UBS, MUFG Bank and Nasdaq. It aims to build a network of distributed financial market infrastructures (dFMIs) using blockchain to deliver the means of payment-on-chain for wholesale banking markets.
An atomic future?
While atomic settlement offers some clear advantages for cross-border payments, its adoption is by no means a done deal. On the one hand, it is unclear that blockchain is essential for optimized cross-border transactions. At present, the private firms building atomic settlement solutions primarily rely on settlement banks that sit in the middle and serve as gateways. With that structure, it is possible a simple database would suffice.
Secondly, the purported benefits of atomic settlement do not all stand up to scrutiny. Some proponents of atomic settlement note that it frees up liquidity for banks. While there is some truth to that, banks still must have money on deposit with the gateway banks.
Further, multi-CBDC initiatives may augur well for cross-border payments in certain respects, but outside of a pilot context, they will be complicated to implement. Directly extending access to central bank money to foreign participants and conducting transactions on a shared ledger necessitate deeper investigation of policy, data privacy and governance considerations.
Digital fiat currency and a multi-CBDC platform also raise tough legal questions that will be answered based on each participating jurisdiction’s regulations. Changes will almost certainly be required that harmonize regulations in the participating jurisdictions.
At the same time, given that atomic settlement in cross-border payments remains a work in progress, many users of payment solutions, from banks to fintechs to corporates, are seeking out solutions on traditional rails that provide a similar (if not identical) level of fast and efficient settlement. Cross-border payments can still be seamless even if they are not atomic.
With that in mind, for atomic settlement to truly take hold, blockchain technology will have to prove itself superior to the alternatives in terms of transaction time, efficiency, cost and the geographic coverage of the relevant payment rails. At this point, the jury is still very much out on this subject.
This commentary was written in collaboration with Banking Circle and originally appeared on Banking Circle.