Bankers design a new blockchain that works like bitcoin — but it's regulated

A team of technology experts within banks and technology companies have designed an anti-bitcoin. It’s the architectural drawings for a distributed ledger that borrows many of the concepts behind bitcoin. But instead of existing outside of the government and the current banking system, the way bitcoin and many other cryptocurrencies do, this version would 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digital currencies with an approved and supervised form of digital dollar, and along the way help modernize many outdated payment rails and other tech platforms used in financial services.

“The impetus for this was that the debate about the future of the digital dollar seemed to be resolving into a kind of Ping-Pong battle between central bank digital currencies and stablecoins,” said 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 counterparts at other banks, including TD, Wells Fargo and U.S. Bank, have designed a shared ledger scheme in which digital dollars issued by governments could coexist alongside digital dollars issued by banks and private companies like PayPal and Square. The group has published a white paper describing the system, which they dub the Regulated Liability Network. 

It starts with first principles, McLaughlin said: Is a dollar only the greenback or coin in your pocket? Or is it a deposit on 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-asset. Bankers would like to see these virtues used in the regulated financial system through the adoption of shared ledger technology.

“We can’t try to disregard or hold back this technology,” said Jon Prendergast, head of U.S. 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 for centuries. But using it in a way that tries to avoid any regulatory oversight from a sovereign government, that’s just a nonstarter. The government ultimately isn’t going to agree that this technology should be used outside of its sphere of influence.”

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

“If allowed to develop outside of regulation, cryptocurrencies and stablecoins may substitute for sovereign money,” the white paper states. “They may diminish 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, research fellow at the Harvard Kennedy School Mossavar-Rahmani Center for Business and Government. “What’s interesting about it is that it tries 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 ledger technology has advantages, then why can’t it be 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 ledger technology,” he said. “Conceivably this is a way to reduce the cost of that, to create a golden record of information. If it can be that plus a transfer mechanism, that’s a promising approach.”

Prendergast also sees this work as part of an effort toward modernization of the financial system.

“Most of the systems that underpin 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 whether it’s the real time systems that have recently come up with ISO 20022 format, or it’s systems like this that are based on distributed ledger, there will be new platforms that evolve and that become dominant in money movement and value transfer.”

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

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

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

Giving the government a role

Banks already use shared distributed ledgers in a few cases. In October, Tassat announced that three banks had begun using its distributed ledger for corporate payments, among other things: Cogent Bank, Customers Bank and Western Alliance Bank. The Provenance Blockchain Foundation, which was started by Figure Technologies, has 50 bank members that use shared distributed ledgers for buying and selling mortgages and settling corporate clients’ transactions amongst each other.

The main difference between the Regulated Liability Network and these existing efforts is the participation of a government entity.

“We wouldn’t have engaged in this if it wasn’t regulated, because ultimately that just doesn’t end well,” Prendergast said. “Furthering 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 ability to use what bitcoin did in a test tube environment and make it applicable to a much wider and much stabler financial environment.” 

Strongest use cases

Another priority for this initiative was that it needed 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 for buying a coffee?” McLaughlin said. “I don’t.”

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

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

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

U.S. corporations have about $2 trillion offshore, he said, money that often needs to be moved around between subsidiaries. 

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

A CBDC wouldn’t suit this purpose because to do corporate cash management with CBDCs would require all of that corporate cash to move into the Fed and off of commercial bank balance sheets.

Stablecoins also don’t work for this purpose because they are not regulated and they’re not all equivalent to cash. 

The RLN might be used for other things later, potentially.

“We’ll see how it evolves as the white paper gets read and people start to think about this,” Prendergast said. “The first thing for us as U.S. banks is to at some point test this and make the case that we think there’s value here. And then evolve 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 it is saying, are there attributes of shared ledgers that might be valuable to import into the traditional financial system?”

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

One type is central bank money, digital versions of dollar bills and coins. In the U.S., these are liabilities of the Federal Reserve Bank. Consumers and businesses can’t have accounts at the Fed at this point, but banks can.

The second type is money deposited in commercial banks.

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

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

All of these are promises to pay by different institutions: a central bank, a commercial bank or a regulated non-bank. They can all live 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 the RLN. 

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

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

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

The RLN disarms some of the potential disadvantages of CBDCs, McLaughlin said.

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

In the RLN, central bank digital currencies act as settlement assets. If a person or company that banks at 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 a different form factor of 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 has to hold.”

To facilitate a $100 payment, the 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 U.S. dollar, proponents say.

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