By David Barwick – FRANKFURT (Econostream) – European Central Bank Executive Board member Isabel Schnabel said central banks should put reserves directly onto programmable distributed ledgers, arguing that doing so would allow them to modernize monetary policy implementation, collateral management and liquidity provision as finance becomes increasingly tokenized.
"Here I will suggest that central banks should embrace DLT and go on-chain themselves," Schnabel said in a speech prepared for delivery Friday at the Jackson Hole Economic Policy Symposium.
"Bringing central bank money on-chain would not only preserve its role as the foundation of settlement – it would also enable central banks to leverage the programmability of distributed ledgers to modernize monetary policy implementation, collateral management and liquidity provision, thereby also fostering financial stability," she said.
Schnabel set out three possible models: issuing tokenized reserves directly on a programmable ledger, linking existing payment systems to DLT platforms through bridges or synchronization, or allowing a private intermediary to tokenize reserves through an omnibus account.
Only direct issuance would make central bank reserves natively tokenized and allow central banks to conduct monetary policy operations directly on DLT platforms using smart contracts, she said.
If both collateral and reserves existed in a programmable environment, standard repo operations could be executed atomically, eliminating separate messaging and reconciliation, while smart contracts could automatically request additional collateral, substitute securities in real time or apply differentiated remuneration rates, Schnabel said.
Such capabilities could become important because tokenization may accelerate the speed at which liquidity needs propagate through the financial system, she said.
Automated margin calls triggered directly by price movements could force rapid asset sales and reinforce procyclical price dynamics, while more frequent and less nettable payments could increase banks' intraday liquidity needs and demand for reserves.
"As a result, the central bank may need to supply liquidity faster than today's operational frameworks allow," Schnabel said.
"This is precisely why operating on-chain matters," she said. "Smart contracts could make monetary policy implementation more flexible by allowing central banks to create new operational facilities and adjust parameters such as interest rates, collateral requirements and access conditions with immediate effect."
Taken together, the considerations made a strong case for central bank money itself to become a native programmable asset, with the ultimate settlement asset remaining a direct claim on the central bank, Schnabel said.
She also rejected the idea that stablecoins could replace central bank reserves as the ultimate settlement asset in tokenized finance.
Even a stablecoin designed to be almost perfectly safe would lack a central bank's ability to expand liquidity elastically in response to surges in demand, particularly during periods of financial stress, Schnabel said.
"Stablecoins are best understood as complements to central bank money, not substitutes for it," she said.
"No matter how advanced the technology or how deep the liquidity of private tokens, financial markets can only scale safely if transactions settle in a risk-free asset that can be supplied elastically to accommodate changes in liquidity demand and ensure monetary and financial stability," she said.
"Central bank money is uniquely suited to assuming that role," she added
Schnabel said the remaining question was how central banks should go on-chain, with the Eurosystem's Project Appia examining architectures ranging from a single unified European ledger to a central-bank-operated ledger connected to private DLT networks or an ecosystem of multiple interconnected ledgers.
A unified ledger could maximize atomic settlement and programmability by bringing central bank money and financial assets onto a common infrastructure, but could pose challenges for governance, resilience, competition and technological lock-in, she said.
Multiple interoperable ledgers could reduce those risks but would require additional interfaces and coordination, while fragmentation could impair the mobility of central bank reserves and increase demand for liquidity, she noted.
Schnabel said the ECB's Project Pontes was already moving some of these ideas into operation. Pontes will initially connect the Eurosystem's TARGET Services with market DLT platforms, but will also include a Eurosystem-operated DLT platform for settling transactions in central bank money.
At its launch next month, legal settlement finality for the cash leg will still be anchored in TARGET2, but settlement finality will ultimately move onto the Eurosystem DLT platform itself, with smart contracts and 24/7 operation to be added later, she said.
"[A]lthough the name Pontes literally suggests a bridge, it goes far beyond synchronization as it will bring native tokenization and programmability onto the Eurosystem's own platform and allow the ECB to extend its operational perimeter into tokenized markets," Schnabel said.
"To reap the full benefits, central banks need to go on-chain too," she said. "That means bringing central bank money into the tokenized environment and modernizing the tools of policy implementation."