Blockchain seems to be not just a straightforward upward movement. This despite the various real-world examples and the growing number of believers. Sometimes it is very interesting and above all educational to look at an individual project for a more back-to-earth view. That experiments do not just show the positives but also the gaps. Last week Carolyn Wilkins senior Deputy Governor of the Bank of Canada published an interesting article on their Project Jasper. There she highlighted a number of important challenges and limitations that first should be “examined and resolved before distributed ledger applications in core parts of the financial system are ready for prime time”.



Project Jasper

Last year June the Bank of Canada launched their so-called Project Jaspers. The intention is to build and test drive a simulated wholesale payment system using a settlement asset based on distributed ledger technology (DLT), an electronic version of the Canadian dollar to be used to their interbank payment system. They thereby focus on LVTS, the Canadian system for electronic wire transfers of large sums of money.

Main objectives

With this experiment the project team had two clear objectives.

The first was to see how the test system could meet international standards for systemically important payments infrastructure that would be set if the system were ever to go live. The Bank of Canada cares about this because of their oversight role in systematically important systems.

“This particular project is one part of a larger Bank of Canada work plan to investigate the distributed ledger technology and better understand its characteristics”.

The second objective was quite simply to collaborate with the private sector on a concrete DLT application.

The project is being carried out in conjunction with several of Canada’s biggest banks, including Royal Bank of Canada, CIBC and TD Bank, as well as Payments Canada to build the experimental interbank payment system. It is using intellectual property developed by R3CEV, the bank-backed blockchain consortium.

The Jasper Platform

In a meeting in Calgary in June last year details of the project were revealed by Canada’s Central Bank.

As part of the project, a functioning blockchain prototype would be built to test the benefits and risks involved with using the technology and create a fiat-backed digital token named CAD-Coin (or ‘settlement coin’).

Under the Project, participating banks pledged cash collateral (= collateral of fiat money) into a special pool (an account at the Central Bank of Canada), which the Central Bank converted into the digital version, the CAD-Coin. That would be then used as a medium of exchange and could be converted back to cash. As a result, the digital money can be interchangeable with Canadian legal tender at any time. Banks exchanged the digital coins between themselves and the Central Bank through an Ethereum-based network. The Central Bank would retain the ability to destroy redeemed CAD-Coins.

“What was referred to as CAD-coin is just a means of representing settlement balances on the distributed ledger, like a deposit receipt. It could also be called ‘deposit-coin’ or ‘settlement-coin.’ It doesn’t exist as a medium of exchange outside the experimental wholesale payment system. Our only goal at this stage is to understand the mechanics, limits and possibilities of this technology.” Begin, Bank of Canada.

Key questions raised

When starting the project the Bank of Canada raised a number of questions to explore. Key question was: will it satisfy the relevant Principles for Financial Market Infrastructure (PFMIs), related to issues such as collateral, credit risk, money settlement, liquidity risk, settlement finality, operational risk, as well as access and participation requirements. PFMIs related to governance and legal aspects of the system have not been examined.

Other important questions the Central Bank wished to have insight in are: will it contribute to cost savings, improved security and resilience, increased transparency and access, better collateral management. And will it lower barriers to direct participation.

Results

The Bank of Canada will soon publish the results of its own coordinated blockchain experiment. In the meantime Carolyn Wilkens already came with some preliminary comments published in a short article.

Important insights

So far, the project has yielded a number of important mutual insights, that will be relevant to the business case for this type of DLT application. Project Jasper is seen as a very useful exercise. The work done to date has shown that the test system could meet the PFMIs concerning collateral, credit risk, money settlement and liquidity risk, but….!.

Shortcomings

Nevertheless, there are still a number of shortcomings, that ask for solutions and further tests. The initial design is quite collateral intensive while the current system is already highly efficient. The current version of the system has too much information sharing compared to what would be desired in a production system.

The experiment also highlights challenges such as cost-efficiency and data privacy. The experiment shows that more cost-savings are unlikely to come directly from the core Proof of Work Ethereum system used in Project Jasper itself. Most savings may be realised through reducing the need for data reconciliation from banks. And even more savings could come from what could be built on top of a core cash payment distributed ledger system (eg financial asset clearing and settlement, trade finance). From the central bank’s statements, it seems a permissioned ledger instead of the public Ethereum platform would be a better fit for the Bank of Canada.

There are some important gaps in the present experiment. Concerns exist with respect to PFMIs for settlement finality, operational risk, as well as access and participation requirements. While DLT may aim to reduce concentration of risk, and the shared, or "decentralized," nature of distributed ledger technology may cut security risks, “a substantial amount of centralization” would still be required if applied to wholesale payments systems, such as for key and node management and setting of operational standards.

Further investigations are needed

The Bank of Canada however said the experiment was a proof-of-concept. The goal "is solely to better understand the technology first-hand".

The experiment will be ongoing until later this spring, but already “it has taught us a lot about how the technology would have to improve to win a horse race with our current Large Value Transfer System”, according to Wilkins in her article.

“Other frameworks need to be investigated, and there are many hurdles that need to be cleared before such a system would ever be ready for prime time,” according to Carolyn Wilkins.

The group is now looking at a new prototype of the platform to see if the gaps can be addressed. Thereby they will try to address further aspects of a blockchain-based payment system, such as between how widely data and transactions are verified by members of the system, and balancing that with how much information participants are comfortable with sharing.

What can we learn from this?

What we learn from these experiments is that there are still a number of gaps between opportunity and reality when it comes to blockchain applications in the real world. But as the number of these experiments accelerate this year all the more of the various challenges will be overcome and solutions brought forward so that we will soon have the first real world use cases accepted in the industry.