The Hong Kong Monetary Authority has recently closed sixteen proofs of concept for a central-bank digital currency, the eHKD. Hang Seng Bank was chosen to operate three of them, across different use cases.
Diana Cesar, executive director and CEO of Hang Seng Bank, says there are “almost limitless” potential applications because the eHKD represents a claim on the central bank.
“From a risk-management perspective and from a user perspective, it’s a safe currency,” she said at an event hosted by the Hong Kong Institute of Bankers. “That means a CBDC is very efficient to use in payments, or to integrate with smart contracts.”
Bankers and regulators emphasize the CBDC’s status as public money riding blockchain rails, as opposed to private stablecoins or crypto wildcat coins.
Hong Kong has been roiled over the past two weeks by a scandal involving JPEX, an unlicensed crypto exchange, which has been accused of distributing products to Hong Kong retail investors and making off with customer money.
“We talk of Web3 and digital assets,” said Arthur Yuen, deputy CEO of HKMA. With an oblique reference to the scandal, he said HKMA wants Hong Kong to build infrastructure atop distributed ledger technology and asset tokenization. “How does the technology transform the way financial institutions conduct their businesses and transactions?”
He thinks DLT and tokenization will indeed be integral to economic activities and capital markets. “It’s important for financial institutions to think about what technology you will need to bring into your own operations, in order to plug into that tokenized world,” Yuen said. “Don’t focus on what’s happened in the past two years but what will happen in the next five years.”
HKMA, he says, is providing guidance to the industry around things such as custody of digital assets, and whether and how banks might tokenize operations such as risk management, or aspects of their balance sheet (eg, tokenized deposits, putting commercial bank money on blockchain).
HKKMA also sponsored green bonds on blockchain earlier this year, and has been promoting M-Bridge, a project with other monetary authorities to study cross-border interoperability of wholesale CBDCs.
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Its most proactive work has been the 16 trial schemes to map out use cases to support the eHKD, both at the wholesale and retail level.
“We want to facilitate banks’ tokenization plans because we want banks to remain relevant,” in the face of rapid innovations that have been led by the crypto industry, Yuen said.
The pilots were launched in May and are now being completed. The HKMA intends to release its findings in the coming weeks.
Hang Seng’s trifecta
Two of Hang Seng’s projects focused on programmable payments, one for how the government can disburse grants and another on merchant reward programs. It also experimented with tokenized deposits (as did HSBC and Visa).
The bank teamed up with Forms Syntron Information, a tech vendor, to work out how to handle instant payment-versus-payment settlements. The CBDC represents the expression of a cash leg in a transaction.
These PoCs suggest that using CBDCs is not just another way of settling a transaction, though. Attaching smart contracts makes money programmable, which creates a new universe of product design. CBDCs are also traceable, which opens new vistas for safeguarding against money laundering or terrorist financing. It has the potential – so far theoretical – to interoperate with other platforms, payment forms, and currencies.
Some ideas that Hang Seng explored include using smart contracts in insurance policies, so that the usual claims processing and paperwork can be transformed into an instant review and payout.
Conditional uses of money are another use case. During Covid, the Hong Kong government disbursed cash vouchers to stimulate spending in local shops. It turned to a few mobile wallet operators such as Octopus and AliPay to manage this, but overall it found the process difficult: with a CBDC, the money could be immediately deposited in consumers’ wallets, with conditions as to where the money can be spent, or within a deadline (to encourage rapid spending).
The long-term goal is to enable CBDCs to become the currency for the digital economy because people trust it – as opposed to crypto, bankers hope.
The biggest technical hurdle remains interoperability. Getting a eHKD to exchange freely on, say, Ethereum is still out of reach. The biggest challenge in human terms is finding enough people within banks able to work with the tech and new ways of doing business. Beyond the banks, there would need to be a big effort to get consumers and merchants to adopt the eHKD. The point of the 16 pilots was to find use cases so compelling that people will be receptive to using them.
That’s a different approach from mainland China, which is relying on government pressure to get people to use the eRMB – for example by mandating people use the CBDC to access government services and disbursements. The HKMA would prefer to rely on innovation and market forces to develop its eHKD ecosystem.
What isn’t being discussed, however, is privacy. A CBDC is backed directly by the central bank (or indirectly via commercial banks), which is pitched as more trustworthy than crypto – as trustworthy as the cash in your pocket. And by using banks, which are trusted institutions, front and center, the HKMA is able to draw a stark contrast to shady operators like JPEX. In other words, the messaging around the eHKD programs is that people can trust it.
But getting the design features right will also be important, because the traceability of the eHKD, while efficient, is totally unlike physical cash. There is also the danger of overreach. Take disbursing healthcare benefits. There may be simplicity in directing recipients towards earmarked hospitals or other providers. This is better than giving people money that they spend on something else.
But is it? Is the CBDC making people’s lives convenient, or is it taking away choice? Will this block the potential for new companies and services to muscle in, possibly creating stagnation instead of vibrancy? Does the government risk becoming a nanny state, instead of freeing people to work out what’s best for themselves?
This isn’t to suggest CBDCs aren’t an advancement. But for such projects to flourish, the next phase of PoCs should look beyond the incentive mechanics of markets.