Recently, the Hong Kong Monetary Association (HKMA Hong Kong Monetary Association) published a report on pilot projects for the Hong Kong dollar digital currency (Central Bank Digital Currency, CBDC) - e-HKD. The regulator launched a pilot program in May to explore the use of a potential digital currency in real-world scenarios. Why is this interesting? Hong Kong is one of the leading economies in the world, occupying the top positions in various rankings for decades. Therefore, it can be expected that best practices will be adopted by other countries. And the report presented following the results of the pilot is one of the few documents covering in detail the testing of digital currency. I have read this monumental work and will tell you what the project consists of.
The solution to a large-scale problem was divided into three sub-items, presenting them as three along the railway path. On the first path, experts are developing various regulations and legal documents that ensure the integration of the digital dollar into the Hong Kong economy; on the second, scenarios for using the new currency are being developed and their practical testing is taking place. According to the creators, both paths will converge into a third in the future. According to it, the locomotive of the digital Hong Kong dollar will burst into the real economy.
The pilot tests, which ended in October, marked the completion of the first phase of work on the second track. They brought interesting results, but before describing them, let’s say a few words about what a central bank digital currency is.
The difference between today's banking operations and a bright future with CBCB
CBCBs are similar to stablecoins—that is, a type of cryptocurrency “backed” by another commodity, currency, or financial instrument. Cryptocurrencies and digital currency are two forms of digital currency that use certain types of distributed ledger technology. This technology makes the data recorded in the registry immutable and verifiable. Essentially a blockchain. However, the Central Bank does not necessarily work on the blockchain; this is just one of the options.
The difference between cryptocurrencies and digital securities is that cryptocurrencies do not have a single control center, while digital securities are centralized and issued by the state. Cryptocurrencies usually do not have guarantees from any government or central authority, and digital securities are “backed” by these obligations.
There are two main types of digital securities: retail and wholesale. Retail digital securities are intended for consumers and businesses. Wholesale digital securities are used for large transfers between financial institutions.
The main advantages of CVCB are considered to be higher speed of transactions (including cross-border ones) compared to classic electronic transfers and low cost for senders and recipients of transfers. In addition, the implementation of the Central Digital Bank will create a payment infrastructure that is devoid of many of the shortcomings of existing systems - mainly associated with numerous (and often manual) checks of transactions. Experts believe that central securities banks can become a platform for the development of new financial services and products.
But this type of currency also has disadvantages. Firstly, privacy. CBTS allow the regulator to easily control who, how much, on what and under what circumstances spends their funds. On the one hand, this helps protect against financial crime, but on the other hand, it opens up, according to privacy advocates, unreasonably wide access to private life.
Secondly, safety. Digital banking systems rely on technologies such as blockchain and smart contracts, and they are regularly targeted by cybercriminals. Moreover, it is one thing when fraudsters exploit vulnerabilities in yet another “homegrown” cryptocurrency, which is used by a relatively small number of people, and quite another thing when an attack occurs on a currency accepted at the state level. The consequences can be catastrophic.
Thirdly, the impact on the economy. The introduction of the central bank may have different effects on the state’s monetary policy, interest rates, loan rates and other parameters of the economy. The danger is that it is difficult to predict this impact now, while such money has not become widespread in economies.
Despite all of the above, the central banks of many countries and territories are looking towards the Central Central Bank with great interest. In Hong Kong, for example, they look especially closely. The experiment, which ended in October, showed the viability of a new type of digital currency in several scenarios.
HSBC Bank created the concept of a private blockchain-based network in which sellers and buyers could instantly exchange e-HKD, “recording” the fact of the transaction directly into the transaction and eliminating intermediate links in the form of several banks. The method potentially allows you to get rid of payments with delays due to errors and also reduce the cost of the transaction for both parties.
As part of the pilot, HKMA partners immediately made a couple of “programmable” projects. China Construction Bank (Asia) and Bank of China have created prototypes of automated escrow accounts, which, like their counterparts in classical trade and financial transactions, act as intermediaries between buyers and sellers. Banks implemented two scenarios. In the first, the client makes an advance payment to an escrow account, where the money is blocked. Using a smart contract, the conditions under which money can be transferred to the merchant’s wallet are determined, and as soon as they occur, the payment is made automatically. Such a scheme should motivate suppliers of goods and services to do better work, and for the client the risk of losing money on an unprovided or poorly provided service is significantly reduced.
In the second scenario, payments are made in advance, regularly (in subscription format) and immediately to the account of the supplier of the product or service. However, payments occur with a programmed return condition if the service or product does not meet the conditions written in the smart contract. This scheme may be suitable for those companies whose business is dependent on a constant flow of revenue - for example, small companies just starting their journey.
The programmable payment concept also allows for the creation of loyalty programs and other marketing tools built right into the e-HKD code - so that even small companies can better research their customer audience and create benefits programs for them. Pilot solutions of this kind were made by Hang Seng Bank, HSBC and AliPayHK.
Scenario for using programmable payments in investments
In addition, programmable payments can significantly speed up investment transactions and make them less risky. As part of its pilot, ArtaEmail adapted smart contracts and e-HKD to carry out trading operations on the exchange. As in previous examples, the client’s money is placed in an escrow account, but is spent only if the assets meet the conditions specified in the smart contract. If the conditions are not met, then the money is simply returned to the investor’s account. This scheme protects the investor from situations where he has decided to buy shares at one price, but due to various technical and documentary delays, the transaction is completed too late and the share price changes.
Standard Chatered Bank and Giesecke and Devrient have created a concept for a system that allows people to exchange e‑HKD without having access to the Internet. The platform assumes that digital dollars are transferred from one device to another via the NFC wireless protocol, and information about the fact of the transaction is recorded in it and stored on both devices. As soon as at least one of the devices gains access to the Network, information about the transfer made offline will become available to all participants in the system. As in the case of cash, such a payment cannot be made twice, but digital money received offline can be immediately without waiting for “synchronization with the server”, use it for other operations.
Mastercard has developed a concept for a solution that will allow you to buy NFTs using e‑HKD. According to the developers’ idea, during the transaction, a special service blocks the amount of the client’s digital dollars that corresponds to the number of units of cryptocurrency required to purchase an NFT product on the selected platform. After this, a smart contract is created, and as soon as the seller downloads the desired digital product (the contract condition is met), the required amount of cryptocurrency is received into his crypto wallet, and the corresponding amount of e-HKD is debited from the seller’s account.
To put it simply, the concept proposed by Mastercard looks like an automated cryptocurrency exchanger with smart contracts and an analogue of an escrow account. However, its value lies in its ability to resolve the important fundamental tension between the distributed and independent Web3 and the centralized and regulated digital digital banks. To take advantage of Web3, the user needs to have a good understanding of technology, the features of cryptocurrencies, and be prepared to lose money due to sudden fluctuations in rates. But they have a relatively high level of privacy and have access to the opportunities (mainly investment) that NFT instruments offer.
Mastercard's "bridge" for e-HKD users removes this limitation and potentially allows regular users to benefit from Web3.
Following the results of the pilot, HKMA representatives noted that the most promising scenarios were programmable payments, asset tokenization and atomic (i.e. instant) transactions. And although Hong Kong regulators have not yet made a final decision on whether to put the digital dollar into circulation, the results of the first pilot look quite optimistic. The study of promising scenarios will continue in the next phases of piloting.
It is not only the Hong Kong authorities who are optimistic about the Central Bank. Projects for their own digital currencies are being discussed by financial regulators in 114 countries, including such developed economies as the USA, Great Britain and the European Union. Pilots have been launched in 21 countries, including Russia, and 11 countries already have their own digital currency.
It all looks as if the emergence of various CVCBs is no longer a matter of “if”, but “when”. And the Hong Kong digital dollar project, although not the only one and not the first, is still notable for the fact that it demonstrates in many ways how digital money can change the financial relationships of ordinary people, businesses and the state in the near future.
"Three Paths" Approach
The Hong Kong authorities have been dreaming about a digital dollar for a long time. The current project began back in 2017 under the name LionRock, and then it focused exclusively on developing a so-called wholesale digital currency - that is, a currency that large banks could use for infrequent and large payments among themselves. In 2021, LionRock evolved into mBridge, a larger-scale project to create and develop a digital currency not only for large banks, but also for non-financial organizations, as well as private users.
The solution to a large-scale problem was divided into three sub-items, presenting them as three along the railway path. On the first path, experts are developing various regulations and legal documents that ensure the integration of the digital dollar into the Hong Kong economy; on the second, scenarios for using the new currency are being developed and their practical testing is taking place. According to the creators, both paths will converge into a third in the future. According to it, the locomotive of the digital Hong Kong dollar will burst into the real economy.
The pilot tests, which ended in October, marked the completion of the first phase of work on the second track. They brought interesting results, but before describing them, let’s say a few words about what a central bank digital currency is.
A short guide to the Central Central Bank
CBCB is a digital version of a country's central bank money (fiat currency), but is not a replacement for it, but rather an additional form. Like cash banknotes, digital money units have unique properties (a type of serial number) and can be converted into cash and back.
The difference between today's banking operations and a bright future with CBCB
CBCBs are similar to stablecoins—that is, a type of cryptocurrency “backed” by another commodity, currency, or financial instrument. Cryptocurrencies and digital currency are two forms of digital currency that use certain types of distributed ledger technology. This technology makes the data recorded in the registry immutable and verifiable. Essentially a blockchain. However, the Central Bank does not necessarily work on the blockchain; this is just one of the options.
The difference between cryptocurrencies and digital securities is that cryptocurrencies do not have a single control center, while digital securities are centralized and issued by the state. Cryptocurrencies usually do not have guarantees from any government or central authority, and digital securities are “backed” by these obligations.
There are two main types of digital securities: retail and wholesale. Retail digital securities are intended for consumers and businesses. Wholesale digital securities are used for large transfers between financial institutions.
The main advantages of CVCB are considered to be higher speed of transactions (including cross-border ones) compared to classic electronic transfers and low cost for senders and recipients of transfers. In addition, the implementation of the Central Digital Bank will create a payment infrastructure that is devoid of many of the shortcomings of existing systems - mainly associated with numerous (and often manual) checks of transactions. Experts believe that central securities banks can become a platform for the development of new financial services and products.
But this type of currency also has disadvantages. Firstly, privacy. CBTS allow the regulator to easily control who, how much, on what and under what circumstances spends their funds. On the one hand, this helps protect against financial crime, but on the other hand, it opens up, according to privacy advocates, unreasonably wide access to private life.
Secondly, safety. Digital banking systems rely on technologies such as blockchain and smart contracts, and they are regularly targeted by cybercriminals. Moreover, it is one thing when fraudsters exploit vulnerabilities in yet another “homegrown” cryptocurrency, which is used by a relatively small number of people, and quite another thing when an attack occurs on a currency accepted at the state level. The consequences can be catastrophic.
Thirdly, the impact on the economy. The introduction of the central bank may have different effects on the state’s monetary policy, interest rates, loan rates and other parameters of the economy. The danger is that it is difficult to predict this impact now, while such money has not become widespread in economies.
Despite all of the above, the central banks of many countries and territories are looking towards the Central Central Bank with great interest. In Hong Kong, for example, they look especially closely. The experiment, which ended in October, showed the viability of a new type of digital currency in several scenarios.
Scenarios for the digital dollar
The Hong Kong government recruited 16 companies from the financial sector to participate in the pilot test. Project participants tested several scenarios for using the digital dollar. Among them: complex payments, offline payments, programmable payments, Web3 transactions and others. We will show you the most interesting examples.Complex payments
The easiest way to buy a product or service is to pay in cash. During testing, the digital dollar was tasked with completely replacing cash in the transaction process. Replace in this case means preserving all the characteristics that cash has: low transaction cost, “instantaneity” and irreversibility. It would seem that various digital payment systems, such as credit cards and electronic wallets, have long possessed these properties, but in fact, the ability of these payment instruments to perform the function of cash has significant limitations. For example, the seller does not necessarily receive money from the buyer exactly at the moment when he touches the reader with his card. It may take considerable time for the buyer's and seller's banks to complete the transfer. In addition, merchants are at risk of not receiving money due to erroneous transactions. In other words, paying by card only to the buyer looks the same as giving a banknote to the seller. It was this situation that the participants in the experiment intended to correct.HSBC Bank created the concept of a private blockchain-based network in which sellers and buyers could instantly exchange e-HKD, “recording” the fact of the transaction directly into the transaction and eliminating intermediate links in the form of several banks. The method potentially allows you to get rid of payments with delays due to errors and also reduce the cost of the transaction for both parties.
Programmable payments
Programmable payments refer to transactions that can be set with conditions that determine when and how the payment can be made. This is not a new thing; this method is already implemented on the basis of smart contracts, but so far it has been used in relatively simple scenarios, for example, in paying bills. At the same time, the potential of smart contracts allows parties to a transaction to introduce into the contract a set of conditions that prevent payment from being made if they are not met. Such conditions may include the amount of payment and the frequency of payments, as well as changes in these parameters depending on the quality and quantity of services and/or goods provided. In addition, the technology allows for multilateral exchange of information about whether the described conditions have been achieved and at what level.As part of the pilot, HKMA partners immediately made a couple of “programmable” projects. China Construction Bank (Asia) and Bank of China have created prototypes of automated escrow accounts, which, like their counterparts in classical trade and financial transactions, act as intermediaries between buyers and sellers. Banks implemented two scenarios. In the first, the client makes an advance payment to an escrow account, where the money is blocked. Using a smart contract, the conditions under which money can be transferred to the merchant’s wallet are determined, and as soon as they occur, the payment is made automatically. Such a scheme should motivate suppliers of goods and services to do better work, and for the client the risk of losing money on an unprovided or poorly provided service is significantly reduced.
In the second scenario, payments are made in advance, regularly (in subscription format) and immediately to the account of the supplier of the product or service. However, payments occur with a programmed return condition if the service or product does not meet the conditions written in the smart contract. This scheme may be suitable for those companies whose business is dependent on a constant flow of revenue - for example, small companies just starting their journey.
The programmable payment concept also allows for the creation of loyalty programs and other marketing tools built right into the e-HKD code - so that even small companies can better research their customer audience and create benefits programs for them. Pilot solutions of this kind were made by Hang Seng Bank, HSBC and AliPayHK.
Scenario for using programmable payments in investments
In addition, programmable payments can significantly speed up investment transactions and make them less risky. As part of its pilot, ArtaEmail adapted smart contracts and e-HKD to carry out trading operations on the exchange. As in previous examples, the client’s money is placed in an escrow account, but is spent only if the assets meet the conditions specified in the smart contract. If the conditions are not met, then the money is simply returned to the investor’s account. This scheme protects the investor from situations where he has decided to buy shares at one price, but due to various technical and documentary delays, the transaction is completed too late and the share price changes.
Offline payments
The ability to buy and sell offline is another unique feature of cash that electronic money has not yet been able to replicate. No matter how mobile existing solutions are, they still require Internet access to communicate with the buyer’s and seller’s banks.
Standard Chatered Bank and Giesecke and Devrient have created a concept for a system that allows people to exchange e‑HKD without having access to the Internet. The platform assumes that digital dollars are transferred from one device to another via the NFC wireless protocol, and information about the fact of the transaction is recorded in it and stored on both devices. As soon as at least one of the devices gains access to the Network, information about the transfer made offline will become available to all participants in the system. As in the case of cash, such a payment cannot be made twice, but digital money received offline can be immediately without waiting for “synchronization with the server”, use it for other operations.
Payments in Web3
Web3, the concept of a new generation of the Internet with a decentralized architecture and the active use of blockchain and NFT tokens, has provoked the emergence of a new type of transaction. They involve “tokenized” goods and services, which can often only be paid for using one of many cryptocurrencies—the cryptocurrencies vary from platform to platform. Not all users find cryptocurrencies a convenient and, most importantly, safe payment instrument. Participants in the HKMA pilot decided to combat this problem and made e-HKD a kind of “bridge” between the official digital currency and Web3 goods and services.
Mastercard has developed a concept for a solution that will allow you to buy NFTs using e‑HKD. According to the developers’ idea, during the transaction, a special service blocks the amount of the client’s digital dollars that corresponds to the number of units of cryptocurrency required to purchase an NFT product on the selected platform. After this, a smart contract is created, and as soon as the seller downloads the desired digital product (the contract condition is met), the required amount of cryptocurrency is received into his crypto wallet, and the corresponding amount of e-HKD is debited from the seller’s account.
To put it simply, the concept proposed by Mastercard looks like an automated cryptocurrency exchanger with smart contracts and an analogue of an escrow account. However, its value lies in its ability to resolve the important fundamental tension between the distributed and independent Web3 and the centralized and regulated digital digital banks. To take advantage of Web3, the user needs to have a good understanding of technology, the features of cryptocurrencies, and be prepared to lose money due to sudden fluctuations in rates. But they have a relatively high level of privacy and have access to the opportunities (mainly investment) that NFT instruments offer.
Mastercard's "bridge" for e-HKD users removes this limitation and potentially allows regular users to benefit from Web3.
New opportunities
In addition to the described scenarios, during the pilot test the capabilities of tokenized deposits were tested, allowing instant interbank transactions around the clock, as well as the use of digital currency in real estate transactions and lending. There, it allows borrowers to take out loans from multiple sources at different and potentially better interest rates, while allowing landlords and banks to process transactions more easily and have better control over how their funds are spent.
Following the results of the pilot, HKMA representatives noted that the most promising scenarios were programmable payments, asset tokenization and atomic (i.e. instant) transactions. And although Hong Kong regulators have not yet made a final decision on whether to put the digital dollar into circulation, the results of the first pilot look quite optimistic. The study of promising scenarios will continue in the next phases of piloting.
It is not only the Hong Kong authorities who are optimistic about the Central Bank. Projects for their own digital currencies are being discussed by financial regulators in 114 countries, including such developed economies as the USA, Great Britain and the European Union. Pilots have been launched in 21 countries, including Russia, and 11 countries already have their own digital currency.
It all looks as if the emergence of various CVCBs is no longer a matter of “if”, but “when”. And the Hong Kong digital dollar project, although not the only one and not the first, is still notable for the fact that it demonstrates in many ways how digital money can change the financial relationships of ordinary people, businesses and the state in the near future.
