Introduction

Thank you for the opportunity to discuss the role that tokenised assets and money might have in shaping
the future of Australia’s financial system. My remarks today will centre on three themes. I will
begin by drawing out some lessons from history as they relate to the evolution of our commercial and
monetary arrangements. I will then outline the opportunities and challenges arising from the tokenisation
of assets and money in the digital age. The punchline here is that tokenisation offers some intriguing
possibilities, but is not without its challenges and more work is needed to understand how we could yield
the benefits while managing the risks. Finally, I will discuss how these issues connect to the next phase
of the Reserve Bank’s strategic work program on the ‘future of money’.

Some lessons from the sweep of financial history

One lesson from history relates to the co-dependence of our commercial and monetary arrangements.
We’ve seen this when commercial activity has chafed against the constraints of the existing monetary
system, before new technologies enabled the monetary system to adapt and accommodate new forms of
exchange.

Take the introduction of paper money. The issues facing merchants trading across the expanses of the
middle kingdom during China’s Song Dynasty (960–1279) were similar to those plaguing the
merchants of Renaissance Europe some 500 years later. In both cases, a chronic shortage of
high-value coinage was a severe constraint on commercial exchange – lugging piles of copper coin
around was hardly conducive to trade. But with the invention of paper (in China) and the printing press
(in Europe) a revolutionary solution was born – paper money.

This interdependence didn’t stop there. The industrial revolution that fuelled the expansion of
global trade was preceded by all manner of financial and monetary innovations. Among them were novel
forms of money like bills of exchange, alongside new types of financial infrastructure and intermediaries
– think of the double-entry book-keeping administered on paper ledgers by the Medicis of Florence.
The socio-economic forces unleashed in this period were immense: the corporation was born, capitalism
flourished and the new merchant class became a political force. Turning to the computerised age of more
recent decades, the dematerialisation of finance saw paper-based forms of assets, money and record
ledgers give way to electronic variants. This fuelled efficiencies that must have seemed unimaginable
half a century ago.

A second lesson we can draw from history is that in the absence of public money evolving to support new
forms of commercial activity, private money has attempted to fill the void – but with decidedly
mixed success. Consider here the disastrous experiment with privately issued notes by ‘wildcat
banks’ during the US free banking era in the mid-19th century. This was a period when no national
currency circulated and unbacked private notes traded chaotically at large and variable discounts,
highlighting that monetary instruments lacking in trust can do more damage to the economy than good. This
was followed (with a bit more success) by the gold era where commercial banks maintained liquid asset
reserves equal to a fraction of the money they issued. But the clearest success story with private money
has been the digital money (i.e. deposits) issued by well-regulated banks in recent decades. In all
modern economies, Australia’s included, this form of money has become dominant. There is good reason
for this.

The enduring challenge for private money is to closely replicate the special features of safe public money
so that they are interchanged at the same rate, thus preserving the ‘singleness of money’. This
requires private money to have enough credibility so that the public is willing to exchange it at par
– without question – into public money or goods and services. Private issuers have sought to
bridge this trust deficit by fully collateralising the money they issue and/or by subjecting themselves
to regulation and supervision. Unbacked cryptocurrencies issued outside the regulatory perimeter have
tried to buck this pattern, without success.

This brings us to a third lesson – the two-tier monetary system comprising the central bank and
commercial banks has served the economy well because it combines the best features of public and private
money. Comparative advantage, and the separation of responsibilities between public and private sectors,
helps to explain why. A reputable central bank is uniquely placed to serve as both an ‘anchor’
and ‘enabler’ in the two-tier system. As an anchor, it provides a foundational
level of trust – trust in the value of public money and on which private money builds; trust in the
finality of payments by settling claims at par across its balance sheet; and trust in the stability of
the wider financial system. As an enabler, the central bank promotes competition by
providing base infrastructure on which private institutions innovate to meet the preferences of firms and
households. As we contemplate how our monetary and financial arrangements might evolve in the years
ahead, my sense is that our efforts should be concentrated more on uplifting than replacing the two-tier
system. And this is where tokenisation comes in.

What might a tokenised asset ecosystem look like?

The tokenisation of assets presents some interesting possibilities for the digital era. Before setting out
why, a few clarifications are in order, starting with some of the features that might distinguish a
tokenised financial ecosystem (Table 1).

The simplest way to think about the tokenised assets that I will focus on today is as digital bearer
instruments that represent claims on underlying assets that exist in the real (traditional finance,
‘off chain’) world. But tokens confer more than just ownership rights. They also contain rich,
unique information that can be updated instantaneously, and can be programmed via smart contracts to
perform functions that are not currently performed in traditional finance applications. Tokens can be
exchanged bilaterally 24/7 on decentralised ledgers that are publicly
or privately accessible. The role for intermediaries may evolve in this
setting, reflecting a reduced need for market making activity and less manual reconciliation of records
which can be duplicative, costly and prone to error. While the full potential of tokenisation requires
assets and money to exist on the same ledger – as this would allow for ‘atomic’
settlement (simultaneous post-trade swapping of payment for an asset) and the real-time updating of
ownership records – separate but synchronised platforms could achieve a broadly similar end.

So much for the technology. The threshold policy question is what potential benefits could tokenisation
crystalise, and are the downsides manageable? These issues need to be understood in the context of the
frictions and risks in our current system, and with recognition that they could unfold differently in
different markets.

Let’s start with some of the potential benefits:

• Increased liquidity, informational transparency and auditability. More timely and
  complete information available in tokenised settings could help to complete markets and boost
  economic efficiency. For instance, consider that pricing in the $750 billion market for bank
  term deposits – comprising around 15 per cent of bank funding in Australia – is
  still largely conducted over the phone, in branches, by email, and on spreadsheets, much like
  25 years ago. Is this the best we can do? Separately, enhanced auditability is one channel by
  which informational transparency could spur activity in developing asset markets. This is
  particularly relevant for nature-based markets like biodiversity or carbon credits, where underlying
  exposures are diverse and data needs to be verifiable in real time to enhance trust. Tokenised
  markets for green bonds, where coupons are linked to real-time measures of clean energy generation,
  are just the tip of the iceberg. More generally, the combination of better information, lower
  barriers to entry from direct access to markets, fractional (partial) ownership and the ability to
  transact and settle 24/7, could increase liquidity in markets and
  increase the scope for mutually beneficial trade. This includes by lowering the cost of capital for
  existing borrowers, opening up access to capital for new borrowers and widening the investable
  universe for suppliers of capital.
• Reduced risks, costs and improved capital efficiency from shorter settlement cycles.
  Eliminating delays between trade execution and settlement, which could occur on ledgers 24/7, could free up collateral and reduce counterparty, operational and
  market risks.
• Reduced intermediary and compliance costs. Token programmability has the potential to
  cut through layers of manual processes currently embedded in the trade lifecycle. As a case in point,
  given that transactions in the securitisation market can involve up to 12 intermediaries, it is
  perhaps little wonder that fixed income markets are viewed by some as ripe for disruption.
  Meanwhile in cross-border payments, fees charged by correspondent banks comprise a large share of the
  5–7 per cent average cost of sending remittances.
  Beyond clearing and settlement benefits, the programmability of asset tokens could help to take out
  costs and frictions in compliance checks and in asset servicing, including the calculation and
  payment of interest and the conditional rebalancing of asset portfolios.

One way to view the growing global interest in tokenisation can be seen in the issuance of around
$4 billion in tokenised bonds in recent years. The official sector has accounted for more than half
of this issuance, including the European Investment Bank, the central bank of Thailand, Hong Kong SAR,
and local Swiss and US government entities. Private sector issuance over the past year has included the
tokenised bond offerings of UBS and Siemens (Graph 1).

However, none of this is to suggest that a transition to tokenised finance would be without its
challenges. A few stand out in this respect:

• Regulatory uncertainty and compliance obligations. It is a perennial regulatory
  challenge to ensure innovation can flourish in a way that is consistent with financial stability and
  consumer protection. Some innovations in tokenised finance have occurred in a grey zone, on the edge
  of the regulatory perimeter. A common theme globally is uncertainty around governance and risk
  management responsibilities – if a smart contract on a programmable ledger goes awry,
  cross-border and anti-money laundering responsibilities do not disappear, but who is accountable?
  Only a small number of jurisdictions have established new regulatory frameworks supporting tokenised
  asset markets, while others have observed that innovations in tokenised finance should operate within
  existing regulatory frameworks. In Australia, work on a regulatory framework for tokenised assets is
  being led by Treasury, with support from agencies comprising the Council of Financial Regulators.
• Interoperability. As investment in new technologies can be costly and take time for
  participants to implement, tokenised asset markets will need to be interoperable with traditional
  infrastructure for the foreseeable future. Communication between different technologies – both
  ‘on’ and ‘off’ chain – will be critical to limiting fragmentation between
  assets traded across different venues. This could otherwise result in different prices and ownership
  information existing in relation to the same underlying asset. And investors may seek the assurance
  that if the ‘on chain’ network malfunctions, they still have recourse to the underlying
  asset recorded and held ‘off chain’.
• The impact on transactional liquidity from prefunding and fragmentation. In a world of
  atomic settlement, trades (and even orders) would need to be prefunded, increasing liquidity
  requirements for market participants. In markets where intermediaries contribute significantly to
  traded volumes, this could lead to market makers showing less competitive prices and widening bid-ask
  spreads. Liquidity conditions could also be made worse by the fragmentation of trading volumes
  between decentralised platforms and traditional financial infrastructure.

To sum up, we should be wide eyed to these challenges. It’s very possible they can be overcome, but
more work by policymakers and industry is needed.

Tokenised money

Transactions in tokenised asset markets could settle in traditional money, though the separate ledgers
required to do so would entail some loss of efficiency. As tokenised money holds out the potential to
yield more of the benefits from tokenised exchange, let me now turn to four candidates:

• unbacked cryptocurrencies
• asset-backed stablecoins issued by banks or non-banks
• tokenised bank deposits
• wholesale central bank digital currency (CBDC) as a tokenised form of central bank reserves (exchange
  settlement (ES) balances in Australia).

By process of elimination, I will begin with unbacked cryptocurrencies like Bitcoin that natively use
blockchain technology. The fundamental issue here is one of trust – or a lack of it. With no
reference to backing assets and operating outside of regulatory oversight, the wild price volatility in
cryptocurrencies (multiples of gold, to which they are sometimes compared) has made them more amenable to
speculative investment than serving as a safe settlement instrument. A lack of fungibility, scale issues
and high fees have also rendered them ill-suited as a medium of exchange. It’s possible that
unbacked cryptocurrencies remain a hotbed of speculative interest, but I struggle to envisage them
playing an expansive role in the financial system of the future.

It is certainly
plausible that stablecoins issued by well-regulated financial institutions and that are backed by high
quality assets (i.e. government securities and central bank reserves) could be widely used to settle
tokenised transactions. But it is more contestable whether this would be the case for stablecoins issued
by institutions that currently sit outside the prudential regulatory perimeter, including non-bank
financial institutions and technology companies. There are a range of issues here, the most fundamental
of which is the risk that a stablecoin issued by non-banks would be more likely to trade below par value
compared to banks, reflecting differences in perceived credit risk. History tells us that much will
depend on the effectiveness and credibility of the regulatory regime governing stablecoin issuance.

Tokenised bank deposits have received less attention to date than stablecoins, but as the BIS has recently
noted, some of their features may make them more suited to settling tokenised transactions. Consider that
when payments are made today using bank deposits, their interchangeability at par with central bank money
is underpinned by effective prudential supervision and the central bank facilitating settlement of
obligations arising between banks (and other payments service providers). This eliminates exposures
between these entities, and the system would not change in a world where interbank payments were made in
tokenised deposits.

The risk of fragmentation might also be higher for stablecoins than tokenised bank deposits.
Interoperability problems could emerge if, as seems plausible, competing stablecoin issuers felt they had
no incentive to support trade in rival stablecoins. Having to manage a multitude of different coins that
were accepted on some platforms but not others could forfeit whatever economic efficiency gains were on
offer from tokenisation. But given deposits issued by a range of banks are already widely exchanged and
settled (at par) across the central bank balance sheet, the introduction of tokenised bank deposits would
represent a minor change to current practice – a payment between two parties using tokenised
deposits would still be settled via a transfer of ES (or wholesale CBDC) balances between the payer and
payee bank.

Another issue more relevant to stablecoins than tokenised bank deposits relates to their potential impact
on collateral markets and credit provision. In some countries, Australia included, the government
securities market is not particularly large and a material share of outstanding issuance is already
encumbered in liquid asset requirements for banks, repo transactions and central bank holdings. In the
absence of a CBDC, there is a question whether there would be sufficient high quality domestic collateral
to support stablecoin issuance at scale. And if banks issued fully backed stablecoins, this would
represent a return of sorts to the ‘narrow banking’ regime of past eras which (by design)
constrained credit allocation decisions. But in a world of tokenised deposits, banks would
continue to extend credit with the usual risk-based considerations in mind.

I’ve said little yet about where a wholesale CBDC could fit into a tokenised ecosystem. One
possibility is that a CBDC might not be necessary at all. Today’s ES balances could instead be used
by suppliers of tokenised deposits to settle their exposures with other payments service providers, or a
modernisation of financial infrastructure could deliver benefits to the financial system in a minimally
disruptive way. An example here could be the so-called ‘trigger model’, with settlement
triggered via an interface between the existing real time gross settlement system and the platform(s)
where digital assets trade.

At the same time, of the various forms of tokenised money under consideration, only a wholesale CBDC would
be completely free of credit and liquidity risk. In representing the ultimate form of safe money, it
could help to anchor and spur innovation in the financial system – including realising the full
benefits of atomic settlement and programmability – just as ES balances do today. As a wholesale
CBDC would simply represent an advanced form of central bank money that has underpinned the Australian
financial system for decades, this would represent an evolution in the two-tier monetary system –
not a revolution. Though there are many issues still to resolve, these are some of the reasons why the
Bank, and many of our international peers, are actively examining the case for wholesale CBDC.

Tokenisation in Australian financial markets – Some hypothetical scenarios

Quantifying the potential benefits of tokenised exchange is a challenging exercise, not least because it
is a greenfield area and tokenisation could support the growth of markets that don’t currently exist
on any scale. At the same time, it is possible to sketch out some hypothetical scenarios for cost savings
in established markets, based on a range of assumptions for transaction costs, turnover and the cost of
capital.
To be clear, these are not forecasts. Rather, they are based on a fraction of the benefits that emerged
in the electronic trading era, and can be paired with data on issuance, turnover and bid-ask spreads for
various Australian asset classes to produce some hypothetical estimates of potential benefits
(Graph 2).

The first set of estimates points to hypothetical transaction cost savings in Australian financial markets
in the range of $1–4 billion per year (Graph 3). This reflects two drivers: tighter
bid-ask spreads reflecting increased trading volumes; and gains from atomic settlement driving down other
fees, including those currently paid to correspondent banks involved in cross-border payments, savings
from reduced collateral requirements and reduced fees from a lower incidence of settlement fails.

A second set of hypothetical estimates suggests that savings of up to $13 billion per year could be
available to issuers in the Australian capital markets (Graph 4). The ranges here reflect different
assumptions for the decline in the cost of capital associated with reduced liquidity premia, and the
share of outstanding issuance that is refinanced at the lower cost of new issuance.
It’s beyond our scope here to discuss wider economic spillover effects, but to the extent that the
cost of capital was lower than otherwise, it would also likely offer some support to investment.

Ultimately, it won’t be possible to make concrete statements about the effects of asset tokenisation
– including on market liquidity and cost savings from faster settlement cycles – until the
ecosystem is better developed. It does, however, seem reasonable to surmise that two types of markets
stand to benefit most from tokenisation: (i) greenfield markets that could develop rapidly by leveraging
programmability and better informational transparency; and (ii) established markets characterised by
manual processes in the trade lifecycle and that don’t already benefit from efficiencies (via
arbitrage relationships) resulting from active derivative trading. In an effort to better unpack the
issues, this is emerging as an active area of research at the Bank and among some of our research
partners at home and abroad.

The Bank’s future of money work program

Let me conclude with some takeaways from our recent CBDC pilot project, and how these connect to the
Bank’s future of money work program.

First, the project highlighted a range of areas where CBDC could add value in wholesale payments,
including by facilitating atomic settlement in tokenised asset markets. Around one-third of the piloted
use cases assessed opportunities for CBDC-enabled atomic settlement to enhance the operation of
established financial markets, or facilitate the development of new asset markets such as those for
biodiversity and carbon credits. We’ve taken a signal from this industry interest.

Second, the project highlighted opportunities for a wholesale CBDC to act as a complement to (rather than
substitute for) new forms of privately issued digital money, namely tokenised bank deposits and
asset-backed stablecoins.

Third, further applied research is needed to better understand operational design issues for new forms of
ledgers. This includes scalability and throughput considerations, and interoperability between
‘on’ and ‘off’ chain ledgers.

Fourth and more generally, the project highlighted the importance of a modern regulatory framework that
supports both innovation in digital financial services and financial stability. Treasury’s token
mapping exercise will help in this regard. Enhancements to the regulatory sandbox arrangements in
Australia, possibly informed by the United Kingdom’s recent experience, also seem worthy of further
consideration.

So where is the Bank on its future of money journey? Our overarching position is that we remain
open-minded as to the functional forms of digital money and supporting infrastructure that could best
support the Australian economy in the future. We have an active research program underway and are letting
the evidence guide us. Some focal points for this program over the next year are as follows:

• We are in the early stages of planning for a new project assessing how different forms of digital
  money and infrastructure could support the development of tokenised asset markets in Australia.
• The Bank and Treasury will publish a joint report around the middle of 2024 that will provide a
  stocktake on CBDC research in Australia and set out a roadmap for future work.
• The Bank will continue to actively contribute to international work streams, including those aimed at
  reducing the frictions in cross-border payments.
• The Bank will step up its engagement with a range of external stakeholders on the future of money.
  This will take a variety of forms and include industry, academia, government agencies, other central
  banks and the wider public.

In closing, the question of how we might arrange our monetary system to better support the Australian
economy in the digital age is now a key priority for the Bank. We are on a journey here, and look forward
to engaging with you and your ideas on how this might best be achieved.