Hi David! Let’s dive straight in. SDX’s strategic goal is to create a global liquidity network for digital assets by investing in the digital financial ecosystem that will enable this. What have you achieved so far in working towards this goal?
We started with the recent launch of SDX: the world’s first fully regulated digital exchange with a license to operate a CSD on a distributed ledger. SDX offers a fully integrated platform for issuance, trading, settlement, servicing, and custody of digital assets. Since our launch, we have already demonstrated that the SDX platform can equally support wholesale CBDC to settle transactions in digital assets through Project Jura and Helvetia conducted in conjunction with the SNB and BIS and, in the case of Jura, also with the Banque de France. A CBDC is a key to the successful build-out and adoption of a token-based financial ecosystem and to leveraging the full potential of DLT and blockchain technology. That potential includes, for example, the efficiency gains and risk reduction realized through atomic trading and settlement. What we have deployed in SDX is effectively a solid foundation. However, further geographic expansion and the creation of a global liquidity network for digital assets can only be achieved through collaboration with existing and new players, through the adoption of global standards, technical interoperability and regulatory harmonization. Our joint venture with SBI Digital Holdings to build out the Asian Digital Exchange in Singapore – focusing on Crypto and Digital Assets – is another significant step in this direction.
From an investor’s perspective, what are some of the benefits of digital assets? How is SDX helping to demonstrate these benefits to the wider market?
Token-based ecosystems supporting digital assets promise a variety of benefits. These range from widened access to capital markets (e.g. investors can invest in small and mid-sized companies that haven’t been traded publicly), increased transparency and liquidity, fractionalization, efficiency gains, or new investment opportunities. SDX has taken a pioneering role and laid the foundation with the first FMI-regulated Digital Asset Exchange launch based on Distributed Ledger Technology. Our platform and the product suite will be continuously enhanced to allow investors to take advantage of the benefits mentioned above. In September 2021, FINMA granted licenses for SDX to operate both a stock exchange and a CSD. Following this and our subsequent go-live – and issuance of our first digital bond – in November 2021, SDX is now open for business. We expect to see more issuances on the platform in 2022 and onboard more members. The onboarding and initial digital bond transaction in November was another historic milestone for SDX, Switzerland, and capital markets in general and has raised our profile and attracted attention around the globe. Since then, we have had overwhelming positive feedback and high interest in additional business. I’m excited to see SDX continue its 2021 track record of industry ‘firsts’ in 2022.
What’s different with the settlement process when applied to digital assets and DLT? What do terms such as “atomic settlement” and “on-chain settlement” mean in the context of this new technology?
When we talk about digital assets, we often refer to the ‘atomic swap’ of the asset and cash legs of the transaction. This is the DLT-based equivalent of delivery versus payment (DvP), whereby a guaranteed transfer of securities only happens after payment has been made, thus reducing settlement risk. SDX, however, offers a ‘more’ atomic service between our exchange and our CSD, whereby the execution of a trade on the exchange, and the settlement of that trade in the CSD, are atomic. Therefore, we can offer three-way atomicity, whereby trade execution, transfer of securities and transfer of payment either synchronously take place or else not at all. Most digital asset platforms support the on-chain (or on-ledger) transfer of the asset leg, but the payment leg – like a classic DvP settlement – must be transferred on a separate system, referred to as an off-chain transfer. This leads to substantial complexities in settlement and eliminates many of the potential benefits of digital assets, as settlement risk remains in the transaction.
What are central bank digital currencies (CBDCs) and stablecoins? How can they help to address some of these settlement issues?
DLT can support all types of tokenized assets, including settlement assets such as cash. It can support the tokenized versions of central bank money and commercial bank money, which are CBDC and fiat-backed stablecoins, respectively. It could also support more exotic flavours of stablecoins, such as tokens issued by various corporations and backed by multiple types of more or less liquid assets, ranging from reserve balances to liquid debt instruments and securities, through to less liquid assets – these are typically referred to as ‘reserve backed stablecoins’. Then there is the very different category of stablecoinsm known as ‘algorithmic stable coins’ which use a mechanism for maintaining their value. UST – the Terra stablecoin which has been in the news lately due to its spectacular failure is an algorithmic stablecoin. At SDX, we only use tokenized commercial bank money that is 100% backed by reserve balances at the Swiss National Bank (SNB), held in an account in SDX’s name, which can be converted one-to-one, at all times, into Swiss francs. This is as close as we can get to tokenized central bank money in terms of what is currently achievable under the policies of the SNB. I would also expect regulators to have a say in the type of stablecoins that a CSD can use through direct regulatory intervention or by demanding that stablecoins used for settlement are backed by a very high level of reserves, transparency around what those reserves consist of and there will be expectations around the operational robustness of the reserve liquidity process.
How might the availability of a wholesale CBDC be a game-changer for the settlement of digital assets in general and SDX in particular?
There are two main ways in which wholesale CBDCs could be game-changers. First of all, if the access criteria for holding and using them will be broader than the current criteria for being part of a national payment system, we could see a much-needed shortening of the chains of correspondent banking arrangements, thus reducing frictions and the cost of cross border transfers. Secondly, while CBDCs can undoubtedly be used for the settlement of traditional assets, they could also be used for settling digital asset trades. The use of a high-quality, safe and stable CBDC for the settlement of digital asset transactions would unleash the potential of the emerging digital assets ecosystem while reducing the overall risk profile of such transactions. DLT makes it possible, and easier, for a broad range of intermediaries to hold and transfer central bank tokens – that is, CBDCs – including non-domestic banks. We have successfully experimented with such scenarios through our participation, alongside SNB, the BIS Innovation Hub, and several domestic and international banks, in Project Jura (which also included the Banque de France) and Project Helvetia. Through Project Helvetia, we have shown that we can extend the SDX settlement model to easily support settlement using a wholesale CBDC. Our DLT platform will allow commercial banks to interoperate. From a technical, operational, and legal perspective, SDX could support a wholesale CBDC today. However, the decision to move forward is a policy decision to be made by the SNB.
In your view as Head of SDX, what are the critical next steps for the firm to take in building out the digital market infrastructure of the future?
SDX represents the dawn of the adoption of atomic settlement by the institutional space. In two to three years, I would anticipate that the concept of the atomic settlement will be fairly widespread in capital markets, in line with the accelerated evolution of a token-based ecosystem. However, I think the practical mass adoption of the on-chain settlement will clearly take some further years. As mentioned before, we have laid the foundation, and now the focus has shifted towards building a functioning marketplace with increased members, products and liquidity. This requires close collaboration with participants from across the financial and digital asset ecosystem and further investments in platform capabilities and new products and services. At the same time, we need to take advantage of market developments and explore and identify the benefits of innovation in technology and the non-traditional assets space.
SIX Digital Exchange is the first fully regulated and fully integrated trading, settlement and custody financial markets infrastructure built on Distributed Ledger technology. The SDX story began in 2018 when our parent SIX Group identified DLT and blockchain as a game-changing technology for financial markets infrastructure. SIX Group embarked on the SIX Digital Exchange initiative with aiming to design, develop and then deploy a fully regulated central securities depositary (CSD) and digital assets exchange based on DLT.