The head of the Federal Reserve’s New York Innovation Center (NYIC), Per von Zelowitz, joined Wilson Sonsini partner Jess Cheng for a conversation on the central bank’s payments innovation initiatives regarding the future of money and new financial market infrastructures at an American Bar Association (ABA) Business Law Section event in New York City on June 7, 2023.¹ This alert briefly summarizes the event’s key takeaways.

The discussion illuminated the attention the U.S. central bank is giving to blockchain and distributed ledger technology (DLT) for improving the efficiency of payments, clearing, settlement, and trading systems. Importantly, the conversation highlighted the sophisticated, forward-thinking research underway at the NYIC in enhancing the movement of money and transfer of financial assets—as well as the emphasis it places on the role of collaboration with private sector partners.

Fintech companies should pay close attention to the NYIC’s experimentation in digital currencies and its prototyping of new DLT-based foundations for next-generation infrastructure. These initiatives may yield new opportunities for responsible payments innovation by the private sector. More immediately, they offer expert and objective articulations of potential value propositions for emerging technologies. Experienced legal counsel fluent in both financial technology and payments law can assist fintech companies to act on these insights and opportunities.

Key Insights on the Central Bank’s Cutting-Edge Research

The NYIC is a strategic partnership between the New York Fed and the Bank for International Settlements, established in 2021 to explore the potential of technological innovation in central banking to benefit the global financial system. The NYIC team works with a range of partners, including other central banks and private-sector financial institutions and technology providers.

• The NYIC focuses on high-value use cases where it believes payments innovation has the greatest potential to make significant practical impact. The opportunity areas it has focused on to date are cross-border payments and delivery versus payment (DvP) securities settlement. Private-sector innovation in these areas is already underway, and the central bank is uniquely positioned to amplify its impact.
• Settlement finality in central bank money contributes to the safety and efficiency of financial markets. The NYIC’s prototyping has focused on how technology can underpin enhancements to settlement finality in payments—in particular, atomicity (in which the segments of a set of coordinated transfers happen together or not at all) and interoperability (across other central bank systems and with private-sector ledgers). The NYIC has confirmed the technical feasibility for these enhancements to support more currency corridors and deliver new efficiencies in payment versus payment (PvP) transfers, though important legal, commercial, and operational questions remain.
• Tokenized assets and reliance on DLT for the holding and transfer of financial assets is garnering significant attention. The NYIC is exploring the feasibility of an interoperable network of central bank wholesale digital money and commercial bank digital money, operating on a shared multi-entity distributed ledger.
  • Such a DLT-based infrastructure would enable the central bank to provide platforms and infrastructure for new forms of money, allowing the private sector to innovate and, for example, embed in tokenized assets characteristics that are not possible today. Important legal questions nevertheless remain.
  • Separately, Acting Comptroller of the Currency Michael Hsu also recently reinforced his view that tokenization has the potential to improve settlement efficiency by minimizing lags and thereby reducing the associated frictions, costs, and risks, particularly where the technology is interoperable with central bank money and other settlement systems. However, “the legal frameworks—and risk and compliance capabilities—for tokenizing real-world assets and liabilities at scale need further development.”

Mr. von Zelowitz and Ms. Cheng also discussed how technology trends often progress slowly until an inflection point is reached, after which developments proceed quickly. The NYIC aims to keep pace with these trends by conducting rigorous research on emerging technologies in relatively nascent stages, with the goal of being well-positioned to support the private sector when momentum builds around such technologies.

Experienced legal counsel can likewise assist fintech companies in keeping a pulse on the central bank’s innovation priorities, staying attuned to the areas of opportunity, and ensuring alignment in approaches to traditional and emerging payment system risks.

Takeaways

The experience of the NYIC—as well as other financial institutions and fintech companies—makes clear that payments innovation requires open-mindedness to potential use cases for new technologies, business-minded pragmatism to delivering viable solutions, and creativity in considering their legal and possibly regulatory ramifications.

[1] Mr. von Zelowitz noted that the views expressed in the event were solely those of his own and should not be interpreted as reflecting the views of any Federal Reserve Bank, or the staff of the Federal Reserve System.