4 June 2019

ECB/BOJ joint research project on distributed ledger technologies

Synchronised cross-border payments
Background to Project Stella
The emergence of distributed ledger technologies (DLT) in recent years has spurred discussions aroundthe future of financial market infrastructures (FMI) supporting payments and securities settlement. Since
its inception in December 2016, Project Stella, a joint research project of the European Central Bank(ECB) and the Bank of Japan (BOJ), has contributed to the ongoing debate with experimental work andconceptual studies exploring DLT’s opportunities and challenges for FMI. 1 This work has already resulted
in two reports. Phase 1, published in September 2017 2, analysed the processing of large-value payments
using DLT, and phase 2, published in March 2018 3, investigated securities delivery versus payment in a
DLT environment. The latest phase of Project Stella, “Synchronised cross-border payments,” builds on
the insights gained from the previous two phases to bring our research into the broader sphere of crossborder payments.

Scope of Stella phase 3
Cross-border payments are payments between currency areas that involve various entities acrossmultiple jurisdictions. Compared with domestic payments, they are often characterised as slow and costly.
While initiatives exist to address these current inefficiencies of cross-border payments, the safety aspectsof transactions across payment ledgers remain a challenge (see Box A). In view of this, Stella phase 3
explores whether cross-border payments could potentially be improved, especially in terms of safety byusing new technologies.

1

The analysis and experimental results presented in Project Stella are not geared towards replacing or complementing existingarrangements, which include central bank-operated payment systems. Moreover, legal and regulatory aspects are outside thescope of the project.

2

Payment systems: liquidity saving mechanisms in a distributed ledger environment, ECB and BOJ, September 2017.

3

Securities settlement systems: delivery-versus-payment in a distributed ledger environment, ECB and BOJ, March 2018.

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Box A – Simplified example of credit risk arising from cross-border funds transferCredit risk might arise if a party fails prior to completion of a cross-border transfer. In this simplified example, Entity Aintends to send ¥100 million to Entity C by sending €1 million to Entity B (e.g. an intermediary bank), which hasaccess to both euro and yen ledgers, and in turn sends ¥100 million on behalf of Entity A. If Entity B fails after thefirst leg of the transfer is complete (i.e. the €1m-transfer from A to B) but before the second leg of the transfer iscomplete, Entity A faces the risk of loss of its funds. This risk can be mitigated if the payments are synchronised andfunds are locked, but in today’s world such synchronisation rarely happens.

Approach taken in Stella phase 3
Stella phase 3 builds on the previous two stages of Project Stella. This is particularly so of Stella phase 2,
which identified a new approach for settlement across ledgers through Hashed Timelock Contracts(HTLC) that could potentially allow the mitigation of credit risks through the synchronisation of settlement.
Stella phase 3 expands the scope of this analysis and investigates the safety and efficiency of a variety ofpayment methods that could be used in cross-ledger payments 4 . Payment methods are thereby
understood as specific bilateral agreements between counterparties to settle obligations (see Box B).
Experiments conducted in phase 3 involved synchronised payments between DLT ledgers, between
centralised ledgers and between DLT and centralised ledgers.

Main results of Stella phase 3
The report concludes that only payment methods with an enforcement mechanism, either through theledger itself or through a third party, can ensure that the transacting parties who completely satisfy theirresponsibilities in the transaction process are not exposed to the risk of incurring a loss on the principal
amount being transferred.

4Five methods are assessed in Stella phase 3: trustlines, on-ledger escrow using HTLC, third-party escrow, simple payment
channels, and conditional payment channels with HTLC.

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Box B – Stylised payment chain constituting a cross-border payment
A cross-border payment chain is composed of a series of bilateral payments (between the Sender and theConnector, between Connectors, and between the Connector and the Receiver) that are synchronised via a
cryptographic condition. Some of the payment methods explored in Stella phase 3, for example, use a smart contract
to enforce a conditional payment, whereby funds are temporarily locked until a cryptographic condition for thepayment is fulfilled. When the condition is fulfilled, payment of the locked fund is executed.

In addition, experiments applying a payment method with HTLC 5 proved the technical feasibility ofsynchronised settlement between different types of ledgers, including settlement between DLT andcentralised ledgers. In conclusion, from a technical perspective, the safety of today’s cross-border
payments could potentially be improved by using payment methods that synchronise payments and lockfunds along the payment chain. It should, however, be noted that further reflections on legal andcompliance issues, the maturity of the technology and a cost-benefit analysis would be required before
the possible implementation of such new methods could be considered.

5The experiment was conducted for on-ledger escrow using HTLC.

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