The Brazilian Central Bank Digital Currency (CBDC) project is finally about to become a reality. On March 6, the Brazilian Central Bank (BCB) announced the commencement of the testing phase for the Digital Real (the tokenized version of the official Brazilian currency), with its definitive implementation expected to happen in about a year, at the end of the development phase – scheduled for February 2024.

According to the plan, the CBDC will serve wholesale operations, with the direct involvement of major financial institutions. For general public use, banks will issue tokenized reals that will be tied to Digital Real’s reserves in the wholesale system.

According to the Brazilian Central Bank, several countries view CBDCs as an opportunity to foster competition and financial inclusion for people with no access to banking services – hence the need to create digital payment systems and financial services, and implement them among the most vulnerable segments of the population.

Following this announcement in the financial market, initial questions revolve around the challenges (and opportunities!) that institutions will face in operationalizing and incorporating the Central Bank’s innovative proposal.

So Parfin explains to you the key benefits and areas of concern of the project that will revolutionize the country’s financial system. Check out the technical and market analysis carried out by our COO/CFO, Carlos Henrique Lopes, on the advent of the Digital Real.

The main challenges for institutional investors 

The first major challenge for the market revolves around knowledge, not only regarding the Digital Real’s impacts but also about the proper training of IT and business professionals. A thorough understanding of blockchain technology, its logic, and the programming languages associated with the subject is crucial to embark on the initiative.

The second challenge is the interoperability with (i) legacy systems, such as current payment, settlement, and custody systems (SPB), and (ii) other blockchains in the ecosystem (wholesale or retail), as each financial institution (FI) may have its own blockchain, and it will be necessary to develop mechanisms for them to connect.

That challenge is related to the third one, which involves providing all functionalities of the Brazilian Payment System (SPB) on the blockchain without legal arbitrariness in the technical solutions. A new "sister" structure to the Reserves Transfer System (STR) and the Instant Payment System (SPI) will be set up, which will connect to the National Treasury, the Special System for Settlement and Custody (SELIC), the B3 (Brazilian stock exchange), and the Interbank Payments Clearinghouse (CIP). The advantage is that the technology will increase the efficiency and transparency of several processes.

And last but not least: when money is programmable, the potential for innovation is broadened, and this will bring about new business models. Evaluating and prioritizing them won't be easy. Any asset representing value could be tokenized, and any transaction that involves a buyer (holder of a tokenized deposit) and a seller (holder of an asset) could happen without intermediaries by means of decentralized finance (DeFi) smart contracts, such as "Delivery versus Payment" (DvP), liquidity pools, etc.

And the list goes on: compliance, back office, and cybersecurity teams will need to get to grips with the technology to ensure that all procedures (AMLFT, LGPD, bank secrecy, self-custody and customer custody control) remain secure.

"Innovation knows no bounds, and the introduction of a digital currency will open up possibilities that were previously unattainable. Technology can bring about significant changes in the way things are currently executed and give rise to new business models. The gains will be relevant: we will have more efficiency, fewer processes, fewer people, lower costs, and fewer services with risks associated."

Carlos Henrique Lopes 
COO/CFO Parfin

Opportunities are coming up!

With a digital currency, Brazil will have more payment options. In the BCB’s Laboratory of Financial and Technological Innovations (Lift), some projects simulate DvP between the Digital Real and a car or between the Digital Real and a property. Have you ever considered the possibility of buying a good without the risk of paying for it and not receiving it?

The BCB is spearheading the initiative, but it will certainly not be alone in this ecosystem. Entities such as the State Traffic Department (Detran) and notaries will probably get integrated in the not-so-distant future. Imagine a scenario where a citizen has a tokenized property; the owner could use it as collateral in a liquidity pool and receive a loan – mostly online and with no red tape. Another example using the CBDC would be a foreign exchange operation (USD-BRL): it could be as simple as sending tokenized reals to a smart contract that delivers tokenized dollars, and this smart contract informs the regulator and the FI about everything they need to comply with the legislation, not to mention the fact that the operation is executed instantaneously.

Moreover, the launch of the Brazilian CBDC pilot project will include financial transfers between clients of two different FIs, using tokenized Real issued by one institution settling in tokenized Real of the other institution, as well as bilateral operations of these clients with Federal Government Bonds (TPFs). This use case will allow the inclusion of other assets later on, and, for example, a client to have access to repos with TPFs or with Corporate Bonds that are currently inaccessible and/or subject to limited access.

And how should institutions prepare for this innovation? 

They should establish teams to study the CBDC and its impacts on their infrastructure. The team should be multidisciplinary, as it will be responsible for understanding and coordinating all the changes that need to be made in the FIs departments (reserve pilots, custody of government/corporate bonds, foreign exchange operations, and so on). Some questions came up, such as: have you realized that the SPB message catalog will work on blockchains? How will an STR0008 between different FI clients work? How will an FI keep custody of a car, a property, or any other asset and still show it on its client’s statement? This team must be responsible for sharing knowledge within the FI, as everything will be new to everyone. To me this is another step for an FI to become a major integrator between finance and the real economy.

However, numerous precautions should be taken. Once the technology is understood, several processes should be redesigned to ensure efficiency and generate points/hubs of innovation and possibly new business models. So, the first precaution is in defining the blockchain topology that the FI will adopt. Once it is defined, the redesign of processes should result in efficiency gains, but it will need to coexist between different worlds – the electronic and the digital. Attention must also be paid to the regulatory side, mainly with custody. The concept now is: what you need to keep is the private key, not the asset itself; thus, the security aspect is crucial.

FIs are unlikely to delegate custody of their assets and clients’ assets to third parties. Therefore, they will need to delve deeper to set up adequate infrastructure.

And what can Parfin do for institutions? 

Parfin, a leader in infrastructure for Web3, has been monitoring the development of the Brazilian Central Bank initiatives and is very close to regulators and the market. We have a highly skilled team and have built an infrastructure with cutting-edge technology that enables our clients to accelerate access to this new market framework.

Some of our clients have been able to integrate our infrastructure into their systems in just six weeks, during which the first tests were run in production.

"We provide all the framework that accelerates entry into the digital asset market, tokenization, control and execution on Digital and Tokenized Real, in addition to native functions of the platform that simplify issuance, register, transactions, transfers, and settlement of bonds and securities operations."

Carlos Henrique Lopes  
COO/CFO Parfin

Additionally, we offer the market an institutional custody solution, that leverages the best of MPC (Multi Party Computation) technology and HSM (Hardware Security Module), where FIs can maintain custody over private keys with complete security and control. Thus, it's possible to adapt this technology to each client, offering them all the necessary control and security. 

Parchain, a permissioned ecosystem of blockchains, can complement the Digital Real project. Private, secure, and scalable, besides being EVM-compatible, it has interoperability as one of its main features – digital assets from other blockchains that are also compatible can be transferred through bridges.

Institution: it's time to take a step into the future!

Is Digital Real still a topic that raises questions within your company? Are your teams ready to join an extremely fast-paced and cutting-edge digital market? Head to parfin.io and book an appointment right now with the top Web3 infrastructure provider in Latin America!