Fed Distributed Ledger Tech Report Singles Out Interledger

The Fed’s Faster Payments Task Force is responsible for improving the U.S. payment system. Photo: Tim Evanson

In the latest report from the Federal Reserve Board on “distributed ledger technology in payments, clearing, and settlement,” the future use of distributed financial technology looks more certain than ever. The exhaustive document details potential and known use cases, the path to adoption for new solutions and legal issues and governance among a whole host of subjects.

Three key takeaways from this report:

  • Distributed ledger technology (DLT) represents an opportunity to deal with existing frictions in payments, clearing, and settlement.
  • As DLT matures, compliance and governance requirements must evolve along with the technology to extend the existing framework.
  • An open interoperability standard like the Interledger Protocol (ILP) could spur further innovation and adoption of DLT-based systems for cross-border payments.

First, the report acknowledges that the system currently in place for cross-border payments is less than ideal. Taking the historical perspective, the Fed points out that the methods for executing, clearing, and settling financial transactions have evolved over many years, through iterations of different technologies and gaining complexity. The complexity contributes to friction between siloed systems, and adds additional costs. As a nascent technology, DLT shows promise to improve this system by addressing the inefficiencies and interoperating separate networks.

Next, the document brings a scrupulous attention to the complicated legalities involved in and governance arrangements that are critical for risk management in payments, clearing, and settlement systems. As Ripple’s Deputy General Counsel Jess Cheng noted in her article in the American Bar Association’s Business Law Today, where she explored the application of U.S. payments law to Ripple technology: “the benefits to having a consistent, unitary law governing all transfers made on traditional funds transfer system apply just as well in the context of distributed financial technology” as they do to traditional financial rails. As Vice Chair of the American Bar Association’s UCC Payments Subcommittee, Cheng has partnered with other experts to lead the discussion around cutting-edge legal issues for payments and emerging payment products.

While the question of how the legal framework currently underpinning our global financial system will govern this game-changing technology is a new and challenging topic for many companies in fintech, Ripple has been leading the charge in establishing governance and rules for how our infrastructure solution can integrate and possibly even improve compliance. Ripple has had a seat at the table in the most influential policy discussions, and are very proud to have our Head of Regulatory Relations Ryan Zagone elected to the Federal Reserve’s Faster Payments Task Force Steering Committee.

Additionally, in 2016, Ripple created the Global Payments Steering Group (GPSG), the world’s only blockchain bankers’ network with defined rules and governance. We predict that 2017 will be a crucial year in policy and regulatory decisions that will determine how distributed ledger tech is integrated into the world’s financial infrastructure. That work has already begun.

Finally, the report makes a specific point regarding the need for an industry standard to unify and interoperate parts of the existing structure with the next step in our fintech evolution: DLT. ILP was created with that exact goal in mind, and Ripple is very proud to see its potential  acknowledged by this report.

The section on cross-border payments specifically singles out ILP, explaining exactly how the protocol works and what it is intended to do:

“In addition, a particular industry development of note is the Interledger Protocol (ILP) which allows transactions to flow across different ledgers and creates connection points between two or more digital ledgers. In effect, the protocol defines a set of procedures for proposing a payments path and cryptographically escrowing funds across a series of interoperable ledgers and then subsequently executing the escrowed transactions once the recipient of the payment validates or acknowledges receipt of payment. The ILP is being developed as an open standard and is intended to improve interoperability and streamline the process for transferring digital assets by enabling entities in different countries with different payment systems to more easily transact with one another. Adoption of this or a similar protocol could spur further innovation and adoption of DLT-based systems for the cross-border payments use case.

Read the full report here.