Multi-Currency Settlement Token: A New Approach to Global Trade Settlement
January 18 2024
by Markus Franke
Global trade settlements come with the challenge of determining the best currency for payment. The choice of settlement currency has significant implications, including exchange rate stability, liquidity, transaction costs, and political considerations. Examples include the settlement of roaming charges between carriers, interconnection charges between network operators, delivery cost settlements for postal operators, or the settlement of freight and transportation costs in logistics networks.
In this article, we explore the concept of a multi-currency settlement token (MCST) as a solution to address these complexities. We discuss the basic design setup of an MCST and its potential benefits in bilateral and multilateral settlement scenarios.
The need for a flexible settlement currency
When international parties engage in bilateral trade, determining the settlement currency becomes a crucial decision. If both parties have a preference for the same currency, the choice is straightforward. However, when preferences differ, selecting a settlement currency becomes non-trivial. Factors like exchange rate stability, liquidity, speed, transaction costs, and political considerations all play a role in finding an optimal solution.
A MCST as a novel settlement solution
A MCST offers a unique approach to work around the challenges of settlement currency selection. It allows for the creation of a synthetic mixed-denomination currency that distributes exchange rate risk among multiple parties and currencies. By leveraging distributed ledger technology (DLT), a MCST can be implemented as a decentralized token representing the settlement currency.
Basic Setup of a MCST
The issuance of a MCST can be conceptualized as locking up a predefined linear combination of existing fiat-tracking digital assets (“stablecoins”). The specific combination and weights of these stablecoins are determined based on the desired composition of the MCST. For example, issuing one unit of a 50-50 EUR-USD MCST would require locking up half a unit of a EUR-tracking asset and half a unit of a USD-tracking asset.
The redemption process is the reverse of the issuance process: users send their MCST to a smart contract, and the contract releases the locked-up stablecoins back to the sender. The value of the MCST is determined by the exchange rate development of the constituent stablecoins and depends on the reference currency.
Benefits and Economic Effects
MCST settlement spreads exchange rate risks across the involved parties, reducing the risk for some, while increasing it for others. By allowing a broader set of risk outcomes compared to settling in a single currency, MCST settlement can lead to economic efficiencies, fairer outcomes and increased gains from trade. The DLT-based nature can also increase settlement speed and reduce transaction costs for the parties involved.
For example, in the scenario above where one party prefers EUR and the other prefers USD, MCST settlement reduces the maximum potential loss for the otherwise disadvantaged party compared to settling fully in one currency. The risks are distributed, resulting in a more balanced outcome.
Discussion and Extensions
The composition and design choices of a MCST can be tailored to specific use cases and market requirements. Factors such as the availability of suitable stablecoins, currency needs among settlement parties, and risk preferences must be considered when designing a MCST.
Additionally, the setup can be extended to include more complex compositions, such as replicating currency baskets like the IMF's Special Drawing Rights (SDR). Such solutions can be preferable in global and multilateral settlement constellations but also come with higher design complexity, e.g. when it comes to collateral composition and rebalancing.
Conclusion
The introduction of a multi-currency settlement token (MCST) presents a promising solution for the challenges associated with selecting a settlement currency in global trade. By distributing exchange rate risks and leveraging DLT, MCST settlement offers economic efficiencies and increased gains from trade. However, careful consideration of composition, design choices, and collateral rebalancing mechanisms is necessary to ensure the effectiveness and stability of the MCST system. As technology advances and the market evolves, MCSTs have the potential to transform how international settlements are conducted, fostering a more efficient and inclusive global economy.
For more questions, thoughts or help setting up your MCST on the Mento Platform, contact us.
About Mento Labs
At Mento Labs, we are on a mission to develop the next generation of digital assets for real-world adoption. We innovate, develop and implement transparent digital asset solutions utilizing our expertise in financial and token economic markets, software engineering, and Web3 product design.
We collaborate closely with forward-thinking partners as a trusted innovation provider and support projects from idea creation, to product design and development, all the way to launching digital assets.
For more information please visit us at https://www.mentolabs.xyz and follow us: @MentoLabs.
Discover more
Sign up for
Mento Magazine
Want to know more about Mento?
Introducing Mento Magazine, featuring
news and updates on the Mento platform
and Mento Labs
