Atomic Settlement: Counting to zero | ShapingFX
Initially emerging from the crypto and blockchain realm, atomic settlement has become a buzzword across financial services. Some even consider it a game changer in the FX world, claiming that it facilitates shorter settlement cycles like T+0. What is atomic settlement, and why is it so novel? And is there a problem with T+2 settlement that needs a solution?
All Greek to me
As is often the case with new developments, there is no agreed definition of ‘atomic settlement’, and it can mean different things to different people. Before discussing its meaning in the post-trade and FX context, it is worth considering how the term evolved over time.
‘Atomic’ derives from the Greek word ‘atomos’, which means uncuttable or indivisible. In the crypto space, the term ‘atomic swaps’ emerged around 2013 to refer to exchanges of crypto assets across blockchains without third-party involvement.¹ Simply put, these swaps can only have two atomic states: fully complete or fail. There is no intermediate state: they either happen or not.
Atomic settlement’s key properties
Approximately two decades ago, the global community of public policy makers agreed on a definition of ‘settlement’: the completion of a transaction wherein the ownership of an underlying asset is transferred from a sender to a receiver. The act of settlement discharges obligations in respect of funds or
securities transfers between two (or more) parties.²
The term ‘atomic settlement’ was developed in the context of research and experimentation around delivery-versus-payment (DvP) and payment-versus- payment (PvP) arrangements in a blockchain environment.
One key attribute of ‘atomic settlement’ is simultaneity, whereby one leg of a transaction settles if and only if the other leg settles. Without going down a technology rabbit hole, it can be said that such simultaneous transfers on an all-or-nothing basis can be achieved, for example, with hash time lock contracts (HTLCs), which create conditionality between two assets. In order to receive the respective assets, the beneficiary must enter a cryptographic passphrase (hash lock) and act within a predetermined timeframe (time lock).³
‘Atomic settlement’ also has a cross-ledger dimension like that of ‘atomic swaps’, at least if HTLCs are used. However, over time the cross-ledger aspect and interoperability became less pronounced, and nowadays certain types of atomic settlement could occur on a single ledger.4
1 The idea of atomic swaps without the intervention of third parties was first presented by Tier Nolan in 2013 in the context of cryptocurrency exchanges. The atomic swap concept was introduced in 2017 by Charlie Lee, who founded Litecoin. 2 CPMI (2003) Glossary of terms used in payments and settlement systems. 3 See, for example ECB / Bank of Japan (2019) Project Stella – synchronized cross-border payments; Bank of Canada / Monetary Authority of Singapore (2019). Enabling cross-border high value transfer using distributed ledger technologies; Federal Reserve Bank of New York / New York Innovation Center (2022). Project Cedar – phase one report; BIS Innovation Hub (2023) Project Icebreaker – Breaking new paths in cross-border retail CBDC payments. 4 See, for example Bech. M, et al (2020) On the future of securities settlement, BIS Quarterly Review; Box C: “If security tokens and the cash tokens exist on the same ledger, then an atomic settlement smart contract can be used to coordinate clearing and settlement. […] If the security tokens and the cash token exist on separate ledgers, then either a centralised party could be introduced to coordinate the transfer or a hash timelock contract (HTLC) could be used.”