Revolutionizing the Brazilian financial system

In this overview of the current state of the Brazilian financial sector, we will delve into the key pillars of Agenda BC# and its remarkable achievements, including the introduction of Pix and Open Finance. We will also uncover the potential game-changer: Real Digital (Digital Real), a CBDC project set to reshape Brazil’s financial landscape. Get ready to discover the objectives, recent developments, and exciting initiatives like the LIFT Challenge and RD Pilot, propelling Brazil into a new era of digital currency.

Agenda BC#

In 2016, the Central Bank of Brazil implemented its strategic agenda to promote “financial democratization” in the country, called Agenda BC#. This agenda focuses on tackling structural issues of the National Financial System (SFN) through fostering technological innovation.

The agenda has six verticals that seek, among other objectives, to reduce the cost of credit, improve banking regulations, increase the efficiency and competitiveness of the SFN, and disseminate financial education in the country.

These six pillars are:

With this technology-based agenda to solve structural problems and challenges of the SFN, several different initiatives have been made possible. So, far, the most impactful has arguably been the development of Pix, the instant payment system created by the Central Bank, launched in November 2020. In 2022, Pix moved US$2.1 trillion with more than 24 billion transactions, adopted by 130 million individuals and 11 million businesses, and greatly reducing the use of cash.

Another important initiative, which is still in implementation, is Open Finance. The interconnection between financial institutions—with more than 800 participants—will enable consumers to have access to better financial products at lower costs and increase the competitiveness of financial services overall. In the words of the President of the Central Bank of Brazil, Roberto Campos Neto: “The greatest merit of Open Finance is to put the consumer back in control of the management of his data and financial resources (…) Open Finance tries to put all institutions on an equal footing, and what should matter is the quality of the service provided, regardless of the brand and size of the institution.”

These two initiatives have already had an enormous impact on the Brazilian payment system and will continue to transform Brazilian society. And yet, a third initiative has the potential to be even more transformative: the Real Digital or Digital Real (the Brazilian digital currency).

CBDCs (Central Bank Digital Currencies) have been studied and explored by most central banks around the world to solve internal financial system infrastructure challenges—many of them focusing on instant payment systems. In Brazil, a working group was set up at the Central Bank in August 2020 to study the possible applications of a CBDC, which started the Digital Real project.

In February 2023, the President of the Central Bank of Brazil summarized his vision for the combined impact of Pix, Open Finance, and Digital Currency. “Today we already have a digital currency pilot that will start running soon. These three things can change the history of financial intermediation in Brazil, transforming our system into something efficient. And today there is no one else in the world as advanced in terms of instant payments, open finance, and the creation of a digital currency.”

The Digital Real

On May 2021, the Central Bank of Brazil (BCB) released a press release in which it presented the guidelines for the potential development of the real in digital form. The main objective is to design a digital currency issued by the BCB itself, to be employed by those using bank accounts, payment accounts, cards, or cash. The guidelines presented fall into three categories: functioning, legal guarantees, and technological premises.

Functioning

• Focus on technology to foster innovative business models, bringing efficiency to the economy.
• Online and offline operation
• Intermediated distribution model (through payment system participants)

Legal guarantees

• Observance of bank secrecy and LGPD
• KYC and AML

Technological assumptions

• “Open” system to conform to international standards, aiming at the future application in cross-border payments and international interoperability
• Resilience against cyber-attacks

According to the Central Bank, a digital real will enable innovative models and new technological evolutions, such as smart contracts, the Internet of Things (IoT), and programmable money, among others.

The focus of the Digital Real is the interoperability between systems within the SFN, solving problems and optimizing processes in its infrastructure. During the last decades, several systems have been created within the SFN (Financial Market Infrastructure), but they were created independently, with different technologies, and without thinking about a structure in which all systems communicate. This lack of interoperability makes the participating institutions need manual and costly procedures to carry out operations, making the SFN less efficient.

The Digital Real will not be a cryptocurrency or stablecoin, as it does not need to be mined, and is issued exclusively by the Central Bank. The Digital Real is a digital representation of the physical real—the difference between the Digital Real and the balance that appears in the consumer’s Internet banking is that the account balance that appears in a given bank is the responsibility of that bank, while the Digital Real is the responsibility of the Central Bank but is only held in custody by the financial institution where the user has an account. So in practice, everything indicates that the consumers will have two different balances when they access their bank accounts, the “regular” account balance and the Digital Real balance, being the two interoperable by the existing payment methods, for example, it will be possible to transfer from one balance to the other using Pix.

After the initial project guidelines were published, seven webinars were held in the second semester of 2021 to discuss the potential applications of Digital Real with the public:

1. Potential of the real in digital format
2. Citizenship, data security, secrecy, and traceability
3. Offline operations
4. Smart contract, IoT, and programmable money
5. Issuance and movement
6. International integration
7. Issuance technologies and compatibility with existing arrangements

At the end of the seventh webinar held, the President of the Central Bank announced the ‘LIFT Challenge’, a kind of hackathon held in partnership between the Central Bank and Fenasbac (National Federation of Associations of Central Bank Servers) with a specific focus on testing potential use cases for the Digital Real.

LIFT (Laboratory for Financial and Technological Innovations)

LIFT’s goal is to foster innovation in the National Financial System by encouraging the creation of prototypes of technological solutions for the National Financial System. It is an ecosystem of innovation. It started in 2018 and has since then increased its lines of action.

---

LIFT Challenge

LIFT Challenge is a special edition of LIFT focusing on a specific topic. The last edition’s target audience was market participants interested in developing minimally viable products (MVPs) based on the Digital Real, so the Central Bank gave the opportunity for participants from the Brazilian market to present the main use cases they imagine that the Digital Real could enable as well as assess its technological feasibility so that the Central Bank can then direct the development of the infrastructure to solve real use cases in the market.

Submitted projects should focus on one of the following categories:

• Delivery versus payment (DvP): settlement of transactions with digital assets, both digitally native and tokenized
• Payment versus payment (PvP): focused on the exchange between currencies
• Internet of Things (IoT): for algorithmic or direct machine-to-machine settlement
• Decentralized finance: focused on the definition of protocols with settlement based on a CBDC and considering compliance and supervision requirements established in a standard
• Potential payment solutions where both the payer and payee are offline

In addition to the categories, the projects were also evaluated in terms of infrastructure and their potential related to:

• Interoperability with other payment systems, available for both retail and wholesale operations
• Scalability of the technological solution, aimed at retail applications of national scope
• Privacy of the information used in the use case, in compliance with the pertinent Brazilian legislation
• The programmability of the proposed solution is aimed at allowing innovation and the construction of new solutions and products based on the proposed platform

In early 2022, project applications were opened and in March, the selected projects were announced after joint evaluation by the Central Bank and Fenasbac. The projects started to be developed in September 2022 with a biweekly follow-up by the Central Bank and were finalized in February 2023. The final presentation of the MVPs was held at LIFT Day in April 2023 and nine projects were presented.

---

LIFT Day – Presentation of the LIFT Challenge results

---

Mercado Bitcoin – presented by Fulvio Xavier

It proposes trading digital assets (with a focus on crypto-assets) via a payment versus delivery (DvP) method, in which payment for the crypto-asset occurs at the same instant its own right is transferred to the buyer.

---

FEBRABAN – presented by Larissa Moreira

It proposes the trading of digitized (tokenized) financial assets using the payment versus delivery (DvP) method, in which payment for the financial asset occurs at the same instant its own right is transferred to the buyer.

---

Santander – presented by Evandro Camilo

It proposes the conversion into digital format (tokenization) of the ownership rights of vehicles and real estate and their negotiation, through the method of payment against delivery (DvP), in which the payment for the good (house or car) occurs at the same instant in which its ownership right is transferred to the buyer.

---

VERT – presented by Martha de Sá

It presents a rural financing solution based on programmable money, through a digital currency of its own issuance with value tied to the real (stablecoin of the real).

---

---

---

Itaú – presented by Francielli Borges Assis

It proposes to facilitate international payments and transfers between Brazil and Colombia through the use of a payment versus payment (PvP) method, in which holders of different currencies—in this case, the Brazilian real and the Colombian peso—can exchange these currencies among themselves, and the delivery of the currency to each of the parties involved takes place simultaneously.

---

---

---

TECBAN – presented by Luís Gustavo Nunes

It presents a parcel delivery solution for e-commerce through a network of programmable lockers based on the Internet of Things (IoT), i.e. it offers a logistics solution, in a potentially open payment and delivery system, in which different e-commerce platforms can have access to secure delivery points.

---

---

---

AAVE – presented by Jorge Ribeiro Borges

It gathers resources from savers (forming a fund, or liquidity pool), through tools of decentralized finance (DeFi), with a focus on offering loans and ensuring that these operations comply with the norms of the national financial system.

---

VISA – presented by Cristiane Taneze

It presents a solution for financing small and medium-sized enterprises, focused on agribusiness, through a programmable financial platform, where small producers can finance and sell their crops.

---

---

---

Giesecke + Devrient – presented by Severino Sequeira

This features a payment and transfer system based on the digital real that can make transactions even when the payer and payee are without internet access (dual offline payments).

---

Pilot RD

While the LIFT Challenge projects were being developed by market participants, the Central Bank itself was already starting the first tests of the Digital Real with the RD Pilot project.

In March 2023 they began testing with the RD Pilot, considering the growing trend of tokenization of assets and the issuance of digital assets on unregulated decentralized registration platforms. The main objective of the RD Pilot is to evaluate the programmability gains enabled by a DLT (Distributed Ledger Technology) platform through tokenized asset transactions being used to settle tokenized federal government securities issued on the platform.

In May 2023 the Central Bank published the regulations for institutions that want to participate in the RD Pilot, with an estimate that only 10 institutions would be selected to participate in the project. Due to the limitation of participating institutions and also to the Central Bank having allowed only the companies that are part of the scope of its regulation to participate, the companies in the market began to organize themselves into consortiums, for example, the consortium that counts on participants such as Foxbit, TecBan, Banco da Amazônia, Amazon Web Services, Dinamo Networks, ClearSale, among others. Several institutions and consortiums have submitted proposals to participate, including public banks, private banks, credit unions, fintechs, and card networks – an ideal scenario for the Central Bank, which has expressed that it would like a diversity of views and opinions during the course of the project.

In late May 2023, the Central Bank announced that of the 36 proposals presented, it selected 14 proposals from institutions/consortia to participate in the RD Pilot, which will be incorporated into the platform by mid-June 2023:

• Bradesco
• Nubank
• Banco Inter, Microsoft and 7Comm
• Santander, Santander Asset Management, F1RST, and Toro CTVM
• Itaú Unibanco
• Basa, TecBan, Pinbank, Dinamo, Cresol, Banco Arbi, Ntokens, Clear Sale, Foxbit, CPqD, AWS, and Parfin
• SFCoop: Ailos, Cresol, Sicoob, Sicredi and Unicred
• XP, Visa
• Banco BV
• Banco BTG
• Banco ABC, Hamsa, LoopiPay
• Banco B3, B3 and B3 Digitas
• ABBC Consortium: Banco Brasileiro de Crédito, Banco Ribeirão Preto, Banco Original, Banco ABC Brasil, Banco BS2 and Banco Seguro, ABBC, BBChain, Microsoft and BIP
• Banco do Brasil

During the RD Pilot, a forum will be created to exchange information and properly orient expectations regarding the development of this platform and the proposed tests. This communication channel of the Central Bank technical staff with the representative entities of the sectors involved will also allow the discussion of the establishment of negotiation and development strategies that are best suited to the needs of Brazilian society.

Key Takeaways and What’s Next

The premises set by the Central Bank have shed some light on the path the regulator expects the Digital Real to take and what innovations they expect it to bring to the Brazilian market. Even more assertive about what we can expect from upcoming developments and applications than the premises set are the projects presented in the LIFT Challenge, which provide insight into what the most important players in the market are aiming for with the Digital Real.

From the not-so-innovative projects to the projects that have really thought outside the box, it’s clear that tokenization is just a first step towards creating most of the entirely new applications and uses cases for the Digital Real. The future of the Brazilian financial market still has several possible paths, and new business models will probably emerge in the coming months and years—thanks to the agenda of the Central Bank and the market players, but we can already predict that:

1. The Digital Real, initially, will have an almost exclusive impact on financial institutions and will be little noticed by end users, but after maturity it will also gradually gain importance for the population

2. Tokenization of assets, whether financial, crypto or real, will be a common reality and very important practice that will serve as a basis for several other applications

3. Using tokenization as a basis, several new forms of assets and credit will emerge, increasing the possible forms of financing and trading

4. Smart contracts and programmable money will be important tools to improve common processes and increase the operational efficiency of society as a whole

5. The current challenges in international payments (cross-border and remittances) will surely try to be solved with CBDC-based solutions, following the trend of several Central Banks and the G20

Consulted sources

Complementary sources

BIS, 2021. CBDCs: an opportunity for the monetary system

BIS, 2020. Discussion paper: Designing a prudential treatment for cryptoassets

FSB, 2020. Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements

Revista do Laboratório de Inovações Financeiras e Tecnológicas #5 | ABRIL 2023

Schär, F. 2021. Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets. Federal Reserve Bank of St. Louis. Second Quarter 2021, Vol. 103, No. 2.

Keep up to date with our Payments and Crypto insights