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Background Notes on “Cambodia’s national mobile payments and digital currency platform- Bakong”

Moderator:

Emmanuel Daniel, Chairman, The Asian Banker

Guests: 

Ms. Chea Serey, Assistant Governor and Director General, National Bank of Cambodia.

All sessions must start with a clear idea of the business questions to answer. The following are only suggestions and the moderator must focus them further before the start of the session.

1. Background on National Bank of Cambodia’s approach to a Next Generation Payment System

• The use of blockchain technology to develop a central bank digital currency (“CBDC”) has attracted attention of central bankers across the globe. While the digital currency, i.e. bitcoin, was first created in response to the financial crisis. Since then, several central banks around the globe have been exploring the introduction of CBDC, and new technological innovations arising from blockchain and distributed ledger technology (“DLT). For developed countries, the introduction of CBDC is in line with the declining use of cash, while for developing countries it intends to promote financial inclusion and improve inefficiencies, especially in payment systems. 

 To address the above objectives and upgrade existing payment systems, in 2017, NBC had started to explore several alternative technologies including DLT and blockchain. Such efforts provide the NBC and the financial sector with an opportunity to explore new alternative payment and operation technologies which are more secure and resilient. The project was named Bakong, and Hyperledger Iroha was selected as the platform for DLT to run on, and the pilot test of the project is currently being carried out since July 2019. Bakong also assesses implications for the adoption of DLT for retail and wholesale payments in the financial sector in Cambodia.

• History on payment systems in Cambodia

Currently, the NBC operates both the retail and wholesale payment systems. The initial adoption of those systems started since 2012, nonetheless since then new features, functions, and systems had been gradually added. Although the current payment systems have been gradually developing over the last decade, the interoperability of retail payments among banks as well as Payment Service Institutions (“PSI”) remains a challenge. Currently, there is no Real Time Gross Settlement (“RTGS”) between banks except for end-users, while interbank clearings and settlements take place twice daily. The usage of DLT in payment system represents an opportunity for Cambodia’s payment systems to leapfrog the traditional mean of connecting all players and address many challenges all at once. Bakong brings all payment service providers into one system through an open API allowing users to transact peer to peer without transaction fees in real time and in a secured manner

• Rationale 

By having such electronic payment account/wallet users do not have to carry large amount of KHR banknote to pay for high-value transaction, which ultimately will ease KHR payment. Given the above considerations, the NBC re-evaluates existing payment systems infrastructure and engages in the Project Bakong - a project to consider alternative technology platforms to create a next generation of payment system aimed at addressing financial inclusion, interoperability amongst players, and supporting the ease of payments in the local currency, while at the sametime doing so in safety and efficiency. The project is undertaken with the collaboration of SORAMITSU Co., Ltd (a technology company based in Japan) and domestic financial institutions interested in the project.

2. Key considerations for the Project Bakong  

• Payment System landscape in Cambodia 

Although the payments landscape in Cambodia has evolved remarkably over the last decade, paper-based instruments in the form of cash and cheques still dominate over electronic payment instruments for retail and business payments. The dominant use of such paper-based instruments over the electronic ones stems from the conventional mindset of users.

The National Clearing House (“NCH”) is operated by NBC, and it consists of NCS, FAST and CSS. NCH’s functions have been improved continuously since its establishment in 1994, with an upgrade to the full-fledged functions of a clearing house in 2012 - providing a more secure and efficient payment system. Each of the three systems facilitates different payment instruments. For instance, cheque and payment order are facilitated by NCS, while KHR interbank funds transfer and automated teller machine (“ATM”) / point of sale (“POS”) interoperability are facilitated by FAST and CSS, respectively. Of these, cheques and payment orders are the most popular payment instruments used in retail payment and business activities. By using cheques and payment orders, consumers can conduct an unlimited number of transactions in both Khmer Riel (KHR) and United States Dollar (“USD”). 

• Launch of FAST

The NBC launched FAST in 2016 as a supplementary payment system to promote electronic payments. FAST allows electronic payment transactions and fund transfers in real time from bank account to bank account (irrespective of the banking entity) in KHR with a daily limit of 40 million KHR (10,000 USD equivalent). As a backbone system, the NBC relies on banking institutions to create the users interface required with their customers to make the transactions convenient. Unfortunately, many institutions do not invest in mobile application that would facilitate such transaction, and customers would still need physically visit the participating banks or microfinance deposit taking institutions (“MDI”) to initiate payments or transfers, rendering the service as inconvenient and inefficient as before. 

• Limitations of FAST

FAST, however did not address card payment connectivity. To address this challenge, in 2017 the NBC introduced CSS, a nationwide infrastructure for local debit card payment operated by ATM and POS machines, and a network for international gateway for payment system integration in the region. The implementation of Bakong would connect all financial institutions and payment service providers under single payment platform which will allow for fund transfers to be processed on real-time basis without the need of a centralized clearing house. Institutions that are current participants of FAST would be able to interface directly with Bakong without making changes to their existing infrastructure.

• Introduction of Project Bakong

Having seen lots of developments driven by technological advancement and the dominant use of paper-based instruments in retail payments, NBC introduces Project Bakong, a wallet based electronic currency operated on DLT, with public mobile application (eliminating the need for banks and PSIs to develop their own while allowing those with existing mobile application to easily integrate through open API), aiming to promote electronic payment and financial inclusion. Bakong processes payment and settlement transactions. 

3. Overview of the Bakong System 

• Bakong started as early as 2017 where several alternative technologies and their applications in the payment system were explored and tested. As a result, DLT was selected as it was believed to be more efficient, reliable and resilient to cyber-attacks than the current payment systems, especially when connecting to payment service providers. Project Bakong is designed as a new platform for a payment system that uses DLT to enhance efficiency (cost, speed and security) of the payment system. The nodes in Project Bakong core are installed in a closed-loop infrastructures that are located at the NBC, and they can be shared with participants through the payment gateway. Only individuals who register in the system can carry out their business transactions. The consensus transactions based on (2n+1) of (3n+1) nodes mechanism while “n” represent the number of nodes. 

• Bakong also provides an extended feature (P2P) which allows for end-users to perform real-time retail fund transfers using its all-in-one mobile payment and banking application. The application enables end users to transfer funds easily by scanning QR codes, keying in phone numbers, or just selecting from their contact list, as well as easily deposit funds to any accounts within the Bakong’s network of participating banks. 

• The end users can download the application from the application store or market and register with their preferred participating banks or PSIs in order to have a Bakong account and participant’s bank/institution account. The participating banks are responsible for performing KYC / Anti-Money Laundering (“AML”) procedures for their end users, storing their information and managing their Bakong accounts.

• The participating banks shall have a Bakong settlement account at NBC. End user’s balance at Bakong account is considered as cash equivalent, and it should be recorded in the participant’s Bakong settlement account at NBC. The balance is subject to update at the end of each business day. 

• Under Bakong, end users have two separate accounts for KHR and USD to allow for transactions in the respective currencies. A conversion or transfer from one currency to the other is not possible on the system. However, the participating banks can provide FX service to end users 

4. Design features of the system  

To ensure smooth implementation of Project Bakong, the platform preserves most of the existing payment system features including FAST and is upgraded by using Hyperledger Iroha, a permissioned blockchain network, as a core system. Some other features include: 

• Bakong maintains existing user interfaces (“GUI”), Application programming interface (“API”, and client module (gateway) of the current FAST system.

• Bakong preserves existing business processes and authentication requirements such as user roles in the FAST system, utilizing Hyperledger Iroha’s role based on access control permission system and native multi-signature capabilities to model business processes.
• Bakong enables plug-and-play mode for participating in the new payment platform. Existing participants can join the platform without re-investing in system integration. Such application shows that the current FAST system is enhanced through the replacement of relational database by the permissioned blockchain network of Hyperledger Iroha nodes. This is a rather conservative use of blockchain technology, as it is mainly a change to the backend infrastructure in a way that will be invisible in many use cases.

Features as result of running a permissioned network on Iroha

• Transactions can be carried out in a decentralized manner (end users can conduct transactions directly with other end users in the same or with different participating institutions) where NBC performs the validation of the transactions within the permissioned blockchain network; 
• Transaction can be done not only between Bakong accounts but also traditional bank accounts; 
• Initiating and settling payment transactions are in real-time with settlement finality;
• transaction time will drop to less than 5 seconds with high transaction throughput;
• Debiting the sender’s balance and crediting to a receiver’s balance in a single, automatically executed operation; and 
• Payment transaction data are stored in distributed storage (Hyperledger Iroha blockchain network).

5. Bakong Architecture: Payment Gateway

• Financial institutions that join Bakong are the participants. Each participant needs to register with NBC to obtain permission to join the network. After successful registration, participants will access the Payment Gateway, so their customers can create accounts under their domain. The Payment Gateway also allows financial institutions to monitor their users’ transactions and to manage the users (accounts) within their institutions. 

Bakong as a Backbone of Payment System

As illustrated in the left hand figure, with 6 participants joining Bakong system, Participants can transfer assets to their customers registered under their domain. Customers of each domain can make transactions within the same domain or across domains. All transactions submitted to the blockchain are validated by the nodes owned by NBC.

• The Payment Gateway also provides participants with a way to monitor the transactions conducted by their customers via accounts in their domain (but not unrelated transactions carried out by customers in other domains). The Payment Gateway is also a platform where participants can manage KYC operations and transaction limits. Although each participant has a respective Payment Gateway to join Bakong Core, their customers holding accounts under their domains can transact directly with other users in different domains.

• By joining the Bakong network, participants allow their customers to create accounts under their domains. To access their accounts, users can use either the desktop or mobile application provided by NBC. Participants who already have a mobile application can integrate with Bakong through an API provided by NBC.

Current banking partners of Bakong include:

6. Efficiency Gain & Solution to Interconnectivity and Interoperability Problems- Project Bakong 

• The adoption of Bakong will allow the public to enjoy value-added benefits at reduced costs. When customers transfer funds from their own banking account to Bakong account or vice versa, they will bear no costs as the transactions would be free of charge (Cost). On the other hand, Bakong clearing system reduces the processing cost and time compared to other retail payment systems that require clearing process between banks (Speed).

• For instance, in retail payments, there is a need to establish a clearing process between banks, and it is inevitable to incur expenses related to the establishment of a separate clearing house and pledging collateral for risk management in the clearing process. On the other hand, Bakong doesn’t require this since there is a connection linked to peer-to-peer (“P2P”) network by both payer and payee due to its decentralized nature and the platform proves resilient to cyber-attacks (Security). Since banks and individual users are now brought into one DLT platform both banks and users no longer face with interconnectivity and interoperability problems. 

Interoperability of Bakong Platform 

Potential challenges from interoperability angle in developing the Bakong System. The need for standardised QR, regardless of system adoption 

On interoperability, she initially thought that we could simply launch the Bakong system and a QR code, and everyone would adopt it. But in reality, banks are embedding Bakong into their apps, and each banks has its own QR code. Therefore, to ensure widespread adoption of our system, there was a need for a standardised QR code, so that regardless of their provider, anyone can use Bakong to send money or make payments, even to someone who does not use the system. She also highlighted that at that time, she was working with the industry to develop a standard QR code, which delayed the launch of Bakong. Bakong was official launched on 28^th October 2020. 

7. Technology consideration for Bakong 

• NBC adopted a permissioned distributed ledger, in which participation is not public and registration is needed, DLT was used as a platform for payment.

• There have been many dialogues about “Central Bank Digital Currencies” or CBDCs, in which a joint report by the Bank for International Settlements (BIS) Committee on Payments and Market Infrastructures provides a definition of a CBDC as “a digital form of central bank money that is different from balances in traditional reserve or settlement accounts” [3]. At a regional level, Japan, China, and Singapore are actively engaged in blockchain research and experimentation. The Bank of Japan performed a joint experiment with the European Central Bank, exploring how DLT could be applied to process streamlining, particularly interbank settlement, through an effort known as Project Stella. The Monetary Authority of Singapore has worked on Project Ubin, which modernizes RTGS using digital SGD for wholesale interbank settlement. Rather than focusing on the wholesale segment, People’s Bank of China assessed the retail payments network and tested a prototype CBDC for the public. At a global level, there is a mix of whole sale and retail areas of blockchain-based CBDC. Bank of Canada is widely known for its Project Jasper which models interbank wholesale payments; while the Swedish e-krona project by Sveriges Risk Bank was meant to develop the concept that the bank could issue retail CBDC (e-krona) to public consumers as a complement to cash. The Central Bank of the Bahamas announced a Payments System Modernization Initiative (“PSMI”) where blockchain or other robust technology was required. Other publicly announced blockchain or DLT projects include Israel, Australia, Brazil, Russia, Estonia, United Arab Emirates, Kuwait, and Saudi Arabia.

• What Bakong does differently?

Rather than focusing on the macroeconomic policy of CDBC, Project Bakong targets infrastructure modernisation and responds to real demands that already exist for wider use of electronic means of payment by expanding access to financial services to people in the rural areas of the Kingdom. The above review of the challenges in the payment system and services in Cambodia, alternative payment technology, i.e. blockchain and DLT, and the experiment of and research into blockchain as an alternative to current payment services among central banks around the globe lead NBC to identify several areas of benefits in the current payment system through adopting blockchain technology (i.e. Project Bakong). 

8.Two important rationales for launching Project Bakong  

Financial Inclusion 

Financial Inclusion is a primary agenda of the NBC. One of the effective measures to promote financial inclusion is to ensure a cashless society where transactions could be performed digitally, and money transfer / mobile banking is accessible and affordable to every citizen. So far, this has been done by private sector players especially PSIs that have been paying much effort to introduce innovative products, that can better serve the market as a whole - people in urban areas as well as the unbanked through their large expansion of mobile and agent network.

• Thus, Project Bakong has been introduced to address this by gathering all participants into one system where finance can be widely spread through their Bakong accounts that can be created through Bakong App installed in their smart phones. It is expected that the Bakong will have potential to bring those unbanked population into formal financial sector that could contribute to the reduction of poverty in Cambodia. With user friendly application and simplified KYC procedure, Bakong user are able to access Bakong channels for all banking transactions (i.e payments, remittances, credits and savings).

Cashless payments and promoting use of local currency 

• Cambodia is still considered as a highly dollarized economy while most of the transactions are still cash- based. This could hinder the effective implementation of monetary policy as well as payment system development. Thus, the NBC as the monetary and payment system authority, has developed the Bakong aimed at promoting the use of local currency and electronic payment in Cambodia. 

• The Bakong is developed with a feature that allows for real-time fund transfer and instant payment transaction and given its interconnectedness and interoperability among different payment service providers and the adoption of QR code payment, it provides more convenience and wider acceptance channel for Bakong users to make electronic payment at any merchant.

• As Cambodia consists of younger population, the introduction of modern payment system via QR code can be easily adopted. This would induce consumer to make electronic payment instead of using cash. Besides, the development of Bakong is expected to encourage the use of local currency in the sense that it facilitates the payment of high value transaction instead of using US Dollar. Furthermore, the Bakong can be utilized as a tool in promoting the use of local currency by providing advantages to transaction in Riel over those in US Dollar. 

9. Key observations and findings 

• Transaction Finality 

The Bakong platform has a consensus mechanism to verify the validity of transactions and avoid double-spending. Where the validation nodes perform verification on a per-transaction basis and at the time of execution. Upon successful verification, the transaction record will be stored in the block distributed on the network. At that instance, the balance of the sender is debited, and the balance of the receiver is credited immediately. The transaction would be considered final, irrevocable and enforceable.

• Scalability and performance 

Results of the technical test carried out by the Bakong Test Lab have shown that the new payment system run on the Bakong platform is highly efficient. Where the execution time for one transaction during a normal load was noted to take less than 5 seconds. In addition, transaction throughout is between 1,000 and 2,000 transactions per second (depending on the network size, hardware, and system characteristics and configuration), which is considerably higher than the number of transactions in other blockchain platforms. This suggests that there is potential for this project to scale. 

• Resiliency 

Bakong platform is designed to be highly resilient to various forms of cyber-attacks. Depending on the consensus algorithm used in the system setup, transactions are processed normally, when the number of network nodes are unavailable due to machine failure, network interruption, among others. New network nodes could be added, and existing nodes could be shut down or removed from the network while the system remains fully functional. 

Additionally, as the Bakong account private key of each end user is stored in their individual device, only that particular end user knows his or her private key. Therefore, any cyber-attack on a particular IP address affects only the account using that IP address, but not the whole Bakong system.  

• KYC and privacy 

Bakong uses a permissioned blockchain technology, where only authorized nodes can join the network. Transaction records are immutable but transparent amongst the nodes. On the network, only addresses are stored without disclosing the details of the end-users. Therefore, participating institutions are responsible for performing KYC/AML procedures on their clients. The customer’s information is stored at the participant’s system. Such mechanism segregates between personal and transactional information, which ensures confidentiality of end-users and trust on the platform.

• Standardised QR code

To achieve interoperability and interconnectivity for Bakong platform, there must be a common standard usage which is consistent with the international standard to enable the platform to work safely and efficiently. Based on best international practice, Bakong will adopt EMV QR Code Payment that facilitates the worldwide interoperability and the acceptance of secured payment transactions by managing and evolving the EMV specifications and related testing processes.

• Remuneration of Payment Service Providers (PSPs)

The area of remuneration needs to be discussed that with the players. If everyone adopts Bakong, then PSP services will become redundant. But the system relies on these companies to recruit customers and introduce new products and services to them. That’s why the central bank just wants to serve as a back-end payment system. It is not the central bank’s job to talk to water or electricity providers and other merchants – that is up to the PSPs and banks. 

There is a need to come with a system that is beneficial for everyone. One solution could be charging a fee to digitise fiat money. At the moment, everything is free. Payment service providers could also charge a fee at the cash-out stage. They could add other services, like topping up mobile phone credit. It is up to PSPs to discuss this with telecoms firms, and decide whether to charge phone companies or customers.

• Competition between players 

The competition will be more meaningful, rather than providing endless discounts to attract more customers. It will be about providing the most convenient and efficient service. 

10. Possible implications of the Project Bakong 

• Efficiency Gain

Since transaction on Bakong platform is carried out on a peer-to-peer basis and without centralized clearing house, time used for each transaction on the Bakong platform is similar to transaction time on other real-time payment system. Thus, cost is reduced, and time is saved as the transaction does not need clearing process between banks, which is an advantage over other retail payment systems because transactions on these payment systems require clearing process which must be conducted through a centralized clearing system. Importantly, investment in centralized clearing system infrastructures is not needed, while time between the initiation and the final settlement of the transaction is also substantially saved.

• Financial Inclusion 

Bakong will function as a mechanism of promoting cashless payment in a digital economy. Given the design of the technology behind the Bakong platform, financial institutions may invest at low cost in Project Bakong to expand payment services via smart devices in order to promote access to financial services of the unbanked population. The Bakong initiative is also coincident with the interest of Cambodian youth in exploring new and advanced technology that offers low cost, secured, fast, and convenient payment services. 

• Monetary Policy 

Project Bakong is likely to have moderate impact on the central bank’s monetary policy and the financial stability because money in circulation will still be managed by the Central Bank provided that Bakong is pre-funded by fiat money through banking institutions and payment service institutions or agents. Consequently, through Bakong the national bank can collect physical cash and create electronic money in the financial system. Doing so the national bank can conduct its monetary policy through the change in size of the electronic money in circulation. In addition, Project Bakong will also help the national bank to conduct foreign exchange policy to stabilize exchange rate as NBC can better forecast the demand of local and foreign currency using information stored in the Bakong system.

• Financial intermediation 

Bakong will not eliminate intermediary function of banking institutions and payment service institutions since the design of Bakong is different from other platforms. It requires banking institutions and payment service institutions to review and manage customer information, conduct KYC procedure, and open bank account for customers to receive an authorization and account for accessing Bakong application. Therefore, transactions will be processed between Bakong and bank account.

• Risk of bank run 

With or without the presence of Bakong, the risk of bank run that may stem from operational management and other uncertainties within the banking and financial institutions remains. Depositors and investors could withdraw their money if they panic or feel insecure about bank solvency. With presence of Bakong, the conversion from cash to digital money affects the movement speed of money comparing with physical cash, so customers may move their electronic money speedily via Bakong from one institution to another, but the movement is subject to the maximum limit required by each financial institution or settlement account held at the central bank.

• Other key risks

To mitigate credit and liquidity risks, Bakong was designed so that its operations are settled in near real-time before participant of the payee credits the funds in the account of its customer. As such, it does not extend credit nor overdrafts to its participant’s accounts; transfers that do not have enough liquidity to be processed are queued until they can be processed.

As for operational risk, NBC is supported by a framework for the comprehensive management of risks that defines roles and responsibilities for the identification and management of risks, their assessment, and the establishment of its risk’s tolerance policy, the basis on which to determine if controls are required to mitigate risks. 

11. About Ms. Chea Serey, Assistant Governor, National Bank of Cambodia  

(In the position of “Director General, NBC” since Sep 1999 as according to her LinkedIn profile) 

• Serey Chea is an Assistant Governor and Director General at National Bank of Cambodia. She is a vocal proponent for greater use of the local currency to promote the country's greater independence on economic and monetary policy. 
• Under her leadership innovative policy instruments were introduced to develop the interbank markets and promote the use of local currency. She is a member of different policy-driven committees within the bank and nationally. She is chairwoman of the Credit Bureau Cambodia Ltd., the first and only privately-run credit sharing system in Cambodia. 
• Under her leadership, retail payment infrastructure has been modernized with the introduction of a national shared switch for cards transactions and FAST payment system, a real time fund transfer from a bank account to another bank account in Cambodia. 
• As a chairwoman of Clearing House Operation Committee, she has been leading the Bakong Project, an initiative of the National Bank of Cambodia in exploring and introducing a new generation of payment system using Blockchain technology. 
• She is also a member of the Southeast Asia Advisory Council of Women World Banking and a member of Young Global Leaders, Class of 2019, a forum of Young Global Leaders created by the World Economic Forum. 
• She is a strong proponent for women economic empowerment and financial inclusion and served as Alliance for Financial Inclusion’s (AFI’s) high level Gender and Women’s Financial Inclusion Committee (GWFIC)  

12. Topical views/comments by Chea Serey 

• 28 October on the launch: “I hope the official launch of the Bakong System today will help promote social welfare and also prevent the spread of [Covid-19] by providing seamless e-payments from person to person," Cambodian central bank director general, Chea Serey said. Online payments can also be made through Bakong System, which also offers alternative options for … transactions such as deposits, withdrawals, sending and receiving [via] e-wallet. However she has also clarified in response to rising concerns domestically and internationally, Serey stressed that Bakong is not a Central Bank Digital Currency”. 
• Next steps:  “Thirteen organisations are part of the Bakong system, with new interest in the programme daily. We are working on cross-border operations and have already signed a memorandum of understanding with Malaysia’s Maybank. We want to allow migrant workers – many of whom are women – to send money back home free of charge, and have more control over their finances. Instead of sending a bulk amount each month to someone in their home country, who could misuse the funds, we want to enable them to transfer money directly to a school or hospital, or to pay a utility bill” 
• Greatest change in wholesale payment systems in Cambodia vis-à-vis SEAsia- “In terms of wholesale payments, it’s not affecting anything. We don’t have an RTGS system. We use a national clearing system, where clearing and settlement happens twice daily between banks and for interbank settlements. Our focus is on retail payments, but we are exploring the possibility of wholesale clearing and settlement using DLT. We are observing project Stella, the joint undertaking by the European Central Banka and Bank of Japan, and learning from various central bank experiments around the world” 
• On Payment Service Providers being remunerated: “We need to discuss that with our players. If everyone adopts Bakong, then PSP services will become redundant. But we rely on these companies to recruit customers and introduce new products and services to them. That’s why we just want to serve as a back-end payment system. It is not the central bank’s job to talk to water or electricity providers and other merchants – that is up to the PSPs and banks.

We need to come up with a system that is beneficial for everyone. One solution could be charging a fee to digitise fiat money. At the moment, everything is free. Payment service providers could also charge a fee at the cash-out stage. They could add other services, like topping up mobile phone credit. It is up to PSPs to discuss this with telecoms firms, and decide whether to charge phone companies or customers”.