Hong Kong and Thailand have developed a cross-border blockchain network prototype to facilitate payments arising from trade activities between the two places.

The Hong Kong Monetary Authority and Bank of Thailand signed a memorandum of understanding in May last year to initiate study of the application of central bank digital currency (CBDC) in cross-border payments. CBDC is the digital form of flat money -- a currency established as money by government regulation or law.

Both parties said cross-border trade settlement will be one of the scenarios in applying the blockchain technology.

According to the Hong Kong Trade and Industry Department, Thailand is one of the city's top 10 principal trading partners with trade value reaching HK$153 billion ($19.6 billion) in 2018.

In December last year, the HKMA and BOT completed a distributed ledger technology-based proof-of-concept prototype with eight Thai banks and two Hong Kong lenders -- HSBC and virtual bank ZhongAn Technologies International.

The prototype network will solve the pain points of low efficiency, high costs, low transparency, heavy reporting burden and high foreign exchange settlement risk associated with the traditional correspondent bank model in international trade settlement.

Leveraging on smart contracts, the cross-border funds transfer process powered by the blockchain corridor network prototype can be made real-time and settlement can be made at a payment-versus-payment (PvP) manner.

"With the use of blockchain technology, the innovative and unique solution not only addresses different issues in practical applications, but also offers good references to the central banking community on the use of CBDR," HKMA Senior Executive Director Edmond Lau said.

The prototype technology will allow users access to competitive foreign exchange rates quoted by participating banks in the cross-border corridor network, and this technology also provides automated tools for liquidity management to smoothen the payment process, such as transaction queuing and netting, token conversion and borrowing arrangement from other participants in the corridor.

According to the newly proposed exchange model, banks in Hong Kong can use their balances in the Hong Kong dollar Real Time Gross Settlement (RTGS) to exchange for local CBDC, and CBDC will be placed as depository receipts in the corridor network for cross-border trade settlement.

The HKMA said the aggregate balance level of the Hong Kong banking system will not be affected.

"This newly proposed payment model can be extended to other financial jurisdictions or currencies or other potential business cases although we do not any specific target at the present moment," HKMA Executive Director Colin Pou said on Wednesday.

"The HKMA, at this stage, will explore the feasibility of issuing CBDC, taking account of whether regulatory compliance could be set in place before issuing CBDC," Pou said.

The HKMA and BOT, for the time being, will proceed in relevant areas, including exploring business cases and connections to other platforms, involving participation of banks and other relevant parties in cross-border funds transfer trials.