The Secret Behind Automated Finance: PSO Explained

The process of 'exchanging money' in financial markets or transactions between companies is more complex and risky than one might think. Beyond simply transferring money, it must be meticulously managed to ensure that funds arrive on time, payments are completed without mistakes, and unnecessary funds are not wasted. It's much like managing traffic on a complex road to ensure that all vehicles reach their destinations without congestion or accidents.

The key technology and process for solving such complex and risky challenges is Pre-Settlement Optimization (PSO). In this article, we will clearly explain what PSO is, how it operates in the real world, and why it is gaining significant attention in an era where automation and risk management are essential.

What is PSO? The Reason for Buckling Your 'Seatbelt' Just Before a Trade!

Pre-Settlement Optimization literally means that before an actual payment takes place, the trading parties deposit money (or securities and other assets) into the system to create a 'perfectly prepared state for the funds'. This is similar to preparing all necessary stationery before taking an important exam.

Basically, financial institutions separate and store collateral in advance to prevent any failures from occurring at the moment of actual fund transfer (commonly known as DvP, Delivery versus Payment), and they deposit the necessary cash into the system beforehand (this is known as cash pre-funding).

By doing this, the risk of 'a transaction slipping due to insufficient funds at the time of settlement', i.e., liquidity risk, can be significantly reduced. This plays a crucial role in enhancing the robustness of the entire payment network. As all transaction conditions (amount, maturity date, payment time, interest rates, etc.) are recorded in an automated program known as a smart contract, which checks everything in real time, it enables 'near-zero-touch' operation that does not require manual oversight.

How Does PSO Operate in the Real World?

PSO operates organically across multiple stages and maximizes stability and efficiency in financial transactions.

1. Collateral Pre-Separation: Storing in a Payment-Specific Vault

Assets such as money, securities, and stablecoins that will be used for payment are isolated and deposited in a separate account before actual settlement begins. This amount is perfectly separated so it cannot be confused with or used for other transactions or operational costs. Think of it as putting money into a 'payment-specific vault' before paying for something in an online store. This money can only be used for this specific transaction.

2. Cash Pre-Funding: Preparing a Bullet in Advance

The cash needed for the settlement is deposited into the system before a specified time, ensuring that this amount is readily available for immediate payment. It’s like when you book movie tickets, paying for the ticket price in advance before attempting to check out and reserving your seat. By securing cash ahead of time, it prevents situations where a transaction may be canceled due to insufficient funds at the moment of payment.

3. Risk Pre-Assessment and Automatic Monitoring: Smart Sensors Monitoring 24/7

Smart contracts automatically check whether the transaction conditions are compliant. The availability of collateral, changes in collateral value due to exchange rate fluctuations, maturity dates, and the payment capacity of the trading parties are verified in real time. If the conditions are not met or risk signals are detected, immediate alerts may be triggered, or payment may even be halted automatically. This is similar to a smart sensor that monitors for anomalies year-round, allowing the system to manage risks without any manual intervention.

4. Automating Settlement Records: Immutability and Transparency

Simultaneously with the payment, all transaction histories are automatically recorded on blockchain or Distributed Ledger Technology (DLT). Thus, there is no need for humans to record or verify, significantly reducing the possibility of human error. Furthermore, due to the nature of blockchain, data once recorded cannot be tampered with, making encrypted transparent data a reliable basis in the event of future disputes or errors.

5. Modularity and External Integration: A Smart Collaboration System

PSO is pre-configured to work with banks, clearinghouses, and other financial institutions via APIs (Application Programming Interfaces) and oracle networks (e.g. Chainlink CCIP). This facilitates the real-time consolidated management of each institution's financial status, asset information, and transaction histories. Multiple modules operate in a seamlessly coordinated manner, resembling an efficiently organized orchestra, eliminating the need for individual approvals from operators.

'Near-zero-touch Operations', How is it Possible?

'Near-zero-touch' means that there is almost no need for operator intervention, as the system autonomously manages all processes. The principles that enable PSO to achieve this are as follows:

• Utilization of Smart Contracts: All transaction conditions and rules are coded into smart contracts. This code only executes when predefined conditions are met, ensuring that only eligible collateral is utilized in the payment process.

• Real-time Monitoring and Automatic Control: The status of collateral and cash deposits before payment is monitored in real time. If a risk of payment failure is detected, the system automatically halts the transaction or diverts it through pre-established bypass routes.

• Event-based Automatic Execution: Payment and settlement processes are automatically executed based on specific events (e.g., reaching a certain time, completing collateral deposit). Immediate warning and halting features trigger in the case of abnormal conditions, blocking potential issues in advance.

• Atomic Processing: Data between pre-integrated institutions and systems is shared in real time, and transactions and payments occur via 'atomic' processing. This means that all parts of the transaction succeed or fail simultaneously, creating a robust structure where intermediates cannot fail.

As a result, PSO operates on principles similar to a one-button push whereby reservations, verifications, payments, and records are 'automatically processed smoothly,' minimizing errors and delays caused by human intervention.

Real-world Cases of PSO

PSO has already proven its utility in various financial markets and systems.

1. CLS Settlement – The Bastion of Global Forex Payment Markets

The world's largest foreign exchange payment system, CLS (Continuous Linked Settlement), is a representative success story of PSO. All financial institutions participating in CLS deposit the currencies and cash for transactions into the system 1-2 hours before payment. The CLS system only uses the pre-separated collateral for payment sessions, and the transactions are processed via simultaneous settlement (DvP) only after collateral eligibility verification, greatly reducing the risk of counterparty default (Herstatt Risk). Thanks to this, the global financial network is provided with immense stability, preventing it from collapsing due to any single incident. (Reference: CLS Group Official Website)

2. Blockchain-based Multi-CBDC Network

In the Multi-CBDC project involving JP Morgan, several central banks, and global financial firms, PSO plays a crucial role. Each participant deposits their CBDC (Central Bank Digital Currency) or stablecoins into the system beforehand, and smart contracts automatically validate payment conditions in advance. All payments and settlements are executed 'atomically,' minimizing risk while optimizing liquidity. (Related Information: BIS - Project Helvetia)

3. Real-time Power Trading Market (ELD)

Interestingly, PSO techniques are being introduced not just in financial markets but also in the Energy Live Dispatch (ELD). Each power plant registers the amount of power, price, and maturity information it can supply into the system in advance, and collateral or deposits for it are submitted beforehand, minimizing the risk of payment failure. PSO plays a crucial role in the automated payment structure based on blockchain, enhancing the efficiency and stability of the power market.

Comparison of Implementation of PSO in Legacy Systems and Web3 Era

The essence of PSO, namely 'reducing risk and preparing funds/collateral just before payment', is shared by both traditional systems and Web3. However, there are significant differences in how these are implemented.

Traditional legacy systems have had many inconveniences and dangers, including processing delays, personnel burdens, and limitations in real-time risk management. In contrast, the Web3 environment enhances automation, transparency, scalability, and real-time guarantees, facilitating innovation in global payment and digital asset trading markets.

Benefits Brought by PSO

PSO serves as an almost fully automated safety net that goes beyond just 'procedures for depositing money in advance', effectively blocking complex financial risks and maximizing fund efficiency.

• Improvement in Operational Efficiency through Near-Complete Automation: Since almost no human intervention is needed, human error and operational risk are drastically reduced. This leads to cost savings.

• Reduction in Liquidity Costs: Through pre-netting and multilateral transaction offsetting, the amount of funds actually needed for payment is minimized, which reduces the liquidity burden that companies or financial institutions must hold.

• Enhanced Payment Stability: In case of payment defaults or bankruptcies, the system automatically manages risks and limits payment to eligible collateral only, preventing a widespread spread of risks across the system.

• Transparent Monitoring and Auditing: All transaction and settlement histories are stored on the blockchain, allowing for verification and auditing at any time. This provides a high level of reliability in the event of disputes.

PSO Establishing Itself as Essential Infrastructure for the Digital Economy

PSO is a key technology that prevents complex risks that may arise in financial transactions while maximizing fund efficiency, establishing an almost fully automated safety net. Particularly, real-time automation, transparency, and efficiency based on Web3 help to overcome the limitations that traditional legacy methods have faced.

The adoption of PSO is rapidly spreading not only in the global financial market but also in the blockchain-based digital asset and physical asset trading sectors (energy, commodities, etc.). In the future, processes like pre-verification and automation, such as PSO, will not merely be options but will establish themselves as essential standards for the innovation and stability of payment systems.

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