Central Bank Digital Currencies: Changing the Architecture of Money

Once a niche enthusiasm with the launch of Bitcoin (BTC), digital money powered by blockchain technology has matured rapidly in just a few short years. The market is now highly diverse. For example, audited stablecoins, along with fixed use digital cash projects introduced by Wells Fargo and JP Morgan last year, stand in stark contrast to cryptocurrencies that fluctuate as much as 10% a day. The ultimate sign of graduation from the margins into the mainstream, however, is perhaps the way that central banks are now embracing the technology.

Central bank digital currencies are now in active pilot programs by many central banks across the world (see our recent report here). The People’s Bank of China has embarked on its own “digital yuan” project and Sweden’s central bank, Sveriges Riksbank, has announced a pilot for a digital version of its currency for retail use, dubbed the e-krona.

Additionally, the United States Federal Reserve, the Bank of England, the Bank of Japan and the European Central Bank are all currently exploring the technology. Meanwhile, the Bank for International Settlements — the so-called “central banks’ central bank” — has been discussing CBDCs at length and recently forecasted that amid the current global pandemic, contaminated bills may be the catalyst for central banks to deliver a digital cash alternative for payments.

Why else are central banks, the heart of the economic establishment, so interested in technology with such radical and revolutionary roots?

In part, they have been responding to challenges from private sector initiatives, such as Facebook’s Libra. However, CBDCs also potentially offer substantial benefits for general purpose use, which make them highly attractive in their own right. Specifically, central banks’ motivations include:

• Providing a cash alternative.
• Promoting financial inclusion.
• Increasing seigniorage profit (the difference between a currency’s face value and the cost of its production and distribution).
• Implementing monetary policy.
• Linking payments to identity.
• Modernizing payments for a digital economy.

What’s interesting about the recent models is the collaborative approach many have been taking with a supporting cast from the private sector. For example, the Bank of England has been researching what it calls the “platform model,” in which the bank is the only entity allowed to create or destroy a token, while leaving payment interface providers to interact with end-users.

The proposal gives PIPs the responsibility to maintain Know Your Customer checks, while providing them with the freedom to differentiate themselves by providing additional services on top of the core payments.

Others have gone a step further. Researchers at the IMF have recently coined the term “synthetic CBDC” to describe a model, in which a non-central bank entity, such as a commercial bank, can issue a stablecoin backed by central bank reserves.

Ultimately, we are likely to see a variety of uses for CBDCs in the retail space and a number of different implementations. These will have important benefits for a wide variety of institutions from corporate treasury departments to payment networks open to the general public. 

We have been witnessing the distinction quickly blurring between the currently evolving retail CBDC models and previous projects with wholesale CBDCs. We have already learned that a CBDC is a great tool at the wholesale level, and its applications can teach us a lot about the prospects for retail CBDCs. For example:

• Project Ubin with the Monetary Authority of Singapore has taught us that a blockchain-enabled CBDC supports more efficient complex payment workflows, including a decentralized liquidity savings mechanism.
• Project Jasper with the Bank of Canada and the Canadian stock exchange have taught us that a blockchain-based CBDC leads to operational improvements — such as 24/7 access to the payment system and T+0 settlement — more effectively than existing financial market infrastructures can provide.
• Project Inthanon with the Bank of Thailand and the Hong Kong Monetary Authority have taught us that a blockchain-based CBDC allows for a cross-border corridor; it has enabled FX price discovery; and has facilitated atomic PvP.

Blockchain technology is crucial in enabling the tokenization of these payment assets, allowing for peer-to-peer transactions and distributed custody. Additionally, blockchain tech enables atomic transactions, which means that any delivery versus payment or PvP scenario can occur, in real time, without the risk that one leg of the transaction will be executed before the other.

Blockchain technology also sets the architecture for a more secure payment system, in which there is no centralized point of failure nor honeypot for hackers to attack. Finally, it allows connectivity into a growing tokenized financial ecosystem with global integrity.

Looking forward, we can imagine a completely new architecture for money in the near future, which will, in many ways, be as significant a change to the nature of money as the invention of the credit card. This architecture is enabled by blockchain technology as a system of record and relies on central banks’ diligence in providing robust governance frameworks for these new assets.

Widespread access to CBDCs will be key for central banks to fulfill their mandate of offering modern payment solutions. Additionally, it will catalyze the connectivity among the general public, corporations and the financial industry with parallel innovations currently being built out by firms leveraging blockchain technology in non-payment-related areas. Central banks have a tremendous opportunity to orchestrate and provide purchasing power into this ecosystem.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

George Calle is the market intelligence lead at R3, an enterprise blockchain software firm. George has been at R3 since June 2017 where he started as a research intern for three months.