Inside the Estonian CBDC Experiment That Could Shape the Digital Euro

At the height of 2017’s ICO boom, European Union member Estonia said it had the digital backbone to issue its citizens a national cryptocurrency, an “Estcoin.”

At the time, then-European Central Bank (ECB) President Mario Draghi slapped down Estonia’s plans. But in an interesting indication of how far things have come, Estonia’s latest round of experimentation in building a central bank digital currency, or CBDC, is a rare example of a project publicly linked to the ECB’s now-energetic digital euro ambitions.

The ECB’s changed position today signifies how serious the discussion around a digital euro has become, said Luukas Ilves, head of strategy and innovation at Guardtime, the technology provider assisting Eesti Pank, the central bank of Estonia.  

It’s a plum assignment for Guardtime, which has a long history helping secure Estonia’s core government infrastructure using a novel industrial-grade blockchain system called KSI (Keyless Signature Infrastructure).

“We know the ECB is going to appraise the work we are doing with Eesti Pank,” said Ilves. “Looking ahead, we hope to pull in other eurozone central banks and make a compelling case that a retail CBDC can be deployed at scale for the entire European economy.”

Weighing scale 

The appropriate technical solution for wholesale or retail CBDCs may incorporate elements of blockchain architecture, but these have to be arranged in a way that can meet the necessary scaling requirements, said Guardtime CEO Mike Gault.

Building such as a system for a large economy and taking into consideration areas like micro-payments and internet of things (IoT), could run to millions of transactions per second, Gault said. That sort of scale really rules out the notion of multi-party validators reaching consensus to provide proof of a transaction being submitted to the ledger, he said.

“The only reason you have these multiple validators is for censorship resistance,” said Gault. “We’ve yet to meet a central bank or a government that is interested in having censorship resistance. They are the censors.”

Eesti Pank did not return requests for comment by press time.

Working within the security parameter of a central bank, Gault explained that the KSI mechanism provides proof the system is operating without fault, using a system of hashes rather than slowing things down with public key infrastructure (PKI).  

Current blockchain technology might be fine for launching a wholesale CBDC, added Ilves, which basically amounts to “better clearing of transactions, and bringing some tokenized assets on top of the way banks do things today.” But a retail CBDC requires a different approach.

Identity politics

Meanwhile, the COVID-19 pandemic has highlighted the need for more digitization of the financial system, particularly in adverse circumstances when a government may want to disburse funds directly to its citizens. So would Estonia’s lauded e-government and digital identity system make this an easier lift from the perspective of the central bank?

The exact question of how Estonia’s CBDC will interface with other services is what the research is setting out to explore, said Ilves. What’s clearly the case, he added, is that Estonia’s existing payments and banking landscape is much less prone to things like fraud and identity theft. 

“There are all sorts of ways that digital signatures and a government-issued digital identity could be built into how to manage a wallet and authorize transactions,” said Ilves. “We don’t have any one particular scenario in mind, but we’re sure that a CBDC ecosystem will work better, faster, safer, cheaper.”

It’s also worth noting that the European Commission, the executive arm that implements the decisions of the European Parliament, has an ambitious proposal to make digital identity systems more interoperable across its various member states. 

“I think by the time a CBDC gets deployed across Europe, the different ID systems will play better with each other and that interoperable infrastructure will be in place,” Ilves said.

Summing up, Guardtime chief Gault acknowledged CBDCs have become a busy and febrile space but reiterated the need for speed when it comes to deploying a truly retail offering.

“We think there are a lot of horses in this race,” said Gault, “but we’ve invented the first combustion engine.”