What are Central Bank Digital Currencies or CBDC?
Updated: Jan 4, 2022
Central bank digital currencies, CBDCs, are cryptocurrencies issued by central banks. The difference to other cryptocurrencies, e.g. Bitcoin or Ethereum, lies in the fact that they are issued by central banks instead of decentralised cryptocurrency networks like Bitcoin’s Blockchain or Ethereum’s Blockchain. Whereas cryptocurrencies issued by private companies are not backed by any central bank but rather only by the reputation of the issuing company, CBDCs are meant to be used as legal tender within their jurisdictions and guaranteed by the central bank itself.
On October 9, 2020, the Bank for International Settlements ("BIS") issued the first report ("Report") in a series of collaborations with a select group of Central Banks in which it conducted an in-depth analysis of the fundamental principles and essential characteristics of the so-called "Central Bank Digital Currencies" ("CBDCs"). (more information here).
In this sense, we will now analyze the characteristics of CBDCs, the international projects that exist today, as well as the central banks in the world that are changing, or will change, the paradigm of the traditional financial system in their respective countries.
Central banks are generally mandated to ensure monetary and financial stability in their respective countries and, explicitly or implicitly, to promote broad access to safe and efficient payments.
To achieve this, a fundamental instrument of public policy is the issuance of central bank money. Since ancient times, this money has acted as a means of payment, a unit of account and a store of value for a given country. However, the overwhelming reality generated by the accelerated digitalization of the economy has generated a new normal for which traditional money is no longer functional.
In that sense, even before the COVID-19 pandemic, the use of cash was already in decline in certain advanced economies (more information here) and was gradually being replaced by digital payments driven mainly by the growth of the so-called Neo Banks. In a previous market study we presented the current Neo Bank offerings in Mexico (more information here).
That is why in order to evolve and pursue their public policy objectives in a world where healthy distance becomes a condition of survival, Central Banks are actively investigating the pros and cons of offering not only digital payment systems, but a digital currency.
It is important to note that the idea of having access to digital forms of money is not an entirely new idea (more information here). Recently, the debate has been driven by several factors: (i) the interest in technological innovations applicable to the financial sector; (ii) the emergence of FinTech bringing new entrants into the payment and intermediation services markets; (iii) the decline in the use of cash in some countries: and, (iv) the increasing attention being paid to so-called private digital tokens.
These factors propelled the idea of a new form of currency, a new form of central bank money, the CBDCs.
What is a CBDC?
CBDC is a digital form of central bank-issued money distinct from balances in traditional reserve or settlement accounts, as stated by the BIS in its Report.
Another way to understand CBDCs may be as a form of digital fiat or sovereign money that is issued by a country's central bank and therefore has legal tender value and dischargeable power in that nation (more information here).
Is a CBDC a cryptocurrency like Bitcoin?
In a recent study by BBVA (more information here) a distinction was made that seems fundamental to us: "In a world of fiat money in the strict sense, the attractiveness of cryptocurrencies lies in part in their detachment from the discretionary decisions of the authorities...".
A CBDC is issued directly by a central authority that seeks to maintain and facilitate a monetary policy in a given state, therefore, it directly escapes the specific definition of a cryptocurrency normally born to be untied.
It is important to know that, in the current crypto sector, the issuance of Bitcoins or Ether have a very powerful drawback, volatility. This is to be expected, as Blockchain technology is still very new and cryptocurrency markets are relatively small so any change in supply or demand has a relevant impact.
Faced with this drawback, the Blockchain ecosystem has designed solutions called "Stablecoins" which in general are assets designed to mimic the value of a crypto basket or fiat currencies such as the dollar or the euro which, in addition to having the advantage of transferring value quickly and cheaply around the world, also maintain their value stable over time. Their forms, advantages and disadvantages we analyzed in depth in a study we published previously (more information here).
In the above context, Stablecoins are becoming a very serious competitor to the traditional money issued by Central Banks. For this reason, CBDCs are becoming more relevant at the international level, as they are being launched in accordance with public policy and macro and microeconomic criteria for the adequate management of monetary and financial stability, positioning themselves as an answer to Stablecoins.
Objectives of a CBDC
The objectives of a CBDC could be listed as follows (more information here):
Generate a new form of money capable of taking advantage of new technologies.
Facilitate means of economic and financial interaction at both national and international levels.
Create new financial and economic structures capable of opening important investment doors.
Stimulate competition among payment systems, making them more economical and more far-reaching.
To create monetary policy control mechanisms with immediate action.
Reduce the level of government intervention in banks by reducing the danger of the "Too Big To Fail" problem.
Create a structure that makes it possible to trace the course of money from its origin to its last acts.
Replace the anonymity of money with anonymity controlled by CBDC issuers.
Fundamental Principles of CBDCs
According to the BIS Report, there are three fundamental principles that must be respected in the issuance of a CBDC:
Do No Harm. New forms of money provided by the central bank should continue to support the achievement of public policy objectives and should not interfere with or impede a central bank's ability to carry out its monetary and financial stability mandate. For example, a CBDC should maintain and reinforce the "uniqueness" or uniformity of a currency, allowing the public to use different forms of money interchangeably.
Coexistence. Central banks have a stability mandate and proceed with caution in new territory. Different types of central bank money - new and existing (cash, reserve or settlement accounts) - should complement each other and coexist with robust private money (e.g., commercial bank accounts) to support public policy objectives. Central banks should continue to provide and support cash as long as there is sufficient public demand for it.
Innovation and efficiency. Without continued innovation and competition to boost the efficiency of a jurisdiction's payment system, users may adopt other, less secure instruments or currencies. Ultimately, this could cause harm to the economy and the consumer, which could undermine monetary and financial stability. The payment ecosystem is composed of public authorities (in particular the central bank) and private actors (e.g., commercial banks and payment service providers). In general, private economic agents should be free to decide which means of payment they use to carry out transactions.
BIS identified fourteen essential characteristics applicable to the proper issuance and implementation of CBDCs, dividing them into instrumental characteristics, system characteristics and institutional characteristics.
Convertible. CBDC must be exchangeable for cash or private money.
Convenient. CBDC should be as easy to use as cash, use a card or scan a code on a cell phone to promote adoption and accessibility.
Acceptable. A CBDC should be able to be used in many of the same transactions as cash, including point-of-sale and person-to-person. It should include the ability to make offline transactions (possibly limited to a certain time and up to certain thresholds).
Low Cost. CBDC payments should be at extremely low or zero cost to end users, who should also have minimal technology investment requirements.
Secure. Both the infrastructure and the actors/participants of a CBDC must be extremely resistant to cyber-attacks and other threats. It must include ensuring effective protection against counterfeiting.
Instantaneous. Transactions must be instantaneous or near-instantaneous for end users of the system.
Resilient. A CBDC system must be extremely resilient to operational failures and disruptions, natural disasters, power outages and other similar circumstances. End users must have the ability to transact offline in the event that the connection to the system is disabled.
Available. End users must be able to make transactions 24/7/365.
Performance. The system must be able to process a large number of transactions.
Scalable. Ability to include large volumes in the future; the CBDC system must be expandable.
Interoperable. The system offers sufficient interaction mechanisms with private sector digital payment systems and has arrangements that easily allow the flow of funds between systems.
Flexible and Adaptable. A CBDC system should be flexible and adaptable to new conditions and policy impositions.
Robust legal framework. The central bank must have sufficient authority and powers to issue a CBDC.
Standards. A CBDC system (infrastructure and participating entities) must conform to appropriate regulatory standards.
Types of CBDCs
The types of CBDCs are born by the distinction in the type of underlying technology and the access to such CBDCs:
CBDCs for general use, in which anyone has access to them, making it a universal payment instrument designed for retail transactions, but also available for wider use.
Wholesale CBDCs, in which access is restricted to certain agents, is a digital settlement token for payment and wholesale settlement transactions.
Account-based CBDC requires the Central Bank to provide accounts for general use to all agents in the jurisdiction. The magnitude of the scale is different, but the novelty is the decision to create this type of accounts.
CBDC with restricted account, in which the opening of reserve and settlement accounts is restricted.
A fundamental distinction between token-based and account-based money is the form of verification required for their exchange. Token-based money (or payment systems) essentially depend on the ability of the payee to verify the validity of the object used for payment. In the case of cash, the danger is in counterfeiting, whereas in the digital world it is the authenticity of the token or currency that is of concern, as well as the possibility that it has already been spent. In contrast, account money-based systems rely primarily on the ability to verify the identity of the account holder. A major concern is identity theft, which allows those who commit this crime to transfer or withdraw money from accounts without authorization. Identification is necessary to correctly match payers and payees and determine their respective account histories.
For a better understanding, we share the money flower described by the BIS (more information here):
Differences with Cryptocurrencies
Cryptocurrencies such as Bitcoin or Ether are open access, a CBDC is not. It is not possible to participate in confirmations, nor to access public transaction addresses. Transactions are monitored directly by the Central Bank in the case of CBDCs, in Bitcoin or Ether this is not the case.
The issuance of Bitcoin or Ether is decentralized, in the case of CBDCs the issuance will be completely centralized.
The money again remains in the hands of Banks or Companies in the case of CBDCs, in the case of Bitcoin the money can be transferred in a P2P way.
The transfer network is managed by the government in the case of CBDCs and in the case of Bitcoin or Ether, the blockchain is controlled by the nodes on which the network runs.
Pros & Cons
Among the advantages to be found in CBDCs, Tao Zhang, the Deputy Managing Director of the International Monetary Fund, discusses the following (more information here):
Creating a more efficient payment system. In some countries the cost of handling cash may be too high and access to the payment system may not be available to the unbanked, or to people living in rural areas or to vulnerable communities in general. CBDCs can lower costs and improve efficiency;
Financial inclusion, CBDCs wallets will be much easier to have than a bank account in a traditional bank;
Greater stability and lower barriers to entry for new entrants to the payments system, such as FinTech;
Better tool to generate a healthier monetary policy;
A means to counter new digital currencies. A domestically issued digital currency backed by a trusted government, denominated in the national unit of account, can help limit the adoption of privately issued currencies (e.g. stablecoins), which can be difficult to regulate and could pose risks to financial stability and monetary policy transmission;
Preservation of comparative advantages, with the private sector to innovate and interact with customers and the public sector to regulate and provide settlement and trust services;
In addition, CBDC could be less costly and risky for the central bank. Whereas the Central Bank does not have to perform customer due diligence, nor be directly responsible for AML/CFT compliance. Furthermore, the Central Bank would not be responsible for technology failures, user interface design, or responding to the customer service line.
Also, despite the potential benefits, there may be risks associated with CBDC. Measures need to be taken to mitigate the risks through proper CBDC design, and the World Economic Forum lists some of the following disadvantages (more information here):
Cross-border availability of CBDC could increase the likelihood of currency substitution ("dollarization") in countries with high inflation and volatile exchange rates and, consequently, reduce the central bank's ability to conduct independent monetary policy;
A CBDC used across borders could also have an impact on capital flow movements, the effectiveness of capital flow management measures and the international monetary system;
There is no clear legislation on how CBDCs will be issued and controlled;
There is a clear conflict between individual rights and freedoms, the use of CBDCs and their ability to control and spy on citizens;
Cybersecurity applicable to such CBDCs considering that their infrastructure is completely digital and, in Mexico, we have already had attacks on our Central Bank's platforms (more information here);
Potential for financial exclusion if populations that do not adopt CBDC are not integrated and are further marginalized from digital technology payment systems;
Notable risks to financial stability from bank disintermediation or other forces;
Challenges unique to blockchain technology such as transaction scalability, user experience, key management, confidentiality and transaction speed.
Design of CBDCs
The World Economic Forum lists the most important design and implementation decisions for issuing a CBDC:
Availability - should the CBDC be available for public use (retail CBDC), or restricted to commercial banks and clearing houses (wholesale)? Who is the primary audience for the CBDC, retail consumers and citizens, or commercial banks?
Distribution and storage. If CBDC is for retail use, what is the most effective distribution mechanism, which achieves the objectives of the program and is the most inclusive to capture all eligible participants? Also, where will CBDC be stored? CBDC can be held in accounts directly at the central bank, in accounts at participating commercial banks if they act as intermediaries for distribution, or on government-issued debit cards, among other options.
Interest payments. If the central bank were to pay CBDC holders, either retail or wholesale, do they have interest? This decision has implications for the attractiveness of holding CBDC. In the retail context, it affects whether depositors prefer to hold savings in CBDC with the central bank or in traditional CBDC. This, in turn, affects the volume and stability of commercial bank deposits, their balance sheets and lending activity. Interest payments will compete with those of commercial banks, potentially putting pressure on commercial banks to increase their interest payments to depositors.
Transaction anonymity. Should CBDC transactions preserve customer privacy? Anonymity could encourage more consumers to use CBDC as a private, peer-to-peer alternative to cash. However, it increases the difficulty of reversing fraudulent transactions, catching illicit activity and recovering lost funds. It should be noted that if a central bank has strong motivations to employ CBDC for anti-money laundering, anti-corruption or tax evasion, or capital control and oversight, it will be less inclined to allow anonymity (at the cost of discouraging adoption). However, unless the central bank or state mandates the use of CBDC, those wishing to engage in illegal or illicit activity will continue to use cash and other privacy-enabling alternatives for these purposes.
Account limits and transaction volumes. Should central banks limit the amount of CBDC that can be held or transferred at one time? The above, as such limitations may mitigate enforcement and money laundering risks.
In a more recent report from the WEF (more information here), more information regarding the policy goals for CBDCs and the technical design considerations to achieve those goals are described:
Policy Goals and Technical design considerations
1. Continued access to central bank money
In jurisdictions where access to cash is in decline, there is a danger that households and businesses will no longer have access to risk-free central bank money. Some central banks consider it an obligation to provide public access and that this access could be crucial for confidence in a currency. A CBDC could act like a ‘digital banknote’ and could fulfil this obligation.
The following technology considerations stand out for this policy goal:
“Cash-like” features for CBDC, such as very wide acceptance and convenience, instant settlement, continuous 24/7/365 availability and offline capabilities.
Compatibility with prevalent point-of-sale hardware to stimulate adoption and merchant acceptance.Policy-makers may consider subsidizing merchant acquisition of necessary technology upgrades.
Related to privacy, physical cash is highly private to all parties except the payee who sees the payer’s identity in many cases; the privacy considerations for the CBDC can take note of the privacy profiles of different payment technologies in the Bank of Canada’s staff note “Privacy in CBDC technology” (more information here).
2. Financial inclusion
Financial inclusion is one of the most important and widely cited policy goals for CBDC, particularly in emerging economies where central banks rank it as the most important motivation alongside domestic payment efficiency. Whether CBDC can meaningfully address financial inclusion across most economies is not yet fully evidenced, but common arguments for how it could do so centre on the following two points:
- Because CBDC can reduce complexity and reliance on intermediaries in payments, it can facilitate time-saving and cost-saving gains for consumers. Lower costs enable wider access.
- CBDC can fill a gap for low-cost, convenient and reliable savings, deposits and payment services that the private sector has not yet provided. It can offer wider access than pre-existing services with lower fees or compliance requirements.
The challenge of financial inclusion relates to situations in which there is demand for a service that is unmet by the private sector, where the public sector has the capability and willingness to step in and provide it. These occasions may be rare, given the private sector’s generally greater competence for innovation in providing financial products to the public.
The following technology considerations stand out for this policy goal:
Low cost, CBDC should aim to be zero- or very low-cost. Total costs to consider include the cost of acquiring the application and/or device for transacting, the costs to link and activate accounts, and ongoing costs such as transaction and data usage fees. Costs related to telecom and mobile phone usage should be transparent and low.
Accessibility and convenience. From a compliance perspective, accessibility can be widened by enabling the use of CBDC with varying or tiered Know Your Customer (KYC) requirements, depending on transaction or account sizes. Pairing CBDC development with an improved domestic digital identity programme can also widen access (globally, 20% of unbanked populations lack the appropriate ID to meet KYC rules imposed by financial institutions). Governments can also provide financial and digital literacy programmes. Finally, the interoperability of CBDC with the relevant payment infrastructure, including mobile money, and its wide acceptance within the jurisdiction would increase both the convenience and the value that CBDC could provide to citizens.
3. Payment system efficiency (domestic or cross-border)
CBDC could increase payment efficiency of domestic payments chiefly through the reduction of intermediaries in favour of central bank transaction settlement and clearing. This is particularly the case if the country lacks an efficient domestic interbank system (such as a real-time gross settlement or deferred net settlement system) or a fast payment system that offers near-immediate 24/7/365 retail payment settlement.
CBDC could increase payment efficiency of cross-border payments in the following ways:–If domestically issued CBDC were compatible with foreign CBDC (in bilateral or “multi-CBDC arrangements”) or foreign payment systems, then retail payments would no longer need to go through the international interbank systems and could settle more directly–If a CBDC were accessible to foreign entities, that would enable both foreign and domestic entities to transact more efficiently through clearing and settlement at the domestic central bank.
The following technology considerations stand out for this policy goal:
Open access to foreign entities to hold accounts or otherwise transact in the CBDC. This may require the central bank to support and enable potentially millions more accounts owned by foreign entities. It may also require close consideration of technical scalability and throughput, security, and regulatory and compliance issues related to overseas accounts. In addition, policy-makers may need to give special consideration to any domestic capital controls, capital flows or foreign exchange policies and compliance.
Allow for domestic citizens to hold accounts or otherwise transact in another country’s CBDC.
Allow transactions to occur between domestic and foreign CBDCs, which could involve enhancing the compatibility of the CBDCs, interlinking them, or integrating them into a single “mCBDC” (multi-CBDC) arrangement. For this, technical interoperability is necessary in various ways, including: common messaging and data standards, legal and regulatory compatibility, overlapping operating times, integration through an interoperable link where CBDC infrastructures combine their functions, and more.
4. Payment system safety and resilience
A technically robust CBDC system can support payment system resilience by virtue of serving as a primary, back-up or additional payment method, assuming other payment methods and instruments remain available. CBDC may become even more valuable as a back-up payment method if access to cash (which otherwise serves as a back-up) is very low. It is also important to note that defending against cyber-attacks is likely to be more difficult in a retail CBDC system as the quantity of endpoints and users can be very large.
The following technology considerations stand out for this policy goal:
Very strong cybersecurity standards and features, including practices such as ongoing cybersecurity monitoring and upgrades that address vulnerabilities and threats (this is generally a priority for all CBDC implementations).
Data and hardware redundancy and continuous or frequent data syncing.
Consideration of potential vulnerabilities of physical devices providing access to CBDC, such as stored-value cards.
Very strong anti-counterfeiting measures and practices, for the CBDC to serve as a safe and reliable system that instils high confidence (also a priority for all CBDC implementations).
Continuous service and availability, including offline functionality, to serve as an adequate back-up system in the event of electricity, telecom or internet network failures.
Interoperability with relevant payment systems to improve the likelihood of serving as an effective substitute where other systems fail.
Resilience of any interdependency or integration with other systems. As stated by the BIS, “if a critical function is provided to a CBDC system by another system or supporting infrastructure, its unavailability could negatively impact the CBDC system”.
5. Mitigation of currency substitution risk
CBDC could support monetary sovereignty and continued use of the domestic currency, in the event that currency substitution risks arise from various sources, such as high adoption of foreign CBDC or high adoption of stablecoins or other forms of digital currency denominated in and/or backed by foreign currency. CBDCs can help mitigate currency substitution if they are used rather than other digital currencies. As with all other policy goals, the feasibility and suitability of alternative solutions such as regulatory action should also be considered.
The following technology considerations related to supporting high adoption stand out for this policy goal:
Very low or no cost.
Wide CBDC accessibility, including to citizens who can use various technologies, such as mobile phones, personal computers and pre-paid cards.
For convenience, the CBDC should be employable in various payment scenarios, including point-of-sale, e-commerce, person-to-person (including with QR codes or NFC) and online. Interoperability with other payment systems will enable a variety of payment configurations, including those already in use in the market, resulting in greater convenience and merchant acceptance.
Functionality to pay interest to CBDC accounts, for the purposes of stimulating adoption
High transaction capacity and scalability to support potentially high adoption.
The CBDC must be perceived to be trustworthy; for this, its implementation could be coupled with a public education or marketing campaign. Policy-makers can also instil trust and confidence through data privacy measures and strategies such as transparent accountability mechanisms that could provide proof-of-privacy for all users, within the bounds of anti-money laundering (AML) and other compliance requirements. For instance, transaction data-access logs could be established that record when user transaction data is accessed and by whom.
6. Improvement of payments and banking competitiveness
The ability to employ CBDC to challenge the monopoly power of private-sector payment providers, or of deposit and savings account providers, can be an important goal for policy-makers. CBDC could serve as a counterweight to the market power of these entities and increase competition in payments and deposits. This can lead to a greater variety of high-quality and affordable payment options and higher deposit rates for citizens, which can increase welfare. As always, policy-makers should also consider alternative solutions to this challenge, including pro-competition policies.
Key considerations for CBDC issued in pursuit of this policy goal are those that make the CBDC competitive for payments and deposits, such as:
Low cost to users
High usability and accessibility
High convenience, including interoperability with relevant payment systems and widespread acceptance by merchants and vendors
Strong reliability, stability and security practices to instil trust among users
Value-add capabilities and features that meet the needs of users in a manner that is competitive with pre-existing payment and deposit services
Ability to pay a positive interest rate (remuneration on CBDC accounts could help push bank deposit rates upwards)
Policy-makers should also consider designing CBDC according to open-source principles, thereby inviting more involvement and innovation from the private sector to the CBDC system
7. Monetary policy implementation
CBDC might be able to support some monetary policy implementation. Most economists have not expressed much conviction in this opportunity, owing to limitations or policy complexities.
Key channels in which CBDC could help with monetary policy implementation are listed below, along with limitations.
- Interest-bearing CBDC can enable a direct mechanism for policy-rate changes to impact households and firms (this is also called “transmission of interest rate policies”). Interest-bearing CBDC could also encourage banks to pass on policy-rate changes to their deposit and lending interest rates. For this activity, CBDC would need to pay competitive interest rates and allow large account balances, which could lead to banking disintermediation and financial stability risks if not managed (e.g. through a tiered remuneration system, or account or transaction limits). A large percentage of citizens and firms would also need to open CBDC accounts for this policy to be effective, a condition which is likely to be challenging.
- Breaking through effective lower bound (ELB) in nominal interest rates: if physical cash is abolished or generally unavailable (particularly large-denomination bills), then CBDC could arguably be used to impose negative interest rates on households and firms. The existence of cash as an alternative for storing money, especially large denomination bills, dampens this opportunity today. Negative nominal interest rates can discourage the use of CBDC in the first place, potentially in favour of other alternatives that weaken monetary sovereignty. They can also be very difficult to implement on a social or political level. Lastly, of utmost importance, the presence of cash in an economy is critical for financial inclusion and resilience, so actions that limit its availability are not advisable.
The following technology considerations stand out for this policy goal:
The CBDC must be capable of having an interest rate that could be positive or negative
The CBDC needs to be easily accessible and widely held among households and firms. As discussed in prior sections, to achieve this requires certain preconditions: it should be low- or no-cost, trustworthy, convenient and easy to use, accessible from technological and compliance standpoints, and it should involve attractive privacy capabilities.
For CBDC to have wider adoption, policy-makers can also consider enacting government identity programmes and/or financial and digital education and literacy campaigns
8. Household fiscal transfers
CBDC could be employed for fiscal transfers to households or firms, such as relief or stimulus payments. Such helicopter drops or subsidies would potentially become easier when there is widespread adoption of CBDC accounts. The transfer payments could also be “programmable”, with conditions such as expiration upon a certain date or a requirement to spend the funds at certain vendors.
Technical considerations for this goal centre on wide accessibility (as described in prior sections), so that the widest population that may be entitled to fiscal transfers can receive the CBDC.
The most representative initiative for the regulation of CBDCs is a joint effort between the International Monetary Fund, the World Bank, and G20 member countries.
In that regard, they generated a specific report that sets out high-level recommendations for the regulation, supervision and oversight of global stablecoin ("GSC") arrangements (more information here). GSC arrangements are expected to adhere to all applicable regulatory standards and address financial stability risks prior to commencing operations, and to adapt to new regulatory requirements as necessary.
CBDCs in the World
It is important to note that, currently, there are a variety of jurisdictions that already have projects for the issuance of a CBDC. In fact, the World Economic Forum generated a report that lists approximately 40 jurisdictions around the world that are experimenting with CBDCs (more information here), for its part, the World Economic Forum maintains a list of more than 60 reports, white papers or speeches by researchers from central banks, international organizations or research economists on the topic of Blockchain and DLT for central banking processes and macroeconomics (more information here):
Central Bank of Canada – Project Jasper (more information here);
Central Bank of England (more information here);
Central Bank of Finland (more information here);
Central Bank of France (more information here);
Central Bank of Israel (more information here);
Central Bank of Japan (more information here);
Central Bank of Nigeria (more information here);
Central Bank of Korea (more information here);
Central Bank of Pakistan (more information here);
Central Bank of Estonia (more information here);
Central Bank of Lithuania (more information here);
Central Bank of Thailand – Project Inthanon (more information here);
Central Bank of The Bahamas – Project Sand Dollar (more information here);
Central Bank of Brazil – Project SALT (more information here);
Central Bank of Luxembourg (more information here);
Central Bank of Uruguay (more information here);
Central Bank of Denmark (more information here);
Central Bank of the Netherlands (more information here);
German Central Bank (more information here);
European Central Bank (more information here);
Hong Kong Monetary Authority (more information here);
Saudi Arabian Monetary Authority – Project Aber (more information here);
Monetary Authority of Singapore – Project Ubin (more information here);
Central Bank of Cambodia – Project Bakong (more information here);
Central Bank of Ukraine (more information here);
Central Bank of Norway (more information here);
Reserve Bank of Australia (more information here);
Reserve Bank of New Zealand (more information here);
South African Reserve Bank – Project Khokha (more information here);
Central Bank of Sweden (more information here);
U.S. Federal Reserve (more information here);
Kansas (more information here);
Atlanta (more information here);
St. Louis (more information here);
Philadelphia (more information here);
Cleveland (more information here);
Yale (more information here);
MIT (more information here);
The Bank of Canada, the United Kingdom and Singapore issued a joint project called “Project Stella” (more information here);
We list the projects that are currently identified by the World Economic Forum. However, we know that there are some projects or approaches that were exempted such as the Marshall Island, Iceland, Russia, Turkey, Argentina, Ecuador, Venezuela, Malta, Philippines, Italy, among others. (more information here).
In the case of Russia, Russian financial authorities have confirmed the government's alleged plans to issue CBDC. Even on October 13, 2020 the Bank of Russia published a consultation paper on the development of the digital Russian ruble (more information here).
In the statement, the central bank said that the digital ruble can become an "additional form of money alongside cash and non-cash." The establishment of Russia's CBDC project will require the creation of additional payment infrastructure.
The bank also said that the digital ruble will have "all the necessary properties to perform the functions of money."
According to the document (more information here), the digital ruble is designed to make payments "faster, simpler and safer." The bank also noted that a CBDC such as the digital ruble will reduce the risk of capital outflows in the country.
Separately, according to an October 20, 2020 Facebook post by the Sand Dollar Project, the Bahamas CBDC was made available to the 393,000 residents of the Bahamas as of approximately 10:00 PM UTC. This makes the Bahamas the first country in the world to officially launch a CBDC (more information here).
The Central Bank of The Bahamas has been preparing for the launch of its CBDC for a few years. In 2019, it initiated a pilot program using 48,000 Sand Dollars on the islands of Exuma and Abaco, which have a combined population of less than 25,000 people. Each Sand Dollar is pegged to the Bahamian dollar, which in turn is pegged to the U.S. dollar.
Furthermore, the Nigerian CBDC, e-Naira, is a fully operational CBDC (more information here).
As an additional report, we would like to share CBDC the The Block Research Report on some of the projects mentioned above (more information here).
There is also a great online resource that identifies and updates CBDC projects worldwide, called CBDC Tracker (more information here).
As an additional important resource we share the latest BIS update on CBDC projects around the world, they list more than 84 projects between retail and wholesale CBDCs (more information here).
It is also important to mention the case of the Bank of Canada, which generated a report on the advantages of generating a CBDC in its jurisdiction (more information here). In this report the bank argued that a CBDC could be beneficial and probably necessary to ensure a competitive and vibrant digital economy. There are two parts to this argument. First, a CBDC could increase welfare relative to the status quo by enabling new markets and applications. Second, a CBDC could also mitigate welfare losses by limiting abuses of market power and preventing coordination failures in payments and new markets, such as smart contracts.
Finally, following the Canadian report, a CBDC could be a tool to promote digital innovation by helping to prevent coordination failures and providing open access to promising general-purpose technologies, such as programmable money.
Most representative projects
Regardless of the existence of different approaches worldwide, we would like to highlight three of the most important projects:
DCEP and e-CNY
DCEP (Digital Currency Electronic Payment, "DCEP") is a national digital payment and processing network run by the Central Bank of China, built with Blockchain technology and the CBDC is called e-CNY or digital yuan. The e-CNY is paired 1:1 with China's national currency, the RenMinBi (RMB). The overall goal of the e-CNY is to increase the circulation of the RMB and give it an international reach, with the eventual hope that the RMB will become a global currency like the U.S. dollar.
e-CNY is a currency created and authorized by the Chinese Government. It is not a stable third party digital currency like the CNHT, Tether's currency paired 1:1 with the RMB. e-CNY is the only licensed digital currency in China.
e-CNY is not listed on digital cryptocurrency exchange platforms and will not be used to speculate on its value.
China has expressed very clearly that its National Digital Currency will not be used for trading speculation purposes. Mu Changchun, the head of the Digital Currency Institute of the People's Bank of China has said that the e-CNY is "a digital form of the Yuan" and there will be no speculation on its value" (more information here).
e-CNY will start distributing to all commercial banks affiliated with the Central Bank of China such as ICBC and the Agricultural Bank of China. The rollout of e-CNY will be similar to that of the physical Yuan. This initial deployment will serve as an official production test for the monetary system, where the network and security will be validated. In the second phase, DCEP will be distributed to larger Fintech companies such as Tencent and Alibaba to be used on WeChat (more information here) and AliPay (more information here) respectively.
e-CNY is a centralized and sovereign currency, it is not possible to mine e-CNY or participate in the DCEP network.
Merchants must accept e-CNY. The government has stated that all merchants accepting digital payments (such as Apple Pay, AliPay and WeChat) must accept e-CNY. This will give e-CNY wide acceptance in China, with all merchants forced to participate or face the potential loss of their license to trade. This will make e-CNY the most widely accepted digital currency in the World.
Even, Huawei will accept e-CNY, due to the widespread use of Huawei phones in China, the company has strong ties with the Chinese Government. It is even rumored to be the first adopter of e-CNY.
NFC payment base
DCEP will have an NFC (Near Field Communication) payment base that does not require devices to be connected to the internet during the transfer. This is intended as a direct replacement for cash, as DCEP will be able to be used in areas without internet. In addition, DCEP does not require the device to be linked to a bank account, so the unbanked population will have access to the digital currency.
China has set up an initiative to use Blockchain technology (more information here), President Xi JinPing has stated that "the country's development in Blockchain technology should be accelerated", he said this on October 24 last year in front of the Political Cabinet.
Currently, DCEP is only available to Banks working directly with the People's Bank of China. This will eventually be expanded to the general public in 2020.
If e-CNY is accepted around the World, China will have full oversight and control over the economic activity of half of the world's population. DCEP and e-CNY will give the possibility for China to trace and track users' spending and transactions and will even be able to seize or block any user's digital assets in their digital wallets, this has already been seen with the notorious "social credit system", in which millions of users were banned from buying airline tickets through their digital wallets.
As the sole issuer of e-CNY, this would give the Chinese Central Bank greater influence over global financial markets. By becoming the world's first global power to dominate the digital sphere (more information here).
Progress to 2021
The equivalent of just over $40 million in digital Chinese yuan has so far been distributed by the lottery, with the People's Bank of China reporting around 70 million transactions since the launch of its limited multi-city pilot in January 2021 (more information here).
Later, the Working Group on e-CNY Research and Development of the People's Bank of China released a report. in July 2021 on the progress in the development of this CBDC (more information here).
For clarity purposes, the e-CNY is the CBDC issued by the People's Bank of China (PBOC) and operated by authorized operators. It is a hybrid security-based, quasi-account and account-based payment instrument with legal tender status and loose account linkage. e-CNY has the following connotations:
The e-CNY is the fiat currency issued by the central bank.
The e-CNY adopts a centralized management model and a two-tier system, it belongs to the state and there are authorized persons and commercial banks.
The e-CNY is mainly positioned as M0, and will coexist with the physical RMB.
As a retail CBDC, e-CNY mainly serves the demand for domestic retail payments.
In the future digital retail payment system, the e-CNY and the funds in the electronic account of authorized operators are interoperable, and both constitute the cash in circulation.
Vision and Objectives of e-CNY
The development of China's e-CNY system aims to create a new form of RMB that meets the public's demand for cash in the era of the digital economy. Supported by a retail payment infrastructure that is reliable, efficient, adaptable and open, China's e-CNY system, will enhance financial inclusion and make monetary and payment systems more efficient.
The first objective is to diversify the forms of cash provided to the public by the central bank, meet the public's demand for digital cash, and support financial inclusion.
The second objective is to support fair competition, efficiency and security of retail payment services.
The third objective is to echo the international initiative and explore the improvement of cross-border payments.
e-CNY Design Principles and Features
The e-CNY was developed with the following design principles and features in mind:
Compliance with laws and regulations.
Safety and convenience.
Openness and compatibility.
The design of e-CNY takes into account the advantages of both physical RMB and electronic payment instruments. Therefore, it shares both the features of the physical RMB, such as settlement at the time of payment and anonymity, and those of electronic payment instruments, which are less expensive, highly portable, very efficient and difficult to counterfeit. The design of e-CNY mainly takes into account the following features:
Identifiable as both an account-based and value-based system;
Settlement at the time of payment;
Anonymity. The e-CNY system collects less information than the traditional electronic payment system and does not provide information to third parties or other government agencies, unless otherwise stipulated in laws and regulations;
It is programmable. The programmability of e-CNY could be realized through the deployment of smart contracts without impeding its legal tender functions.
As e-CNY is China's fiat currency, international standards and Chinese AML/CFT laws apply. Authorized dealers and other commercial institutions providing e-CNY exchange and circulation services are entities required to comply with AML/CFT regulations, including customer due diligence, retention of customer identity data and transaction records, and reporting of relevant and suspicious transactions.
In carrying out their anti-money laundering duties, authorized operators and other business institutions should protect trade secrets, individual privacy and personal information in accordance with laws, and should not disclose customers' identity data and transaction records. The PBOC, as the competent AML administrative authority, carries out anti-money laundering regulation by urging all parties concerned to fulfill their AML obligations and monitoring compliance accordingly.
The PBOC has made consistent efforts to explore, update and improve relevant CBDC theories and technologies, which has shaped the current e-CNY business model and framework. Going forward, the PBOC will build on the results of the pilot project and continue to improve the technological, business and policy frameworks.
The PBOC will continue to move forward cautiously on the e-CNY pilot project in accordance with China's Five-Year Plan, with no pre-set timetable for the final launch. Efforts will focus on the following areas:
The PBOC will move forward with the e-CNY project in a prudent and orderly manner.
The PBOC will improve relevant institutional arrangements and standards.
The PBOC will strengthen R&D on important topics.
On October 2, 2020, the European Central Bank ("ECB") published a report on the digital euro (more information here). This report examines the issuance of a CBDC - the digital euro - from the perspective of the Eurosystem. Such a digital euro can be understood as central bank money offered in digital form for use by citizens and businesses for retail payments. It will complement the current supply of cash and wholesale deposits from central banks.
The potential benefits of a digital euro and the rapid changes in retail payment imply that the Eurosystem needs to be equipped to issue in the future. The digital euro could support the Eurosystem's objectives by providing citizens with access to a secure form of money in the changing digital world. This would support Europe's drive towards continuous innovation. It would also contribute to its autonomy strategy by providing an alternative to international payment providers for fast and efficient payments within and outside Europe.
A digital euro could support the Eurosystem's objectives by providing citizens with access to a secure form of money in the rapidly evolving digital world.
The Eurosystem would design the digital euro in such a way as to avoid possible undesirable consequences for the fulfillment of its mandate, for the financial industry and for the economy in general.
A digital euro would also support other strategic objectives of the Eurosystem. It could provide state-of-the-art payment services that reflect people's changing needs and actively promote innovation in the field of retail payments, complementing payment solutions. It could increase choice, competition and accessibility when it comes to digital payments, supporting financial inclusion.
Finally, the digital euro could represent an option to reduce the overall costs and ecological footprint of monetary and payment systems.
This initiative is still in the development stage, so before considering issuing a digital euro, a thorough and balanced policy-oriented assessment of the challenges it poses and its potential relative to alternative options is needed. The views of institutions, citizens and practitioners will make a valuable contribution to such an assessment, including through a public consultation.
In this regard, the European Central Bank launched a public consultation on a possible digital euro on October 12 (more information here).
Progress on the CBDC front in the eurozone has accelerated amid the COVID-19 pandemic, and the central bank has framed its introduction to the public consultation with the claim that issuing a CBDC could help "cushion the impact of extreme events - such as natural disasters or pandemics - when traditional payment services no longer work."
The technical implementation of a digital euro must be thoroughly tested and legal considerations carefully examined before any decision on issuance is made.
To ensure that meaningful answers to the open questions raised in the report are obtained, by mid-2021, the Eurosystem will decide whether to launch a digital euro project that would start with a research phase.
On August 13, 2020, the U.S. Federal Reserve ("Fed") highlighted research and experiments conducted to improve its understanding of the opportunities and risks associated with CBDCs (more information here).
In addition to detailing past and current efforts around CBDCs, there is already an effort by the Boston Fed whereby it announced a new collaboration with the Massachusetts Institute of Technology ("MIT") for the creation of a CBDC (more information here).
It is also important to note that there is a parallel project, former Commodity Futures Trading Commission ("CFTC") Chairman J. Christopher Giancarlo, former LabCFTC Director Daniel Gorfine and investor Charles Giancarlo want to develop a digital dollar as well (more information here).
The three are forming the Digital Dollar Foundation to design and drive a potential U.S. CBDC (more information here).
In the case of the Digital Dollar Project, the new nonprofit has a multi-part plan to first create possible designs and proposals; convene economists, lawyers, academics, technologists and others to evaluate these designs; and create a framework for testing the new system, all with the goal of making dollar transactions as seamless as a text message.
The idea is not new: former CFTC officials called for a Blockchain platform to be used to support a digital dollar from an op-ed published in the Wall Street Journal (more information here). Essentially, a non-governmental group would lead the project, with support from the Federal Reserve and other interested parties.
The proposed digital dollar would be a tokenized form of U.S. currency, working with other existing Federal Reserve obligations, but would act as a digital settlement medium.
This initial effort will culminate in a set of principles, which will then be compared with stakeholder needs and practical requirements for a CBDC, as well as assessed for U.S. legal compliance.
The Fed's commitment is key: The digital dollar would have to be backed by the U.S. central bank, unlike most existing cryptoassets and dollar-fixed stablecoins.
In particular, the Digital Dollar Foundation's proposals would seek to preserve the existing financial system, not replace or otherwise substitute for it.
Like Brainard, Giancarlo has said that a digital dollar would benefit the U.S. both in terms of distributing or quickly transferring funds when needed, as well as continuing to maintain the dollar's dominance in the global economy.
Many questions remain before the U.S. can even consider a CBDC. These include whether a CBDC issued by the Federal Reserve would be legal tender under the law.
Like the Digital Euro, the Dollar is still a project in the research stage, lacking development and implementation analysis, which, as of today, is still far from happening, contrary to the case of the DCEP.
The World Economic Forum lists the main applications and use cases that Central Banks are investigating for the use of CBDCs:
Retail central bank digital currency - A central bank-issued digital currency that operates and settles in a decentralized, peer-to-peer manner (without intermediaries), widely available for consumer use. Serves as a complement or substitute for physical cash and as an alternative to traditional bank deposits.
Wholesale central bank digital currency - Digital currency issued by the central bank that operates and settles on a decentralized, peer-to-peer basis (without intermediaries), available only to commercial banks and clearing houses for use in the wholesale interbank market.
Interbank Securities Settlement - A focused application of Blockchain-based digital currency, including CBDC, that enables the rapid interbank clearing and settlement of securities for cash. It can achieve "delivery versus payment" interbank systems in which two parties trading an asset, such as a security for cash, can make payment and delivery of the asset simultaneously.
Payment system resilience and contingency - The use of DLT in a primary or standby domestic interbank payment and settlement system to provide security and continuity in the face of threats, such as technical or network failures, natural disasters, cybercrime and other threats.
Bond issuance and lifecycle management - The use of DLT in bond auction, issuance or other lifecycle processes to reduce costs and increase efficiency. It can be applied to bonds issued and managed by sovereign states, international organizations or government agencies. Central banks or government regulators could be "observer nodes" to monitor activity where relevant.
Know your customer and fight money laundering - Digital KYC/AML processes that leverage DLT to track and share relevant customer payment and identity information to streamline processes. Can connect to a national digital identity platform or connect to pre-existing e-KYC or AML systems. It could potentially interact with CBDC as part of payments and financial activity tracking.
Information and data exchange - Use of distributed or decentralized databases to create alternative systems for information and data exchange between or within related government or private sector institutions.
Trading - The use of a decentralized database and functionality to enable faster, more efficient and inclusive trading. Improves current trading processes, which are often paper-based, labor-intensive and time-consuming. Customer information and transaction histories are shared among participants in the decentralized database, while maintaining privacy and confidentiality when necessary.
Cash supply chain - The use of DLT for the issuance, tracking and management of the delivery and movement of cash from production facilities to the central bank and commercial bank branches; could include the ordering, deposit or movement of funds, and could simplify regulatory reporting.
The search for non-invasive technology
On June 8, 2021, the BIS issued a new report (more information here) that established the search for the best technology for the issuance of a CBDC.
In that sense, the BIS stated that CBDCs should enable central banks to provide a universal means of payment for the digital age and, at the same time, should safeguard consumer privacy and keep the financial system stable.
What the BIS lays out in its report are the economic and operational requirements of a "minimally intrusive" design that preserves the private sector's leading role in retail payments and financial intermediation. For CBDCs, the implications for the underlying technology are discussed.
The economic design of a CBDC should allow commercial banks to maintain their intermediation role between savers and investors. The operational design lies in the fact that the private sector best manages customer-facing retail payments, not the central bank, so the underlying question is how an operational architecture can balance the direct demands of the central bank with the operational involvement of private sector payment service providers.
Now, how can these designs affect the underlying technology?
Recall that any form of digital money requires a distributed registration system as it is implemented in many different places (i.e. merchant terminals). This system updates that distributed register and assigns certain monetary units to account holders according to the credits and debits that are made (i.e. we must be able to know the current balance of a consumer's digital wallet). In the case of CBDCs laws/regulations must be created to ensure that the information encoded in this statement is mapped to ownership of claims against the central bank.
BIS mentions that the technical architecture of a CBDC is defined by the role of the components of the distributed recording system, their communication relationships and the question of who controls each component. To this end, BIS provides an overview of possible CBDC architectures. Their examples differ in terms of the structure of legal claims and the register kept by the central bank.
In this case, technological resilience is achieved in the hybrid design by the operation of a back-up infrastructure by the central bank (hence the name hybrid: a payment system that can operate on both a public and private infrastructure). If a PSP fails - financially or technically - there must be a way for the central bank to unequivocally address claims and, ideally, resume payments to customers of the failing PSP without much delay.
In the report, the BIS noted that some central banks may avoid keeping track of all retail data, for example, due to data privacy and security concerns. Such central banks might consider a "brokered" CBDC architecture, where the central bank records only wholesale balances. One advantage of having less payment data at the central bank is that it is less exposed to malicious attacks than in a hybrid (or direct) architecture.
In summary, both "hybrid" and "brokered CBDC" architectures would be more financially resilient than fully backed payment accounts. These options also appear simpler for the central bank to manage than a "direct CBDC". Since the central bank does not interact directly with retail users, it can focus on a limited number of core responsibilities, while competing intermediaries handle the operation.
Can cryptocurrencies provide the necessary technology?
Several CBDC prototypes are based on enterprise versions of distributed ledger technology, such as Corda, Hyperledger or Quorum. This technology is inspired by decentralized cryptocurrencies and they borrow their concepts. However, most central bank projects have good reasons to run them in configurations that resemble a redundant but centrally controlled database, rather than architectures like Bitcoin.
Some academic proposals , by contrast, are designed to break away from conventional databases. They adapt certain principles of decentralized cryptocurrencies to the CBDC use case. In doing so, they often defend against the wrong threat, namely unaccountable and potentially malicious intermediaries. Indeed, these pose a challenge to cryptocurrencies running on many computers whose owners are barely identifiable, let alone known and trusted. However, in the case of CBDC, it is unimaginable for a central bank to allow unidentified parties to manage critical records. If a CBDC architecture uses designated intermediaries, these would consist of licensed and supervised banks, established payment service providers or technology companies if they are subject to oversight.
In addition, there are several adjacent debates. One is the balance between accessibility and security against attacks on electronic payment devices. Another is that no CBDC design can be fully cash-like, as users must rely on a technical infrastructure and may need to check intermediaries for failures or at least respond to notifications. Third, and perhaps paramount, is the question of how e-money could be designed to offer privacy, a property that cash offers by default. In any technology for e-money, privacy is a feature that has to be laboriously designed in rather than being an intrinsic feature of the system of record.
The report concludes that, going forward, the IT community will have to accompany the development of CBDC and realistically communicate what current technology can and cannot deliver. Since the technology to replicate all the properties of cash does not yet exist, the transition to CBDC could transform the current monetary system, which relies on cash as a fundamental building block. Given society's heavy reliance on a functioning and predictable monetary system, we call for a minimally invasive technology: one that offers consumers a digital complement to cash while preserving the two-tier monetary system and the important role of the private sector in it.
CBDCs, an opportunity for the monetary system?
Once again, the BIS pronounced itself on CBDCs in a report published on June 23rd, 2021 (more information here), in which he described the main results as:
CBDCs offer in digital form the unique advantages of central bank money: settlement, liquidity and integrity. They are an advanced representation of money for the digital economy.
Digital money must be designed with the public interest in mind. Like state-of-the-art instant payment systems, CBDCs with a retail design could ensure open payment platforms and a competitive level playing field conducive to innovation.
The ultimate benefits of adopting a new payment technology will depend on the competitive structure of the underlying payment system and data governance arrangements. The same technology that can foster a virtuous cycle of increased access, lower costs and better services can equally induce a vicious cycle of data silos, market power and anti-competitive practices. CBDCs and open platforms are most conducive to a virtuous circle.
CBDCs based on digital identification could improve cross-border payments and limit currency substitution risks. Multi-CBDC arrangements could overcome the obstacles of sharing digital IDs across borders, but will require international cooperation.
These results were generated in the context of the famous BIS "Project Helvetia" for wholesale CBDC use (more information here).
The BIS's consensus view derived from the report is that central banks are at the center of a rapid transformation of the financial sector and the payments system. Innovations such as cryptocurrencies, stablecoins and walled ecosystems of large technologies tend to run counter to the public good element underpinning the payments system. The end result will depend not only on the technology, but on the underlying market structure and data governance framework.
Central banks around the world are working to safeguard public confidence in money and payments during this period of turmoil. To shape the payments system of the future, they are fully committed to the development of retail and wholesale CBDCs, along with other innovations to improve conventional payment systems. The goal of all these efforts is to foster innovation in the public interest.
CBDCs represent a unique opportunity to design a technologically advanced representation of central bank money, offering the unique characteristics of finality, liquidity and integrity. These currencies could form the backbone of a new, highly efficient digital payment system by enabling broad access and providing robust data governance and privacy standards based on digital identification. To realize the full potential of CBDCs for more efficient cross-border payments, international collaboration will be critical. Cooperation in the design of CBDCs will also open new avenues for central banks to counter currency substitution and strengthen monetary sovereignty.
Benefits and downsides of DLT-based CBDC
The WEF published a whitepaper on November, 2021 regarding some technical considerations for CBDCs, in this paper (more information here). the WEF described the main benefits and downsides of a DLT-based CBDC:
Potential to bypass central bank or other authorities in transaction validation, clearing and/or settlement. This could increase speed and alleviate operational or technical challenges related to dependency on the central bank to validate transactions where those challenges cannot be solved by other means.
Potential for higher hardware fault tolerance, data redundancy from continuous syncing, and continuous service during extended periods of internet connectivity loss. These features generally increase as the quantity of geographically diverse nodes increases.
Potential for greater transparency in the account balances of participants and in the software code employed to execute conditional transactions, as account balances and software may be publicly visible.
Potential to reduce need for trusted intermediaries (e.g. clearing houses or custodians) and counterparties in interbank payments (such as in DvP or PvP53 transactions), as software enabling conditional transactions can be programmed in a manner that is difficult for individual entities to tamper with or alter.
If permissioned DLT: For cross-border CBDC arrangements, through shared ledger, potential to: (i) provide economies of scale in technology development and maintenance, (ii) provide an alternative solution for cases where involved jurisdictions cannot agree on common governance arrangements unless ownership and management of the ledger is shared, (iii) provide other new benefits with respect to greater integration, interoperability and the ability to settle international currencies (multiple foreign CBDCs) on a single distributed ledger.
If permissioned DLT: Ability to implement alternative governance structures that might be valuable in the CBDC context (e.g. to implement “checks and balances” and reduce dependency on one department or institution for sound governance). Namely, central banks can distribute certain responsibilities across different inhouse departments or external organizations. Nodes (internal or external to the central bank) could perform functionality that is specific to the mandate of that entity.
If permissionless DLT: Potential for lower-cost and more rapid deployment, as the CBDC operates on a pre-existing network and the monetary authority does not need to design, implement and manage the technology infrastructure itself. That said, the total cost of operating the CBDC must be considered, and it may not be lower in permissionless blockchain given the presence of transaction fees and potential for higher security and privacy costs (see right-hand column).
Where validation of CBDC transactions is influenced by or deferred to parties beyond monetary authorities, there may be greater risk of digital counterfeiting (including “double spending” activity) or harmful interference with CBDC operations, as well as potential loss of monetary sovereignty or independence
Higher complexity with respect to governance as entities beyond the central bank and traditional authorities may have powers and permissions related to the CBDC network and its transactions. More difficulty implementing protocol-level governance decisions or security fixes.
Higher overall privacy costs and more difficulty maintaining data confidentiality and preventing unwanted data dissemination, as more parties have access to transaction and account information.
Higher overall security costs from greater system openness and wider “attack surface”, if nodes beyond the central bank and public authorities have various permissions and powers in the CBDC network, and if software code for the CBDC network’s operations is transparent (i.e. publicly visible). As with other software, if smart contracts are coded improperly, they can create errors in the programme or be exploited. The decentralized and “immutable” nature of blockchain generally increases the difficulty of correcting software “bugs” or faulty transactions. These challenges are higher as the blockchain is more public and open.
Lower transaction speed and scalability, depending on implementation. Transaction throughput and scalability are generally inversely related to the degree of decentralization (or positively related to the degree of centralization). Relevant implementation factors affecting this issue include consensus algorithm, quantity of nodes, and the various powers and permissions of nodes.
Greater operational complexity and likelihood for operational risks. Challenges to overall technical resilience, continuous operation and cybersecurity, given newness of DLT infrastructure with lower testing and track record at scale coupled with greater operational complexity. DLT arguably presents a higher degree of uncertainty and potential for new or different forms of cybersecurity challenges, risks and attack vectors, as distinct parties are linked in a more complex network with a higher variety and quantity of participants.
If permissionless DLT: Leaves operation of the CBDC subject to the security, transaction throughput, governance rules, transaction fees and smooth functioning of the DLT network, which includes up to thousands of non-central bank parties and activities outside the central bank’s control.
Higher total cost of transaction validation and updating transaction records.
Presence of transaction fees, which fluctuate and may be high at times.
Potential legal and compliance challenges with the transaction network and database operating across borders and in a manner that is generally outside any jurisdiction’s control or liability.
Finally, the WEF details the cybersecurity challenges that may arise regarding the operation of CBDCs:
Credential theft and loss
Access credentials for CBDC may come in different forms, depending on CBDC implementation. They could be given in the form of a passphrase that could be easily communicated even on paper, or they could come in the form of a hardware token which stores the private keys. Regardless of the form in which access credentials are provided, the threat of theft and loss of such credentials is significant. The impact of credential theft and loss could be extremely damaging to an individual’s or entity’s savings held in CBDC, and it could also damage the central bank’s reputation.
It could be advisable for a DLT-based CBDC to use a multi-signature wallet, also known as a “social recovery” wallet. In addition to the credentials held by the owner of the wallet, there would be at least two other trusted parties who hold credentials to the same wallet (this could be the central bank itself, family members or other contacts of the end-user). Such multi-signature wallets enable the removal of a compromised or lost credential or key and the addition of new credentials.
Users with privileged roles
One concern of CBDC users is that government institutions, law enforcement and other entities may have roles which allow privileged actions, such as the freezing or withdrawal of funds in CBDC accounts without the user’s consent. These capabilities are in line with today’s compliance procedures in regulated payment systems. Although such roles are likely to be a functional requirement of a CBDC, they could lead to the threat of malicious insiders abusing the CBDC system. As with other types of information security, the central bank – and any intermediaries involved – should have in place a cybersecurity risk management plan to cover such privileges.
In a DLT-based system, depending on the consensus protocol used, nodes could declare transactions as invalid, essentially blocking them from being accepted by the network and creating a denial-of-service attack for CBDC users and censorship of their transactions. Collusion by non-central bank nodes could also enable double-spending attacks, a form of counterfeiting where the CBDC is spent multiple times illegitimately. The nodes may also decide to fork the distributed ledger, creating a different track and view of the ledger of transactions that disagrees with that of the central bank.
Denial of service
In addition to the potential denial-of-service attack that could be caused by validators described in the previous section, the threat of malicious CBDC end-users issuing too many transactions simultaneously is important to consider. If a very large number of CBDC users (possibly controlled by the same organization) were to issue transactions simultaneously, the CBDC system could become overloaded and stop serving legitimate users, potentially losing benign transactions. This may occur with CBDC operating on DLT or on centralized technology infrastructure. Another threat which could lead to such a denial of service is a natural or technological calamity (e.g. flood, fire, power-outage etc.) close to the infrastructure on which the CBDC system is running.
One way to mitigate this threat could be to use a highly distributed system with sufficient redundant machines on different cloud platforms (e.g. AWS, Azure, GCloud, Salesforce, “on-premise” or private cloud etc.) in different physical locations. This mitigation is more naturally applicable to DLT-based CBDC systems, where computing resources may be more distributed across various cloud platforms and locations. Moreover, this mitigation also solves the threat of malicious cloud or system administrators who could single-handedly cause a denial of service or even of privileged actions, by tampering with the software stored on the systems under their control. Leveraging public cloud infrastructure would also benefit from the robust security that such organizations have built up over time.
As introduced above, CBDC end-users could try to spend funds from their wallets in multiple places, constituting a form of digital counterfeiting.The risk of double spending is higher if the CBDC has an offline capability, depending on the technology with which it operates. Doublespend transactions could be sent to entities that are offline without the high-security validation process that would normally occur online.
Anonymity in CBDC accounts aggravates doublespend risk in offline payments, as the central bank or authorities may have greater difficulty identifying the attackers or blacklisting wallets that are used on a one-time or ephemeral basis
Regardless of whether the implementation of the CBDC system will be using a DLT- or nonDLT-based solution, it will involve cryptographic primitives for protecting the confidentiality and integrity of the data being stored and transmitted. Therefore, the threat of emerging quantum computers should be taken into account when choosing the cryptographic techniques used in the CBDC system. Moreover, quantum computers developed in the future may be able to break current cryptography without detection. Quantum computing will ultimately impact all financial services, as it compromises major data encryption methodologies used today.
CBDCs are advancing and evolving, the race for the issuance of the first digital currency is quite hectic considering all the projects and initiatives of Central Banks around the world.
There is still a lot of research to be done, from legal modifications and reforms, to security and privacy considerations for citizens, but CBDCs can be a very valuable instrument for governments to counteract the advance of cryptocurrencies such as Bitcoin, Ether or Stablecoins.
A design focused on citizens rather than government control is fundamental for the issuance of CBDCs to be truly beneficial and to achieve financial inclusion, a competitive payments market and a tool for fast and efficient international transfers, as opposed to a tool for citizen control and espionage.
There are too many challenges in the world, which Blockchain technology could address in different ways, we are sure that little by little will generate a massive adoption of this technology that will impact in an improvement for our society.
In a second installment of this research we will propose the definition of what we understand as Alternative Central Bank Digital Currency or "ACBDC".
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