Supporting The Next Central Bank Digital Coin (CBDC) (Part 1)

80% of the world’s central banks are engaged in research or experimentation toward developing a CBDC

Early 2020, the PBoC has filed more than 80 patent applications related to digital currency, and by 2025 Sweden aims to be conducting 100% (now 75%) of its payments online using e-krona. So the race is on, and many countries have embraced the challenge, that’s why Unity Network today has no choice but to support the next CBDC by raising awareness around the different problems it will solve and pose at the same time. In this post (part 2 coming soon) we will start first by getting the basics of what a state-backed digital currency is and why it matters now more than ever before.  

1-What is a CBDC exactly?

In short, CBDC is a fiat currency issued by central banks  in digital form in place of, or as a complement to, physical currency (banknotes and coins). In opposition to the traditional cash system, digital money can be accessed more broadly than reserves and has potentially greater functionality for retail transactions than cash.

2-Why issue a CBDC in the first place?

Rather than threaten the monetary sovereignty of the state over the Dirham as the saying goes for bitcoin and other cryptocurrencies, CBDC would discourage illicit activities (anti-money laundering/combating the financing of terrorism) and rein in the shadow economy by reducing the anonymity of transactions now provided by the use of currency banknotes. More transparent transactions would also affect tax revenues, both by bringing more activities out of the shadows and into the tax net and also by enhancing the Moroccan government’s ability to collect tax revenues more efficiently.

Another important point to consider here is how CBDC will help establish a more social-friendly environment by guaranteeing financial inclusion, by taking advantage of mobile technologies to increase access to financial services for the poor, rural households, and other segments of the population that may be underserved by the banking system.

3- How can we issue it?

It’s very important not to be scared of cryptocurrencies before understanding the technology behind them. To issue a CBDC, the central bank will have to put in place a blockchain ecosystem using the distributed ledger technology. The ledger infrastructure is distributed, which means multiple parties are following some precise rules(consensus) to hold a global state so that all the parties at every second will be synchronized to the next state. This allows a contemporary digital currency system to maintain a global state (Digital yuan, e-krona..) by comprising the balances of all their users. Updates to the state are then called transactions – these could be simple transfers of funds or interactions with smart contracts. The state of the system is the result of processing the transactions in the ledger according to their order. The transactions are typically aggregated into so-called blocks, each containing many transactions, and the blocks are linked to form a chain, imaginatively called a blockchain.

4- How decentralized is a CBDC?

We should be careful not to mistake a CBDC for another classic cryptocurrency like bitcoin and ethereum. It’s worth stressing then that a CBDC should operate under a distributed system but not a decentralized one!

Because decentralization also implies no central control even when it is necessary, no reversal of transactions in case of mistakes, and no prevention of operator misbehaviour like front-running ( trading financial asset by a person/bot who has inside knowledge of a future transaction that is about to affect its price substantially).

To reduce centralization, a CBDC can instead be operated by a larger set of independent parties chosen or approved by the central bank. A simple example is how the « digital yuan » was architected to be token-based, with commercial banks and financial institutions circulating the tokens.

5- How safe are CBDCs?

No digital currency will remain operable and in use for long without satisfying certain fundamental information security properties. In particular, classical information security principles defined by the 3 complementary dimensions of information security: confidentiality, integrity, and availability.

A CBDC will rely heavily on cryptography and distributed systems technologies to guarantee these 3 security concerns. As of privacy concerns that a public ledger may pose, we can aim for something similar to « controllable anonymity » as China calls it. So that at first sight the transactions are anonymous but not for central authorities who hold the permission to verify the sender and receiver of every transaction. And that’s possible by implementing a private ledger where only authorized parties can verify it.

6- Who will manage your wallet?

To store a CBDC, users need to hold a digital wallet with digital ledgers, protected by cryptography and consensus protocols.

The task of creating wallets for users should be delegated to commercial banks, this is the best approach. The former head of the PBoC’s (People's Bank of China) Digital Currency Research Institute described that the digital yuan would be based on the model: “one coin, two repositories, three centres.” “One coin” is the digital yuan, the “two repositories” lie in the central bank as well as the commercial banks who will distribute the digital currency and individual wallets; “three centres” refers to the data centres which will perform authentication, registration, and big data analysis.

CBDC will revolutionize the money system, by making money smarter and more resilient. But each country will have to take into account its specific circumstances and initial conditions before deciding whether the potential benefits of introducing a CBDC outweigh the possible costs.

About the Author

Soufiane Hajazi
Solidity Developer & Advisor

Soufiane is leading the blockchain development inside Unity Network.