Thomas Kudrycki, Chief Technology Officer, eCurrency
Much has been published about the new generation of the financial sector technologies over recent years, and a lot of the writing focused on digital currencies. The discussion mostly had involved the cutting-edge technology firms and the venture capital behind them but has recently entered the mainstream financial circles. The International Monetary Fund (IMF) devoted a full day to digital currencies in its Spring 2019 meetings, and its Chairperson encouraged the member banks to look into the possibility of digitizing their currencies. Several central banks are in the process of defining the requirements for a digital legal tender, with pioneering central banks such as Swedish Riksbanken already in advanced stages of contracting a firm to deliver a pilot implementation of a Central Bank Digital Currency (CBDC). The discussion has been galvanized further by Facebook’s announcement of the Libra and the almost universal concern of the central bankers that a supranational currency will displace the use of the local currencies severely limiting central banks’ ability to manage their countries’ economies while continuing to hold them responsible for the economic stability and performance.
The continuing discourse to be effective requires a common understanding, and a clear set of definitions to allow unambiguous communications. I’ve previously described the efforts of the International Telecommunications Union’s (ITU) working group (link) to provide the industry with such common vocabulary. The working group published the results of its standardization effort in September 2019, and this article attempts to summarize these results. It is interesting to note that the ITU has taken an early adopter risk in undertaking this effort. It is not self-evident that an international telecommunications body should lead the standardization efforts in the financial realm, but upon a more careful look at the problem it is clear that in order for digital cash to operate efficiently, a global telecommunication network is needed and standardization is necessary to reduce friction and provide some level of future-proofing safety to the participants. The central bank digital currency discourse was very young when the ITU took the risk of jumping into it in 2016 and is now much more mature and more relevant to our immediate future partly as a result of ITU’s effort. I gratefully acknowledge ITU’s contribution to the digital future of currency.
Group Photo at ITU Digital Fiat Currency Showcase, Geneva, Switzerland, June 2019
The outputs of the effort can be found here and come in three broad categories: definitions of terms, CBDC security, and implementation architecture and use cases. This article focuses on the architecture and use cases report.
The ITU output documents identified three main areas where CBDC could be used: wholesale, retail, and cross-border.
Wholesale CBDC facilitates wholesale payment transactions among financial market participants and between the national central bank and participating financial institutions. It is a settlement instrument to execute relatively infrequent and high-value transactions. It can be thought of as an improvement to the Real Time Gross Settlement (RTGS) systems, or perhaps a replacement for them. Most countries have RTGS systems operated by their central banks. RTGS money, that is to say, the form of money used to settle the large transactions on the RTGS systems is a form of central bank money. The use of CBDC for wholesale purposes produces several benefits described in the output document, but the benefits are limited by the fact that the RTGS systems are already under full control of the respective central banks. The use of CBDC produces some benefits but is not revolutionary in this scenario. If we factor out that many existing RTGS systems were built some decades ago, are antiquated and should be replaced by faster and better contemporary products anyway, CBDC would replace an already good approach only with a somewhat better one.
Cross-border CBDC is probably more accurately named cross-currency CBDC to account for monetary unions operating on the same currency managed by the same central bank, such as the European Central Bank (ECB) or the Central Bank of the West African States (BCEAO). In a cross-border CBDC, several participating jurisdictions, through either their respective central banks or a global multilateral institution, agree to create a universal CBDC. The U-CBDC will be backed by a basket of currencies issued by the participating central banks. The U-CBDC would be issued via an exchange specifically created to allow for issuance and redemption of such U-CBDCs. This application of the CBDC concept to cross-currency payments is revolutionary and is expected to lead to significant reductions of the cost of international payments and remittances. The emergence of Facebook Libra since the conclusion of the ITU effort illustrates this point in succinct, commercial terms. However, the U-CBDC described by the ITU is created by groups of central banks or governmental, international bodies such as IMF and, therefore, more closely resembles the existing paper currency, rather than private money created by commercial entities, such as Libra or MTN Coin.
Retail CBDC is a widely accessible digital representation of sovereign currency (cash) that is issued by, and liability of, a jurisdiction’s central bank or monetary authority, and is a legal tender within that jurisdiction. The ITU CBDC standardization group identified several key characteristics of a well-designed retail CBDC. The characteristics range from compliance with central bank policies and the non-disruptive nature of the approach to security and ubiquity. They can be all summarized by a simple statement: CBDC must behave like physical cash but without the limitations imposed by the physical form of the current cash.
The ITU effort has identified three main use cases for retail CBDC, which mimic the use cases of cash: issue the money through a central authority, distribute it through existing distribution channels, and transact using, as much as possible, the existing means of electronic transactions rather than replace them.
CBDC issuance is a process by which a central authority, and only the central authority, can create the initial CBDC value. It is critical that the process is of the highest security to preserve the integrity of the currency, it cannot be “hackable” by any external entity, it needs to be controlled by a group of authorized officials rather than any single person, and its details must remain secret to prevent any attempts at replication.
CBDC distribution is also initially controlled by the central bank, but in an analogy to the printed physical currency, subsequent distribution down to individual wallets needs to be done through commercial entities such as banks and e-payment operators.
CBDC payment transactions exchange the digital banknotes for goods and services using emoney systems. The CBDC transactions must utilize as much as possible the existing payment infrastructure to ensure the adoption and continuity of the financial systems. The ITU effort has also identified three main architectural approaches to building possible CBDC implementations: centralized, as-a-service, and decentralized.
The centralized architecture combines all three use cases into a single system, which by necessity is then fully controlled and operated by the central bank, or a tightly controlled entity created and managed by the central bank for that purpose. This centralized system can be thought of as a way to directly extend the RTGS to the public. It suffers from many drawbacks. It does not separate the various concerns of issuance, operations, and security, thus creating undue risks of a breach extending to all aspects of the solution. It requires the central bank to manage individual wallets of the members of the public, thus forcing it into a consumer business with all the responsibilities of managing customer relations and customer support. It puts the central bank into direct competition with commercial, financial institutions leading inevitably to only one of two possible outcomes: stifling of the market competition or failure due to the lack of adoption. It is also illegal in many countries for the central bank to compete with the commercial banking and payment sector. This approach, like any other centralized approach, does not scale well. It may work on a small scale or in small countries but is almost guaranteed not to function well even in medium-size environments of a few tens of million people.
CBDC as-a-service architecture has the central banks deliver the core services of issuance, distribution, and registering the digital banknotes and then provide a technical way to integrate external services into this core via an Application Programming Interface (API). This approach corrects some of the drawbacks of centralized systems. It scales much better than the centralized approach and does not put the central bank into the direct competition with commercial consumer payments institutions. However, it continues relying on the central bank to operate significant additional technology infrastructure not under its control today.
Decentralized CBDC architecture allows the central banks to maintain control of the CBDC issuance and the initial distribution while allowing commercial entities to distribute CBDC through existing commercial channels further and to operate the payment infrastructure. It most closely resembles the current physical currency approach where only the central bank can print it, but commercial entities and individuals perform the distribution and payments themselves. It is, after all, the very nature of the physical currency to be completely decentralized and allinclusive in its operation, while being controlled at the source by the central banks. This approach corrects all the shortcomings of the centralized system and continues building on the advantages of the CBDC as-a-service approach by limiting the responsibility of the central banks to what they have been created to do: to develop monetary policy and create and manage the money supply, including printing and distributing cash, but not manage the ATMs or public’s wallets.
The eCurrency CBDC solution has been developed as a decentralized CBDC system. The solution is specifically designed to mimic today’s physical currency issuance and distribution. The eCurrency solution provides central banks the tools to develop monetary policy and create and manage money supply in digital form in the same manner as it does physical currency.