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Central Bank Digital Currency (CBDC) as a Tool for E-money Interoperability

Contributed by Thomas Kudrycki, Chief Technology Officer, eCurrency

A possibility of Central Bank Digital Currency (CBDC), or Digital Fiat Currency (DFC), has gained significant attention in the past two years. Several sessions were devoted to the subject of CBDC at the Spring Meetings of the International Monetary Fund (IMF) held in Washington DC between April 10 and 14, 2019 ( ).

In parallel with the IMF meetings, the third meeting of the ITU DFC (CBDC) Reference Architecture Workgroup was held on April 11, 2019, also in Washington DC. The International Telecommunication Union (ITU), initially created in 1865 to standardize telegraph communications, is a specialized UN agency for information and communication technologies. The ITU is leading the efforts to standardize the terminology used to describe digital currencies and to delve deeper into the possible technologies and system architectures used for implementations of DFC. One of the new and exciting uses of CBDC discussed at the Workgroup was e-money interoperability.

E-money use has grown tremendously in the past five years. In many developing countries where the traditional financial institutions have underserved the population, e-money has revolutionized the way payments are made, has reduced market friction, and has contributed to financial inclusion and economic growth. The World Payments Report 2018 ( content/uploads/sites/5/2018/10/World-Payments-Report-2018.pdf ) is representative of research in this area. According to the report, global non-cash transaction volumes grew by 10.1% globally and by 16.5% in the developing markets in 2016. Non-cash transaction growth in the developing economies is estimated at 21.6% annually between 2016 and 2021.

In many markets e-money systems are closed-loop, siloed operations allowing transaction flow only within their own, limited scope. The growth of the e-money industry would be even faster if e- money systems could inter-operate more effectively, just as roaming agreements helped the massive growth of mobile communications in the 1990s. Solving the issue of interoperability is currently a subject of many efforts around the world.

Despite all its benefits, many central banks and e-money operators are ambivalent about e-money interoperability. On the one hand, interoperability is demanded by the public and more frequently required by some central banks. On the other hand, many operators still prefer to operate within their silos to avoid additional complexity and risk, and many central banks feel that the regulations are not robust enough to allow interoperability.

Unlike with traditional banks, regulators typically have little visibility into the e-money transactions or the flows of e-value within the economy. For example, it has been reported that e- money has been used to facilitate funding for terrorist activities. E-money fraud and digital counterfeiting is possible and happens around the world. It is also easier to hide fraudulent activities when e-money can flow freely across multiple e-money providers because of the necessary coordination of efforts and inherent barriers to communication about possible fraud cases.

Overall e-money ecosystem security risks and e-money counterparty risks are higher when subscribers of multiple operators can freely exchange value through interoperability, and settlement among the various counterparties is complex and grows quadratically with the introduction of interoperability.

CBDC creates significant new tools to counter those problems. In the CBDC implementation by eCurrency, the central bank initializes security and forms a cryptographic security boundary around the components of the entire ecosystem, including all the interoperating parties. The digital currency objects are stored in e-money wallets and bank account entries and make the balances impossible to forge. The digital currency cryptographic objects circulate among the participating, interconnected commercial banks, e-money operators, and financial networks using a secure CBDC API and utilizing existing, or planned National Payment Systems (NPS or NPRS). The participating commercial entities forming this interoperable ecosystem retain their specific characteristics, customer relationships and competitive advantages, while operating using secure, digital cash instrument issued by the central banks, thus solving many of the interoperability challenges.

Anticounterfeit: Advanced digital currency technology secures customer balances in bank accounts and e-money wallets making the balances immune to modification except through legitimate transactions. The CBDC payment instrument cannot be counterfeited, modified to hold a different value, or double-spent.

Instant settlement using digital cash: Transactions and settlements between the senders and recipients are executed in the digital form of cash and therefore are instant and final. When using standard e-money or bank transfers, the multiple participating parties must all reconcile and agree to the final, settled amounts. The interoperable components of the CBDC ecosystem send across the real, digital currency and therefore the transactions occur only between the senders and the recipients in one step. There is no next step to be executed. The settlement is instant and final.

Interoperability risk reduction: The security protects against fraud and removes risks from e- money operations and risks associated with connecting e-money platforms to the banking platforms. With the instant settlement there is also no counterparty risk and, being backed by the central issuing authority removes the risk of the individual e-money operators or banks being insolvent.

New revenue streams: traditional financial institutions looking to create e-money for their customers through external technology partners can secure the value flowing through their systems and can allocate a maximum amount of e-money transacting in those systems.

Traceability and regulatory compliance: within the applicable laws of the country, eCurrency CBDC gives real-time monitoring and reporting access to the authorities and significantly improves AML and CFT protections

Financial inclusion: Direct access to the central bank money in a digital form fosters trust in the e- money solutions and promotes financial inclusion through its availability, security, and trust. Several studies have found a positive impact of Central Bank Digital Currency on the usage of e- money systems. Some central banks, such as Swedish Riksbank, have decided that the public’s direct access to Central Bank money will continue to be necessary in the digital age and have established programs to pursue this goal. Many are expected to follow suit.

Cashless society: Cost of cash is estimated to be between 0.5% to 3% of each transaction depending on the geography and infrastructure of the country. Many highly developed economies, such as Sweden, are actively working towards reducing cash usage. At the same time, many Central Banks are concerned that removing public’s access to the base money issued by the Central Bank will be detrimental to the economy and will reduce the effectiveness of the Central Bank’s financial policy tools. CBDC charts the way forward and provides a solution that enables the society to stop using physical forms of cash but without removing the idea of cash from the economy. It merely evolves cash into a digital form.

The new generation of National Payment Systems (NPS or NPRS) augmented and fortified by the use of CBDC is full of promise and is the next big opportunity of building better financial systems.


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