Exploring Central Bank Digital Currency development on Algorand
Central Bank Digital Currency (CBDC) is a digital currency issued by central banks of countries where the power of money issuance and monetary policies are still in hand of the central bank. It is analogous to the uncollateralized stablecoin of the crypto sphere in that they are not backed by any assets though the community backing it is the central bank and financial policy makers.
What prompted countries and central banks to explore CBDCs? Was it the challenge to financial stability and to the dominance of national fiat currencies posed by digital currency issuance by private companies such as global social media giants, technology specialists or is it a cheaper method to print money with minimum overheads or is it to mitigate corruption and counterfeits. The short answer is that it is a combination of all as well as to keep evolving to utilize the available technology.
What are the check points to implement CBDC successfully?
The check points that have to cleared for a CBDC implementation to be considered successful are as follows:
- The underlying technology and algorithm design which is utmost important for scalability and developing a level of trust
- Enhanced security features for transparency, traceability, Anti-Money Laundering (AML)
- Supply limits to moderate the inflation and interest rates to keep the financial norms in check
- Ease of access as well as usage to allow users to start using them without any confusion
- Regulations imposed by central banks and policy makers, which depends on the design of the CBDC, for the availability and acceptability of the CBDC globally
These checkpoints will serve as challenges to the central banks of each country which they have to overcome in order to not only keep the payment and financial system updated with the latest technologies but also not concede any further space to cryptocurrencies.
How will DLT play a role in it?
The technology being used, whether with centralized or decentralized ledger, and the algorithm design of a CBDC will be detrimental to define its effectiveness as a monetary policy instrument and whether it may cause any financial instability. Blockchain,the Distributed Ledger Technology (DLT) is the front runner on the technology front to be used as the platform to build CBDCs but the consensus mechanism and the algorithm to be used to create the perfect CBDC is still uncharted territory.
Here it must be said that DLT is by no means at the optimum levels to be adopted which is causing existing technologies to evolve or be replaced. With issues such as scalability, privacy and lack of interoperability with other DLT networks still being worked upon, there is some work still left. Moreover, consensus protocols do not offer absolute finality required for payments rather only probabilistic finality. But DLT is still way ahead of the other available options in terms of providing transparency, immutability, traceability and security. CBDC creation has been tried on Algorand, R3 Corda, Ethereum, etc. as some of these blockchains have worked to tackle the issues mentioned above.
How is Algorand placed to be used as the underlying tech for CBDCs?
The assets to be created and/or issued on the Algorand blockchain will have the advantage of a secure, scalable, transparent and highly accessible blockchain network making it the one of the better options for countries which are in economic distress to issue digital currencies in a standardized and regulation compliant format. Moreover, with asset spam protection that prevents unknown assets that may have tax, legal, or reputational risk from being sent to users without their explicit approval (users must opt-in to accept new assets), the privacy and security of users using have been taken care off.
Marshall Islands’ Marshallese sovereign (SOV), built using Algorand technology will circulate alongside the US dollar and help the Marshall Islands efficiently operate in the global economy.
Market Opportunity
The position held by cash as the primary mode of financial transactions had already been taken over by online payment systems and with the launch of digital currencies the challenge has been heightened even further, leading the central banks of many countries to respond.
Exploratory research, pilot testing and in some cases even implementations are being worked upon currently by Central Banks in China, Russia, Germany, Switzerland, Venezuela, South Korea, the United Kingdom, UAE, Senegal, etc. with majority of them using blockchain and pegging the CBDC to the fiat legal tender of their respective countries while some are using are experimenting with pure blockchain based algorithmic token currencies. Digital currency exploration was mentioned even in the US stimulus package issued but never made the cut to the approved bill. This clearly shows that central banks across the globe are not only aware of the forthcoming challenges as well as the glitches in the existing financial and payments system but also are decisively working on developing CBDCs.
Future insights
In the next few years, we will see developed as well as developing economies using CBDCs, more so for practical reasons to eradicate money laundering, to curb inflation and most of all to improve the payment system. For sure the number of blockchains will either merge or fade away to enable interoperability and scalability to produce a solution that can cater to the requirements of true global presence. CBDCs will gradually become the accepted legal tender in place of fiat though the journey sure will be interesting.
With features of interoperability, scalability, increased security, simplified usage, transaction finality, no forking, asset spam protection, etc. the Algorand blockchain platform is placed very strategically to be used for creation and issuance of CBDCs.
