Central bank digital currencies (CBDC) are coming whether you like it or not. The efficiencies that will be gained from issuing digital currency can’t be ignored and I do believe that it’s just a matter of when, not if, at this point. You can read my previous post about why we need them, this post is focused on how to get them right.
I’ve read dozens of reports and articles from central banks, the international monetary fund, the world economic forum and other major players in the world economy about CBDCs. I’ve met with government officials that are researching and/or experimenting in this area. I’ve met with a central bank. I’m working with a company that is building CBDC technology for central banks. I founded a blockchain company that builds and operates a high performance public blockchain network with Fortune 250 companies like Lenovo and Dish Network running nodes on it. That company is also building blockchain solutions for large enterprise companies to help them become more efficient.
CBDCs are coming whether you like it or not.
Nearly 80% of central banks are working on central bank digital currencies in some form or another. The Eastern Caribbean Central Bank has announced they will be piloting the world’s first CBDC for the Eastern Caribbean Dollar in Q2 2020, with a handful of financial institutions, hundreds of merchants and thousands of residents using the currency. The World Economic Forum created a CBDC Policy-Maker Toolkit. A consortium of the largest central banks including the Bank of England, the Bank of Canada and the European Central Bank are working together on CBDC research. Search for “CBDC” and you’ll find a lot more going on too. It will probably be a few years before we see real adoption, but it’s starting to happen today.
Taking into account what I’ve learned along the way and where central banks are headed, I’ve come up with a few things I think a proper central bank digital currency will need in order to get mainstream acceptance and achieve their goals.
What are the Goals of the Central Banks?
First off, what are the goals of the central banks with regards to CBDCs. This is a chart from a study by the Bank for International Settlements that answers this question:
What is a Central Bank Digital Currency?
The easiest way to think of it is like this: instead of the central bank printing new physical bills (the ones you can touch), they will issue a digital token on a blockchain where one token issued on the blockchain is exactly equal in value to one physical dollar bill. You will access and use your money via your phone or computer.
The difference between this new form of currency and existing payment apps is that these wouldn’t be run by a third party company that holds custody of your money until you withdraw it. Instead you will own your own money, just like cash.
Requirements for a CBDC
These requirements are just my personal, arguably educated opinion.
Open, publicly accessible network
The network (blockchain or similar) must be openly accessible to the public, anywhere in the world. It shouldn’t need to be accessed through a third party.
That said, it can (and probably should) be a closed network of nodes that validate and sign blocks. Anybody should be able to be a part of the network to validate and monitor, but the nodes that accept transactions into the network can be a closed group. A good CBDC network could be run by a consortium of organizations. For instance, a blockchain network for a Euro CBDC, issued by the European Central Bank, could consist of every country in the Eurozone. Each country would run a node in the network, plus the central bank itself, and maybe some citizen organizations run nodes to keep everyone honest.
In the end, we will likely end up with a bunch of separate networks, each perhaps containing just one currency each. Which would actually be a good thing as it will allow scale that existing blockchain technology can’t achieve just yet.
The wrong way to do this is to build an API in front of the blockchain to control and restrict access to it. If the central banks do this, then it is no better than any existing payment system and they might as well not bother as they would be making nothing better and missing out on the whole point of this technology altogether.
Cash like usage
The general public needs to be able to access the currency just like they can cash. There shouldn’t be a middleman getting in the way. I shouldn’t need to go to a bank, login to a bank or payment service provider or even have a bank or payment service account to use the currency.
Cash is still king today and if the CBDCs don’t get this part right, cash will remain king.
Don’t get scared governments and bankers, this may sound like it leaves a door open for illegal activity (which it does), but it’s still better than cash because you can monitor and track transactions easier, even though they may be anonymous.
Banks can still do their thing by providing a safe place to store money, provide credit and other financial service. The main difference being they’d store the digital version of your money (aka: look after your private keys), some of which would probably be held by the same central bank that issued it (thanks to the wonder of fractional-reserve banking).
And for the 1.7 billion adults that can’t get a bank account, they only need their phone to be able to safely store and send money anywhere in the world for next to nothing. And these same people could gain access to many other financial services that have been inaccessible to them such as investing or earning interest on their money. This would be a life changing development for a large percentage of the world’s population. Even in relatively advanced countries, it can be very hard to invest in the stock market or even earn interest on their bank accounts.
Allow new financial services to openly build on the network
This will be the main driver of financial innovation making the world a better place. A programmable currency is an amazing boon for innovation, like we’ve never seen before. It can alleviate all the issues with existing fintech businesses that require them to hold custody of the funds, in order to use the service. This reduces the risk of using financial services that may not be in your best interest and reduces the need for things like bank account insurance, ie: you won’t need to care anymore if your bank goes belly up.
Think of Venmo, PayPal, Transferwise, Robinhood, etc. They all require you to send them your money (deposit), then you can use their service. With CBDC (or any cryptocurrency for that matter), they do not need to hold custody. You can remain in custody of your funds while using third party products and services. You’ll still be free to make stupid decisions with your money, but at least it will be harder for companies to take advantage of you and you don’t have to be at the mercy of your bank.
Another key benefit of CBDCs is that it’s interoperable money, much like cash is, but you don’t have to be in the presence of someone. Consider how you use a payment service like Venmo. It requires you and your friend to both have an account with that company. With CBDCs, you could use an app like Venmo and send money to your friend that is using a totally different service. A CBDC can enable these services to accept and interact with this new digital currency, openly and freely.
Use a standard programming interface
The defacto standard for blockchain interfaces is the Ethereum JSON RPC API. Pretty much every app or service you can use today uses this API. Why? Because Ethereum basically invented the programmable blockchain so people built on it first and it’s now where a large number of tokens live including ALL the current stablecoins.
If you release your CBDC using an Ethereum compatible blockchain, all the apps, tools and services that are on the market today will be able to start using your new digital dollars immediately with very little effort.
So if you want fast, easy adoption of your shiny new central bank digital currency, you better stick with what people know.
An additional benefit of using an Ethereum compatible blockchain for your CBDC is that there are open source token contracts that are basically hack proof and that have been proven after years of holding billions of dollars in value, USDT and USDC for example. So yes, you could go build your own smart contract on Hyperledger or something, but is it worth the risk? Proceed with caution.
I’m not saying this will be the standard forever, but for the time being, it is.
After working in this space for years now, spending time in a country where banking is so bad it makes you want to use cash again, and working with the people that are making CBDCs a reality, it just seems inevitable that it’s going to happen. I’d bet by 2030, digital currency on blockchain will be the new norm.
If you are involved with designing a central bank digital currency, please ensure to include the above points in order to satisfy the main motivations behind it including financial inclusion, cheap global payments and drastically reduced costs of issuing and administering currency. Perhaps just as important, it will enable the future of financial technology by making it easy to use and integrate with no barriers to entry.