3 Reasons Why Blockchain For Central Bank Digital Currency (CBDC)

In Blog, Enterprise by Darpan Keswani

This blog is a transcript of a segment from our webinar “Why Blockchain For CBDC?” held on the 12th of November. If you’d like to get first dibs on tickets to our events and webinars, sign up for our newsletter.

In many ways, CBDC has become synonymous with blockchain. However, CBDC can easily be implemented without it. Just look at China’s DCEP, which uses a central state-owned database instead of a distributed ledger. So the question of why blockchain for CBDCs as a preferred or even valid solution remains.

The simple answer? Blockchain provides the ability to create a fully decentralized CBDC network. Entities other than the central bank can participate in the operation of the network, increasing resilience, security, efficiency, programmability, and interoperability. And compared to traditional financial networks, blockchains enable high speed, low-cost transactions. But there are three other reasons we feel blockchain is suited for CBDC. Let’s explore those:

Digital Token Properties

I want to start with a basic blockchain functionality that is well-aligned with CBDC’s needs: digital token properties. As we support ERC-20 tokens on OMG Network, I’ll reference that standard in particular.

  • First, ERC20 tokens can be issued on any Ethereum based platform, including Hyperledger Besu. Token issuance on multiple platforms is also supported, enabling future cross-chain use.

  • Second, tokens are controlled by the issuing smart contract owner. This allows them to manage supply by minting and burning tokens and potentially maintaining a list of restricted wallets.

  • Third, tokens cannot be counterfeited as they are irreplicable. Tokens issued from any other contract apart from that owned by the central bank will not be accepted. And there are many ways to secure the private key controlling those functions. And the ERC-20 standard, in particular, has a whole ecosystem to support it, allowing for programmability, security, and interoperability.

DeFi & Innovation

The blockchain ecosystem has grown exponentially over the past few years, with mature and innovative tools, products, and services. The Decentralized Finance or DeFi boom has created lending platforms, decentralized exchanges, and other financial services with increased accessibility and efficiency.

This ecosystem also provides a set of tested best practices against a very advanced adversarial environment. As we will present later, our CBDC lifecycle uses a variety of those best practices.

These practices include leveraging hot, warm, and cold wallets to ensure funds are safely held while still accessible for immediate needs. It comprises key management techniques for custodial wallets to ensure those managing wallets can keep them secure. And it includes liquidity, settlement, and exchange services that help funds flow between the traditional and digital channels.

All this innovation can quickly be leveraged by CBDCs in adopting blockchain technology. Plus, for those fearful of the riskier DeFi schemes, the added support and oversight of a central bank reduces the risk of mass adopting these new financial services.

True Public Ownership

Almost all CBDCs designs are aiming for a cash-like asset with direct claims on the central bank. Blockchain technology is uniquely suited for these cash-like properties with a path to true and direct public ownership of the currency.

For me, the most exciting possibility for CBDC on an open platform is the idea of public ownership. The public can actively participate in the operation of the CBDC network, becoming a true public good. The network will continue to operate uninterrupted for as long as the public is willing. Openness also paves the way for numerous possibilities for interoperability, especially at the supranational level.

At the individual level, traditional digital money systems are custodial, with trusted central parties holding their funds. Blockchain technology gives us the option of true cash-like bearer ownership. In its purest form, wallets holding cryptographic keys have sole control over their funds.

Wallets can still be custodial for those who don’t want that responsibility. This gives people a greater choice in how they want to manage their funds. At their best, blockchains are trustless networks. Sometimes this can also be seen as trust-minimized or distributed trust networks. For the sake of this conversation, I’ll refer to this characteristic as “trustlessness.”

The participants’ actions in a trustless network are governed by protocols, crypto-economics, and consensus mechanisms — rather than by trusted, centralized parties.

Trustlessness is the fundamental invention of blockchains that make them unique. Never before have we been able to create such large trustless financial networks. By reducing the need for trust, we can also reduce much of the legal overhead to enforce that trust. We reduce the need for contracts and agreements and arrangements of liability.

This is most interesting at the supranational level. CBDCs are necessarily global. As large economies develop their own CBDC networks, smaller economies are at risk of being supplanted by these networks. This opens up issues of sovereignty and national security. Regional and consortium networks are going to become more important. Trustless networks are better aligned to those sovereignty issues since these networks are truly peer-to-peer. Achieving regional or consortium CBDC interoperability through trustless networks can be more efficient by reducing the need for multilateral agreements. Central banks in a particular region or economic cooperative can agree on and trust consensus mechanisms instead.

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