Central Bank digital currencies, or CBDCs, are one of the biggest boogeymen for the crypto industry. If you search CBDC on Twitter, you’ll find a list of CT users airing their concerns, most of which are well-founded with a small minority being conspiratorial. Nevertheless, it should not be understated that CBDCs have as much danger as they do potential. Therefore, it is all the more important to provide some proper information about the timeline of CBDCs and where development is for the concept.
CBDCs are digital currencies issued by a central bank rather than a commercial entity. Many countries have a CBDC project underway in some form. To date, there are nearly 100 CBDC projects, the majority of which are in research and development. 25 projects are fully launched or under public piloted testing. Earlier this year, the IMF published a paper exploring some of the projects already launched or in development, focusing on Canada, Sweden, China, the Bahamas, Jamaica, and Uruguay. It explored their motivations, models, and flaws.
Goals
All projects had very similar goals and very different outcomes. Their goals were more or less the following:
Financial inclusion
Mass payment access
Resilience and security
Competition*
Maintaining sovereignty*
Efficiency
* further elaboration in the paragraph below
The idea is to make a more efficient payment system. Current infrastructure sucks (see wire transfers) and these central banks want to improve that. Another motivation is to prevent a future CBDC substitution event. The concern is that a country’s citizens could possibly adopt a foreign country’s CBDC or a stable coin if they do not release their own fast enough, leading to a currency substitution event, making them dependent on the policies of another central bank. Perhaps the least intuitive goal is competition. The policy objective is to increase competition in a country’s payment sector both directly and indirectly. This system could become direct competition for other payment service providers. An alternative possibility is that a CBDC platform, if designed properly, could serve as a platform for private service providers, thus indirectly promoting competition.
Operating Models
There are three different types of operating models for how CBDCs may function. They can be unilateral, intermediated, or synthetic. The Unilateral model is when the central bank carries all functions of payment, distribution, and interaction with end-users. The Intermediated model means that the central bank is only involved through the issuance of the CBDCs and other institutions are still responsible for interacting with users. Last but not least, the Synthetic model is where CBDCs are backed by the central bank, but issued by non-central bank actors. It’s important to note that these models are not mutually exclusive, as there is more than enough capability to mix and match. Of the 6 countries studied in the IMF paper, none were fully unilateral or synthetic, all used forms of intermediated models.
Problems
Countries converge on non-invasive models to prevent negative consequences in the private sector. Many CBDC projects, including projects not listed in this study, have decided to provide 0 interest to users holding CBDCs to prevent competition with commercial institutions. Additionally, many choose not to use a distributed ledger system since there would be no need as it would be run by a centralized entity. One of the biggest issues to take away from the IMF CBDC research paper is that their development requires many countries to amend and change their current laws. In addition, another issue was the general unwillingness by the public to adopt CBDCs out of concerns for privacy. Users did not want their transactions easily on record and were worried about the security of their transactions. Some of the projects took different stances on privacy, usually opting for users to have fully private transactions as long as their account had under a certain amount of the digital currency. Once that wallet reached a certain threshold, the user would lose their privacy.
Project Hamilton
Now out of the projects listed, you’ll notice that the United States is not present. That’s because the United States has multiple ongoing CBDC projects with different teams, the most public of which is Project Hamilton, a CBDC program headed by the Federal Reserve Bank of Boston and researchers at MIT’s Digital Currency Initiative. 6 days after the IMF paper examining CBDC trends, Project Hamilton released a comprehensive whitepaper and summary of their successful phase 1 testing for a US transaction system. It is currently an open-source project that is under the name OpenCBDC.
Phase 1 Results
While the U.S. may be behind in implementation, it is certainly not in development and research. Compared to other projects, Hamilton seems to be the most heavily influenced by cryptocurrencies as there are mentions of Ethereum, Monero, and Bitcoin. In it, the team decided not to focus on the roles of intermediary institutions like commercial banks in this first phase, leaving it for a later stage, along with fees, compliance, and fraud controls. Similar to cryptocurrencies, users would have a digital wallet that stores their CBDCs and would sign transactions using public and private keys.
One of the few design choices decided on is the exclusion of distributed ledger technology, as they found that even under a central actor there were bottleneck problems. The team experimented with two architectures for a CBDC transaction system, the first (Atomizer) used an ordering server, and the second (2PC) used parallel processing on multiple computers. The former structure had a bottleneck issue and a limit of 160,000 tx per second. The latter, using parallel processing, had about 1.7 million tx per second. However, 2PC would not create an ordered history of transactions.
Phase 1 Reflections
Phase 1 focused on creating a foundation for more complicated functionality that is planned for Phase 2. Since the project has exceeded expectations they have shifted their goals and began developing a transaction system exploring privacy, smart contracts, interoperability, and offline payments. Finally, and probably most importantly, is that they note in their wrap-up that they “are confident that our[their] designs could support interoperability with cryptocurrencies via Layer-2 payment channel networks, though specific implementation details still need to be determined.”
For a more in-depth view, you can read about their technicals through the project’s GitHub and their recently published whitepaper.
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Central Bank digital currencies, or CBDCs, are one of the biggest boogeymen for the crypto industry. If you search CBDC on Twitter, you’ll find a list of CT users airing their concerns, most of which are well-founded with a small minority being conspiratorial. Nevertheless, it should not be understated that CBDCs have as much danger as they do potential. Therefore, it is all the more important to provide some proper information about the timeline of CBDCs and where development is for the concept.
CBDCs are digital currencies issued by a central bank rather than a commercial entity. Many countries have a CBDC project underway in some form. To date, there are nearly 100 CBDC projects, the majority of which are in research and development. 25 projects are fully launched or under public piloted testing. Earlier this year, the IMF published a paper exploring some of the projects already launched or in development, focusing on Canada, Sweden, China, the Bahamas, Jamaica, and Uruguay. It explored their motivations, models, and flaws.
Goals
All projects had very similar goals and very different outcomes. Their goals were more or less the following:
Financial inclusion
Mass payment access
Resilience and security
Competition*
Maintaining sovereignty*
Efficiency
* further elaboration in the paragraph below
The idea is to make a more efficient payment system. Current infrastructure sucks (see wire transfers) and these central banks want to improve that. Another motivation is to prevent a future CBDC substitution event. The concern is that a country’s citizens could possibly adopt a foreign country’s CBDC or a stable coin if they do not release their own fast enough, leading to a currency substitution event, making them dependent on the policies of another central bank. Perhaps the least intuitive goal is competition. The policy objective is to increase competition in a country’s payment sector both directly and indirectly. This system could become direct competition for other payment service providers. An alternative possibility is that a CBDC platform, if designed properly, could serve as a platform for private service providers, thus indirectly promoting competition.
Operating Models
There are three different types of operating models for how CBDCs may function. They can be unilateral, intermediated, or synthetic. The Unilateral model is when the central bank carries all functions of payment, distribution, and interaction with end-users. The Intermediated model means that the central bank is only involved through the issuance of the CBDCs and other institutions are still responsible for interacting with users. Last but not least, the Synthetic model is where CBDCs are backed by the central bank, but issued by non-central bank actors. It’s important to note that these models are not mutually exclusive, as there is more than enough capability to mix and match. Of the 6 countries studied in the IMF paper, none were fully unilateral or synthetic, all used forms of intermediated models.
Problems
Countries converge on non-invasive models to prevent negative consequences in the private sector. Many CBDC projects, including projects not listed in this study, have decided to provide 0 interest to users holding CBDCs to prevent competition with commercial institutions. Additionally, many choose not to use a distributed ledger system since there would be no need as it would be run by a centralized entity. One of the biggest issues to take away from the IMF CBDC research paper is that their development requires many countries to amend and change their current laws. In addition, another issue was the general unwillingness by the public to adopt CBDCs out of concerns for privacy. Users did not want their transactions easily on record and were worried about the security of their transactions. Some of the projects took different stances on privacy, usually opting for users to have fully private transactions as long as their account had under a certain amount of the digital currency. Once that wallet reached a certain threshold, the user would lose their privacy.
Project Hamilton
Now out of the projects listed, you’ll notice that the United States is not present. That’s because the United States has multiple ongoing CBDC projects with different teams, the most public of which is Project Hamilton, a CBDC program headed by the Federal Reserve Bank of Boston and researchers at MIT’s Digital Currency Initiative. 6 days after the IMF paper examining CBDC trends, Project Hamilton released a comprehensive whitepaper and summary of their successful phase 1 testing for a US transaction system. It is currently an open-source project that is under the name OpenCBDC.
Phase 1 Results
While the U.S. may be behind in implementation, it is certainly not in development and research. Compared to other projects, Hamilton seems to be the most heavily influenced by cryptocurrencies as there are mentions of Ethereum, Monero, and Bitcoin. In it, the team decided not to focus on the roles of intermediary institutions like commercial banks in this first phase, leaving it for a later stage, along with fees, compliance, and fraud controls. Similar to cryptocurrencies, users would have a digital wallet that stores their CBDCs and would sign transactions using public and private keys.
One of the few design choices decided on is the exclusion of distributed ledger technology, as they found that even under a central actor there were bottleneck problems. The team experimented with two architectures for a CBDC transaction system, the first (Atomizer) used an ordering server, and the second (2PC) used parallel processing on multiple computers. The former structure had a bottleneck issue and a limit of 160,000 tx per second. The latter, using parallel processing, had about 1.7 million tx per second. However, 2PC would not create an ordered history of transactions.
Phase 1 Reflections
Phase 1 focused on creating a foundation for more complicated functionality that is planned for Phase 2. Since the project has exceeded expectations they have shifted their goals and began developing a transaction system exploring privacy, smart contracts, interoperability, and offline payments. Finally, and probably most importantly, is that they note in their wrap-up that they “are confident that our[their] designs could support interoperability with cryptocurrencies via Layer-2 payment channel networks, though specific implementation details still need to be determined.”
For a more in-depth view, you can read about their technicals through the project’s GitHub and their recently published whitepaper.