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Blockchain Solutions for Central Bank Digital Currency

A Central Bank Digital Currency (CBDC) is a blockchain-backed, digital form of central bank money that reflects a claim on a central bank rather than a commercial bank.

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Cryptocurrency has been seen as the latest innovation with the ability to bring in a new era of global financial inclusivity and simplified banking and finance infrastructure. However, to date, its prominence has stemmed from its capacity as a store of value rather than a medium of trade. This divide is steadily decreasing, with both governmental and private financial agencies, as well as commercial entities, issuing stable cryptocurrencies as viable mainstream payment options.

Recently, the European Central Bank revealed that it had entered a more extensive examination phase of its "digital euro" initiative. Similarly, more than 80% of the world's central banks are conducting pilots or other CBDC initiatives. Several private, stabilised cryptocurrencies, commonly referred to as stablecoins, have also developed outside of state-sponsored channels as part of efforts in order to improve liquidity and simplify settlement across the rapidly growing crypto ecosystem.

The potential for the considerable upheaval of conventional financial procedures is evident. However, the outcome of this wide-ranging action, which includes agile fintech, deep-pocketed incumbents, and mainly government-appointed central banks, remains unclear. In light of this, we present a fact-based primer on the world of collateralized cryptocurrencies, as well as an analysis of numerous conceivable future scenarios, including potential benefits, barriers, and near-term measures that should be considered by any participants in today's financial ecosystem.

What is CBDC?

A Central Bank Digital Currency (CBDC) is a digital form of central bank money that reflects a claim on the central bank rather than a commercial bank or a Payment Service Provider (PSP). CBDC is governed by a digital ledger, which may or may not be a blockchain, that enables banks, institutions, and individuals to make faster and more secure payments. In other words, CBDCs are digital assets that are backed and controlled by the Central Bank.

CBDCs and their uses

CBDC can be used for both retail and wholesale transactions. A wholesale CBDC is a new infrastructure for interbank settlements, whereas a retail CBDC is a digital form of currency. Central banks that have been dealing with CBDCs have mainly focused on rapid and low-cost payments.

Retail CBDC - Similar to digital banknotes, retail CBDC is used for payments between individuals and businesses or other persons. The daily volume of retail CBDC transactions is typically larger than 100 million.

Wholesale CBDC - Wholesale CBDC is mainly used to enable interbank settlements, which is defined as transactions between banks and other firms that have accounts with the particular central bank. The average daily volume of wholesale CBDC transactions is less than a hundred thousand.

Also read: BlockX for cross-border payments

Benefits of CBDC

Nowadays, the financial infrastructure of central banks is encountering various challenges, ranging from high-cost payment settlements to decreasing use of banknotes and a lack of financial access for residents living distant from bank branches. According to studies, the cost of clearing and settling securities for G7 central banks is over $50 billion per year, owing in part to the resources needed to move assets and reconcile accounts. In fact, today's cross-border payment services necessitate the movement of assets and sensitive transaction data through many correspondent banks, putting organizations and individuals at operational and settlement risk.

Blockchain-based CBDC is able to address the inefficiencies and weaknesses persisting in our central banking architecture by simplifying the establishment of a secure payments system that functions as a decentralised clearinghouse and an asset register.

Blockchain for CBDCs

A CBDC can benefit from blockchain technology in many ways. In terms of scalability and privacy, Ethereum is the most production-ready blockchain to satisfy CBDC criteria.

  • Trust - Using a blockchain-based CBDC, central banks can control the currency  while maintaining the privacy and independence of the CBDC's use by end-users. Once trusting and using the CBDC, users must not be trapped by intermediaries.
  • Programmability - CBDC restrictions, such as wallet thresholds or third-party access to the system, can be hard-coded in the protocol in order to make compliance easier.
  • Innovation - A blockchain-based CBDC benefits from the unique goods and services of the blockchain ecosystem, including non-custodial wallets, zero-knowledge cryptography, and DeFi. With over 350,000 developers, Ethereum remains the world's biggest blockchain ecosystem.
  • Data accessibility - In transaction history, blockchains and other distributed systems ensure data availability and resilience, as well as trust and transparency. Ethereum has proved its ability to sustain very large networks with tens of thousands of nodes and users.

What does the future of CBDCs look like?

Given the numerous unresolved design elements, it is too early to accurately estimate the trajectory and endgame for CBDCs and stablecoins. For example, will central banks prioritise retail or wholesale use cases and domestic or cross-border applications? How quickly will national agencies pursue stablecoin regulation before releasing their own CBDCs?

Our understanding of these scenarios can only come from observing the different varieties and real-world applications of CBDCs and stablecoins as the financial markets begin to take a strong footing in the post-covid world.


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