You can’t talk about blockchain and not bring up CBDCs and stablecoins

Ever since the publication of Satoshi Nakamoto’s white paper back in November 2008, “Bitcoin: A Peer-to-Peer Electronic Cash System,” the term “blockchain” has been synonymous with digital currencies in the sense of the underlying technology that allows for the transfer of value, peer-to-peer. 

What’s interesting is that the term “blockchain” is not used once in that white paper. The purpose of the paper was to propose a solution to the core issue of double-spending a digital currency, which is the representation of a transfer of value directly between transacting parties, without the use of a central trusted third party.

Currencies by definition are a medium of exchange for goods and services, a unit of account, as well as stores of value. Money, in its traditional sense, fulfills all of these three elements.

Central bank digital currency

There is continued significant interest in central bank digital currencies, or CBDCs, at this time — not from the blockchain and crypto community but actually from a core group of some of the most influential central banks, including the Bank of England, the Swiss National Bank, the European Central Bank, the Bank of Japan, the Bank of Canada, the Swedish Riksbank and the Bank of International Settlements.

Related: Did CBDCs affect the crypto space in 2020, and what’s next in 2021? Experts answer

The confirmation in late 2020 from the United Kingdom’s chancellor of the exchequer (the head of Her Majesty’s Treasury), states that the United Kingdom will draft regulations for private stablecoins and research CBDCs, demonstrating the momentum that this topic currently has. China has undoubtedly emerged as a leader in its development of CBDCs, having recently proposed that there be a global set of rules that addresses issues such as interoperability between jurisdictions.

Related: How the digital yuan stablecoin impacts crypto in China: Experts answer

Central to any national monetary policy and financial stability is the public’s trust in central banks, and its trust that money provided by the central bank fulfills those three key elements of a currency — whether it’s issued in physical or digital form. A central bank digital currency is not a stablecoin nor is it a digital asset but rather a digital representation of cash — i.e., that a digital pound today is worth the same tomorrow and its purchasing power (what its holder can buy) does not fluctuate beyond certain thresholds.

The European Central Bank’s proposal for a digital euro is built upon the premise of complementing the current cash and wholesale central bank deposit system in place. It is seen as a way of ensuring that European citizens are provided with access to a safe form of money in a fast-changing digital world, while actively promoting innovation in the field of retail payments, supporting society’s vulnerable and reducing their potential financial exclusion. A digital euro is also seen as an option for the reduction of the overall cost and ecological footprint of the current monetary and payments system.

Related: All that mined is not green: Bitcoin’s carbon footprint hard to estimate

With economies currently experiencing the development of ideas around central bank issues, stablecoins or private digital currencies, the experience has been roughly the same as with previous monetary innovations: coins, banknotes, checks and credit cards. Many see blockchain and distributed ledger technology, or DLT, as the mechanism to replace electronic currency in traditional bank accounts. Just as paper money succeeded gold and silver, electronic transfers could replace paper money.

The rise of digital currencies

The current COVID-19 pandemic bought motivation for cashless transactions and impacted the way society interacts financially, which has accelerated the concept of digital currencies in people’s minds. With fewer cash transactions taking place, businesses and consumers are more aware of the attributes and advantages of digital currencies.

Related: How has the COVID-19 pandemic affected the crypto space? Experts answer

Already, central banks engage with other qualifying financial institutions, most often clearing banks, through the use of electronic central bank deposits. Alongside this system, they also issue banknotes and coins to the public. A shift to digital versions of those notes and coins is a natural progression in our more digitized world.

However, this trend could lead to an unintended consequence: Within a cashless society, where the public no longer has access to a state-guaranteed system of payment, the private sector would control access to, development of and pricing for alternative payment methods. Unless, that is, governments issue digital currencies to the public through their respective central banks. But in a system where central banks could have a direct relationship with each individual, there would be significant disruption in the commercial banking market, including the issues of significant data holding and related data privacy. Would citizens want the central bank to know about each transaction they’ve made?

To facilitate any CBDC, the technology platform should fulfill certain key attributes:

  • Convenience: The penetration of smartphones in modern society allows for a “tap-to-pay” system that is well understood or for a QR code-based system.
  • Security and resilience: Current mature cryptographic techniques provide users with data protection; either software- or hardware-based privacy enforcement. The resilience of a 24/7/365 infrastructure is critical to a CBDC’s performance.
  • Speed and scalability: Transaction volumes and throughput will need to be maintained at a justifiable cost. Current centralized card networks show that very high transaction capacities are possible. Permissioned DLT networks could be equivalent substitutes for conventional technologies.
  • Interoperability: The use of application programming interfaces, or APIs, are well established to support technologies interoperating and allow interaccount transactions. Common data standards will also play a part in interoperability.

With the example of Bitcoin (BTC), the blockchain infrastructure provides a fully decentralized, fully permissionless public network that, theoretically, no-one person, entity or authority has control over. In the same way, blockchain and/or DLTs can provide a similar network to support the issue of CBDCs among a national population.

However, the more popular framework for digital currencies is a centralized, permissioned network that provides the issuing authority, which is usually the national central bank, with a degree of control and greater oversight of the “blockchain” that records the digital currency transactions. That centralized permissioned distributed ledger could address these key attributes.

For some commentators, the ability of central banks to issue programmable CBDCs on a centralized permissioned blockchain is a positive development — for example, defining and controlling the uses of the digital money issued so that it can only be used for food, not alcohol, cigarettes or gambling. There are also transparency benefits that allow governments to act upon tax evasion and other criminal activity, by way of access to the underlying transactional data.

The original rationale for Satoshi’s white paper was to establish a protocol that allowed for the digital exchange of value, peer-to-peer without the reliance or requirement to go through a central authority.

It’s ironic that the very benefits that Satoshi explained in that white paper are now being considered by central banks as they research and consider how the technology could underpin new digitally issued currency. The two concepts have come into everyday conversation almost simultaneously, making it seem as if they are interwoven. Yet both the technology and the use case can exist apart.

Digital Isle of Man, an executive agency for the Isle of Man’s government, continues to encourage and support research into the issuance and use of digital currencies in all their forms, including stablecoins and CBDCs. Soramitsu, a fintech company delivering blockchain based solutions to businesses and governments — which is currently an associate of the agency’s accelerator program — recently announced its partnership with the National Bank of Cambodia to establish a secure, standardized digital currency alternative to paper bank notes on a single payment platform. The Bakong system is built upon the Hyperledger Iroha DLT, integrated with the traditional banking system, and providing users with easy access via ID document scan, photo check and biometric detection. Having such international experience provides the island with significant insight into any potential future implementation of digital currencies.

There are, of course, a number of technical, economic, financial and legal issues, including the impact of a digital currency on monetary policy, financial stability and banks’ business models, which are unfortunately beyond the limits of this article.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Steve Billinghurst is regulatory lead at Digital Isle of Man, responsible for engaging with businesses and individuals interested in understanding how the island’s financial services regulatory framework impacts their digital business proposition. Steve’s role has also extended to maintaining an awareness and understanding of international crypto finance developments in key competitor jurisdictions and ensuring the Isle of Man its competitive position through ongoing review and update of its own legislative framework.

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