The International Association for Trusted Blockchain Applications (INATBA) welcomes the rising interest in and development of Central Bank Digital Currencies across the world. In July 2021 the European Central Bank (ECB) decided to launch a two-year investigation of the Digital Euro. The ECB is researching how a digital euro could be designed and distributed to both commercial parties and the general public. The ECB’s primary inquiry is on the impact that such a monetary tool would have on the existing financial infrastructure, as well as the necessary changes to European legislation that must be conducted before the introduction of such a Digital Euro.
INATBA and its members have been actively engaged on policy developments, providing industry expertise and feedback to a wide panel of stakeholders. While INATBA is aware of the different architectural possibilities for CBDCs, we believe that Digital Ledger Technology (DLT) is the best-suited solution for the kind of maximally secure, global-scale, interoperable settlement platforms that CBDCs require.
This document summarises several important issues in need of further development, namely the use of DLT versus blockchain for the issuance of CBDCs like the Digital Euro, the need for seamless and fast cross-border settlement, the must-have interoperability with existing financial systems and the privacy and usability seen in the emergent crypto-asset ecosystem. In addition, wide direct access to Tier 1 issuance and transparency in the design process and implementation of CBDCs is a necessity for all industry participants, including INATBA and its members.
Authorship of the Report:
A special thanks to all members of the Finance WG that reviewed this position paper, and a special thanks to the chief authors of the report, namely:
- Tareq Shaheen – EastNets
- Ivona Skultetyova – Academic Advisory Board Member – Tilburg University
- Ivan Visconti – Academic Advisory Board Member – University of Salerno
- Benjamin Bürgi – Cardano Foundation
To provide any comments or suggestions, please contact email@example.com.
Issue # 1: Using Non-Blockchain DLTs for CBDC Issuance
Blockchain is a subset of Distributed Ledger Technology (DLT). Within blockchains, cryptographic techniques and consensus algorithms are utilised to achieve features like decentralisation, traceability, immutability, pseudo-anonymity, transparency, and security.
As part of a blockchain network infrastructure, only transactions confirmed can be recorded on the blockchain, and once validated by other nodes, transactions cannot be cost-effectively altered. This feature is especially useful for public, permissionless networks, but it cannot be the appropriate structure for a financial system that must provide anti-terrorist financing and anti-money laundering (AML) assurances. As such, the use of a non-blockchain DLT is the preferred technical solution, with the added benefit of allowing the recuperation of lost funds of novice parties that use said CBDC, for example retail users.
With the benefits of DLT, DLT-based CBDC can help to increase efficiency and create more secure payment systems. Characteristics like auditability and immutability make DLT-based solutions ideal to meet requirements of a CBDC. Central banks around the world are actively researching and exploring potential applications of DLT in CBDC:
- In 2016, the Bank of Canada launched Project Jasper, as a DLT-based wholesale CBDC, which, in 2017, morphed into a DLT-based CBDC prototype named CAD-coin. Many commercial banks joined and cooperated to build the experimental inter-bank payment system with CAD-coin.
- In 2016, The Monetary Authority of Singapore launched a DLT-based CBDC, Project Ubin, to explore the use of DLT for clearing and settlement of payments and securities, providing evidence that DLTs can be applied to commercially viable CBDCs.
- In 2018, the South African Reserve Bank launched Project Khokha, a proof-of-concept inter-bank payment and settlement system based on DLT, showing that the technology can help accelerate transaction processing and lower overall transaction costs.
- China’s CBDC is DLT-based and used for property right confirmations and registrations, as well as transactional security enhancement. The People’s Bank of China (PBOC) and Chinese commercial banks united to build the DLT and a ledger explorer, which can provide others with query services for CBDC ownership and transactions.
- In their July 2021 paper “Digital Euro experiment Combined feasibility – Tiered model”, when discussing ledger choice, the ECB concludes that “a tiered architecture with multiple Tier 2 platforms increases the flexibility and supports the resilience of the system.” Here, “multiple Tier 2 platforms” refers to DLT and non-DLT based systems of transferring Digital Euros between supervised intermediaries and end-consumers.
INATBA believes that it is essential that the Digital Euro investigative phase considers the use of DLT at minimum at the same time as alternative solutions – this is the only way for the ECB to keep at pace with private sector innovations and “avoid dependence on digital means of payment issued and controlled from outside the euro area, which might undermine financial stability and monetary sovereignty.”
Issue # 2: Cross Border Settlement and Interoperability
The evolution of cross-border payments to seamless and instant settlement has been on the table for years and has gained more momentum because of transformative technologies such as blockchain, as well as the effect of the COVID-19 pandemic. While CBDCs have been vividly discussed for local payments, they can also bring many benefits to cross-border payments and help achieve the objective of making cross-border payments frictionless and instant.
Applying CBDCs in cross-border payments entails some of the challenges that would be faced in domestic payments but unearths other challenges as well. The European Central Bank Report on the Digital Euro emphasised that “[i]t should therefore be convertible at par with other forms of the euro, such as banknotes”. Therefore, as banknotes are easily used outside their issuing countries, the same should be anticipated for CBDCs and investigated in the early stage of any CBDC project.
Cross-border payments put more emphasis on a CBDC’s most important requirement, its interoperability with existing payment systems. CBDCs must be carefully designed and implemented shrewdly from the earliest stages to incorporate the interoperability needed for CBDC cross-border payments.
Existing payment market infrastructures and different future CBDC implementations will have to be able to effectively co-exist for successful CBDC adoption in cross-border payments, or it will slow down households and businesses from making frictionless cross-border payments using a CBDC. Such a reality will allow multiple competing systems to co-exist.
As such, INATBA members believe that to realise the benefits of a CBDC, and especially as a cross-border payments tool, a phased approach, along with co-existence with existing national and international payment systems, is needed. We believe that this will be critical to achieve the full potential of CBDC.
CBDC use cases for cross-border payments should focus on bridging between new CBDC systems and existing payment systems and market infrastructures. Use cases should include: CBDC to CBDC transactions, CBDC to fiat transactions and fiat to CBDC transactions. The latest announcement by SWIFT on experiments to link the multiple domestic CBDC networks emerging worldwide with existing payment systems for seamless cross-border payments demonstrates the significance of such use cases.
In addition to interoperability, two CBDC requirements require further elaboration for cross-border payments, offline payments and privacy.
Offline payments are one of the key requirements of CBDCs. It allows for offline payments which match the most distinctive feature of cash. Central bank should consider how CBDC offline usage will happen outside the issuing central bank jurisdiction. In addition, balancing privacy with AML assurances becomes even harder for CBDC outside its originating jurisdictions.
Including different cross-border use cases at the start of any CBDC project, rather than in a later phase, is, in our members’ view, essential to ensuring that a CBDC initiative is utilised towards enhancing cross-border payments. INATBA members believe that a slower time frame for CBDC cross-border payment use case will create CBDC islands and will not realise the full potential of CBDC.
Including different cross-border use cases at the start of any CBDC project, rather than in a later phase, is in our view, essential to ensuring that a CBDC initiative is utilised towards enhancing cross border payments. INATBA members believe that a slower time frame for CBDC cross border payment use case will create CBDC islands and will not realise the full potential of CBDC.
Issue # 3: Wide Direct Access to Tier 1 Issuance
The ECB has stated that a most sustainable model is based on two tiers – with the Digital Euro being issued by the ECB at Tier 1, utilising the TARGET Instant Payment Settlement (TIPS) or a similar system, and distributed to regulated intermediaries which already have direct access to TIPS.
Limited direct access to TIPS has already stumbled competition in e-money markets and in the case of challenger banks. Against this background and in order to maximise the efficiency potential of CBDCs, a mostly open approach, allowing a broad range of domestic and also foreign intermediaries to gain access to Tier 1 issued CBDCs, seems preferable.
INATBA is of the view that access to Tier 1, in the model proposed, should be wide and supportive of FinTech entrepreneurs.
Issue #4: Usability
When implemented, CBDCs will be used alongside existing forms of payment, whether it is cash, mobile/online payment apps or digital transactions through commercial banks, including infrastructure that supports them, such as TIPS in the EU. In those cases, mainstream users and merchants are not only familiar with these payment options but also accept them across the board.
The attributes of existing payment options create a significant level of path dependency and considerable network effect in use. In order to become viable for mainstream adoption, CBDCs will have to clearly define its use cases that will be, at least in some aspects, superior to the existing payment options. Therefore, it is essential that CBDCs, as a new payment option, would demonstrate clear user advantages.
In short, users will prefer existing options unless CBDCs offer a significant advantage. Through enhanced usability, whether it would be in the form of a more convenient payment or provision of access to and interaction with new markets, such as direct payment options in crypto markets, could tip the scale.
In the context of usability, CBDCs architects should consider the following attributes:
As mentioned before, CBDCs should strive to emulate cash-like features, because cash can be easily used by anyone, whether a consumer or merchant. Therefore the barriers for using CBDCs should be minimised.
In recent years, with growing understanding of the data collection practices, the public began to require enhanced privacy when interacting online. That naturally applies also to payment history and transaction details. Especially for transactions with low value, CBDCs should provide privacy protection through layered anonymity or pseudonymity.
Negligible or Non-Existent Transaction Fees:
To align CBDCs with the universal access requirement, the conducted transactions should not be burdened with noticeable transaction fees, which would compel users to think about alternative payment methods. This recommendation closely relates to the universal access requirement but also to the overall competitiveness of CBDCs as compared to other existing payment methods.
Possibility to Conduct Peer-to-Peer Transactions Offline:
The possibility to conduct peer-to-peer payments in the offline environment could potentially equip CBDCs with a cash-like attribute for digital transactions. However, this attribute would likely require involvement of a hardware device, which should be sufficiently secure and accessible to users for minimal costs. Alternatively, users could use their mobile phones for this purpose. In such a case, safety and privacy safeguards must be placed.
Interoperability with Other Blockchains to Enable Instant Access to Crypto Markets:
CBDCs could embody a viable alternative to existing stablecoins in the context of the current blockchain ecosystem. Its use in the DeFi protocols for instance could serve as an important niche use case facilitating their adoption. However, in that case, CBDCs should be designed with interoperability in mind, ensuring that such interaction will be possible (for instance through use of bridges, currently used to connect different blockchain networks).
Smart Contract Implementations and CBDC as Collateral:
One of the most important and prominent features of emerging crypto assets is the ability to perform automated computations through smart contracts. Novel applications have emerged as a subset of the industry called Decentralised Finance (DeFi). INATBA members believe that the whole ecosystem would be more secure and stable once CBDCs could substitute the stablecoins used as collateral in these smart contracts.
INATBA members believe that users will prefer existing options unless CBDCs offer significant advantages. Through enhanced usability, whether in the form of a more convenient payment or provision of access to and interaction with new markets, such as direct payment options in crypto markets, could tip the scale.
Issue #5: Transparency in the Process of Design and Implementation of CBDCs
CBDCs represent a novel intervention in the market of payment options initiated and deployed by the public sector. From the perspective of the central banks, CBDCs, if successfully adopted, may enable them to get a greater control of the monetary policy that has decreased since the emergence of private payment options in regular commercial transactions and stablecoins in the crypto sector.
Since CBDCs will become somewhat competitive to existing payment options, and thus have impact on private sphere and consumers, it is of utmost importance that the design as well as implementation process is transparent and consulted with the public and representatives of affected stakeholders. To what extent and how the process becomes transparent largely depend on the policies and regulatory framework in individual jurisdictions.
Nevertheless, INATBA members suggest several best practices in this context:
- Larger scale-market research and CBDCs comparative and impact studies made available to the public before or immediately after the approval of the CBDC initiative;
- Several months long and open public consultation on design options with layman-accessible results (for instance in form of a report);
- Focus groups with affected/benefiting stakeholders in various segments;
- Pilot implementation actions (such as proof of concepts) with publicly accessible results;
- Evaluation studies analysing the operation and impact of CBDCs 1–2 years after the implementation.
CBDCs will become somewhat competitive to existing payment options, and thus have impact on the private sphere and consumers. It is of utmost importance that the design as well as implementation process is transparent and consulted with the public and representatives of affected stakeholders.
Issue #6: Privacy
The design of a CBDC requires various technical decisions that impact both on the privacy of transactions transferring digital money and on mechanisms to reduce risks of frauds and to allow the recovery of digital money in case of lost keys.
A main separation that has been discussed in various reports is among the account-based model and the token-based model. The account-based model imitates the current use of money through online bank accounts, where every transaction explicitly identifies the source and the destination of a money transfer among accounts. The token-based model instead imitates the current use of crypto assets. Such coins, which are by default non-serialised, act like digital money, and shall be anonymous trading units that can be spent without identifying the current owner of the coin.
The consequences of the above separation is evident. While the account-based model can directly implement mechanisms to detect frauds and to implement key-management procedures reducing risks for users, it also enables a massive surveillance of the spending habits of CBDC users. INATBA members believe that this would discourage users that could instead look for other options available in the cryptocurrency ecosystem.
On the other hand, the token-based model can be more appealing for its similarity with cash, but opens risks due to the possibility of losing money by simply losing the keys associated to the ownership of the tokens, and to the possibility that illegal activities could try to hide behind the anonymity shield offered by this solution.
Interestingly, the above two solutions are just two extreme points and a CBDC could rely on a combination of the two, or on the use of intermediate mechanisms to try to obtain the best of both worlds.
A first simple approach could be the use of the token-based model for transactions with limited amounts. Notice that in some countries there is already a limit to the amount of cash that can be used in a transaction. Therefore, it is pretty natural to adopt a similar approach to the token-based model in order to protect privacy, but at the same time mitigate risks when large amounts are considered.
A more advanced approach could rely on more sophisticated cryptographic mechanisms that enrich the token-based model with features like key recovery and selective disclosure of information. Essentially one could use the token-based model optimistically, preserving privacy as long as there is no specific incident. Still, in case of a key loss one can recover the associated money invoking specific procedures that can be run by designated authorities able to regenerate the lost key or to produce a new legitimate key that replaces the lost one. Moreover, in case of suspicious transactions, some designated authorities can have the right to jointly cooperate to disclose information selectively, about those transactions only.
An account-based model can offer protections similar to existing online bank accounts, while a token-based model can be more appealing to citizens for its similarity with cash. The above two solutions are just two extreme points and a CBDC could rely on a combination of the two, or on the use of intermediate mechanisms to try to obtain the best of both worlds.
As stated at the start of the report, this document summarises several important issues in need of further development, namely the use of DLT versus blockchain for the issuance of CBDCs like the Digital Euro, the need for seamless and fast cross-border settlement, the must-have interoperability with existing financial systems and the privacy and usability seen in the emergent crypto-asset ecosystem. In addition, wide direct access to Tier 1 issuance and transparency in the design process and implementation of CBDCs is a necessity for all industry participants, including INATBA and its members.
INATBA members are eager to see the implementation of a CBDC that is based on DLT and follows the above characteristics. INATBA members believe that only a CBDC that can offer seamless and a fast cross-border settlement while providing interoperability with existing payment systems will succeed. In addition, the CBDC that will emerge as the ultimate victor must protect privacy and offer the utilities we see emerge in the existing crypto-asset ecosystem.
INATBA members welcome the ECB’s proposed Digital Euro and are looking forward to engaging with all relevant stakeholders about the design of this world-shifting innovation.