Bryant Nielson | March 20, 2023
Discussions that include Central bank Digital Currencies are often implicitly linked with blockchains and DLTs, Digital Ledger Technology. Since the whole financial market has begun to take an interest in CBDCs currently, this has led the private digital currencies to emerge like Bitcoin, eventually leading to few assumptions about how the CBDCs would be implemented. For example, would the CBDCs also require DLTs or a form of blockchain to run? In this article, we will explain that it might not be necessary for a CBDC to use a DLT to run, but even if it uses a DLT, there are many reasons why it is beneficial.
Central Bank Digital Currencies and DLT
Digital ledger technology refers to the family of technologies using a distributive participant group to maintain a replicated, shared, and synchronized record collectively, without relying on a single central party or centralized data storage. One of the most prominent examples of DLT is blockchain technology, which was inaugurated by Bitcoin over nine years ago. For maintaining the records, the traditional centralized systems rely on trusted central parties in contrast.
Thus, CBDCs could be centralized or might use some form of DLT. Several options should be accessed against the very requirements. We are already aware of the general benefits of CBDC implementation; therefore, the area of interest today is exploring the possible benefits of using DLTs or blockchains for CBDCs.
Benefits of using digital ledger technology for CBDCs
Before we get into the discussion sometimes later of how to use a DLT for CBDC, the more significant question is why should a DLT be used for CBDC? We have compiled a few potential benefits for CBCDs to use the digital ledger technology. Have a look.
- One significant advantage of using DLT for CBDCs is that DLTs might offer a high level of operational resilience, avoiding every point of failure. This, in turn, could enable the increased availability of every widely available digital currency.
- The DLT’s distributed nature proves that if any of the validators stop working for some reason, the system would not stop operating and would work without any interruption. Therefore, this could enable the power of CBDCs to withstand the current centralized financial architecture.
- However, centralized financial systems also take many measures to achieve a high resemblance level. Still, a digital ledger technology in CBDC would offer a significantly increased cost-effective and efficient resilience.
- CBDCs can enable everyone to make payments digitally via electronic money, resulting in a massive volume of transactions, making it hard to cope with computing or operational capacity for the central banks. However, using DLT for CBDCs would help the central banks set rules for CBDCs, thus providing on-demand operational capacity without having the central banks change their entire computing infrastructure.
Why blockchain or Ethereum for CBDCs?
Blockchain technology offers unique benefits for CBDCs. The CBDCs based on blockchains can efficiently resolve vulnerabilities and inefficiencies in the central banking financial infrastructure by implementing a secure payment system that would serve as a decentralized, large-scale asset register and clearinghouse. Ethereum, for example, is one of the most production-ready and prominent blockchains, supporting the Central Bank Digital Currency’s requirements concerning providing privacy and scalability. A few more benefits associated with blockchain-based CBDCs are as follows:
- A CBDC based on blockchain technology enables the central banks to protect the independence and privacy of the CBDC users while being in complete control of the currency. This means that the users will not be locked in by the intermediaries, thus increasing the trust and use of the CBDCs.
- Blockchains are based on distributed systems that ensure resilience and data availability along with transparency and trust around the entire transaction history of the user. Ethereum, to be specific, has proven its ability to support massive networks with 15K+ nodes and millions of users.
- Blockchain-based Central Bank Digital Currencies can take advantage of the innovative services and products built in the open-source blockchain’s ecosystem, including zero-knowledge cryptography, non-custodial wallets, and decentralized finances. However, Ethereum is the most powerful blockchain technology globally, with more than 400,000 developers.
- The rules of CBDCs can be hard-coded to facilitate compliance. For example, third-party system access or waller thresholds.
So, there are many benefits involved in using blockchain or digital ledger technology for CBDCs. However, along with the adaption of DLT for permissioned environments, along with the benefits, there might be some risks involved as well. Furthermore, using digital ledger technology for CBDCs, unfortunately, moves further away from the reason why CBDCs were designed originally. Many concerns arise from using DLT for CBDCs, like would the adapted digital ledger technology become the optimal solution for Central Bank Digital Currencies? Would all the CBDC goals be achieved conveniently and uniquely via DLT? Therefore, the ongoing research will benefit from different views or disciplines, while there is so much scope for the upcoming research informing central banks’ decisions.