ConsenSys: How an Ethereum-based CBDC can help central banks?

Central Bank Digital Currencies (CBDC) have gained prominence at the 2020 World Economic Forum. ConsenSys, a blockchain firm, released a whitepaper that outlined a practical proposal for central bank digital currencies on the Ethereum blockchain.

ConsenSys office in Brooklyn, New York.

The whitepaper stated that they propose that central banks issue CBDC on a large-scale, private, permissioned, Ethereum-based network in which central bank appointed intermediaries to act as nodes.

Incorporating digital innovation and maintaining control over money has been the motive of central banks across different countries. According to the whitepaper, using a permissioned blockchain, Ethereum-based, would help central banks retain control over the onboarding and distribution of the CBDC to the intermediaries. The whitepaper also highlighted that while public Ethereum is opened to all, Ethereum has permission variants capable of offering enterprise-grade security and performance. They believe that private, permissioned Ethereum would offer the best possible platform for the CBDC requirements.

ConsenSys’s whitepaper also highlighted that while Ethereum’s “permission capabilities” would allow central banks to seamlessly “authorize and deauthorize” those participating in the network participants, private Ethereum networks that use proof-of-authority (PoA) consensus can offer “quasi-real-time asset transfers” at a very low cost.

The central banks can also create tokens on top of Ethereum, the issuance and destruction of which remains under their control. Moreover, PoA consensus is not energy-intensive and would support a large-scale network at low energy cost and environmental impact.

Source: ConsenSys

The whitepaper’s foreword from the CEO of ConsenSys, Joseph Lubin, which stated that CBDCs can offer a range of advantages diverse in playing a central role in advancing the regulated cryptocurrencies revolution, having lower-risk and accessible way, helping make financial markets more efficient and available to all global citizens. CBDC can also give the central banks more effective, future-oriented tools to allow them to implement monetary policy in more direct and innovative ways and keep pace with technological change.

Benefits of digital currencies for central banks and the economy

While we have yet to see CBDC projects in production and so have no empirical evidence of their impact, many believe CBDC can offer a number of significant benefits for central banks and the wider financial system.

1) Push the digital assets revolution

Digital assets, in general, are set to disrupt today’s capital markets, offering among other things cheap issuance and distribution, massively increased efficiency and flexibility due to programmability, instant delivery versus payment, and automated lifecycle management.

CBDC could be the key ingredient in introducing a viable, broad-based blockchain-based payments system that could enable a large-scale, decentralized clearinghouse and asset register and in turn allow digital assets to reach their potential. If central banks do not issue their own digital currency, the markets will move to private payment tokens. This would expose users to various risks. Privately issued tokens may also not be accessible to all, leading to financial exclusion. A CBDC would represent a risk-free, widely accessible alternative.

In some countries, the creation and distribution of banknotes are expensive and can be a major catalyst for unlawful activity. In many parts of the world, it is also difficult for citizens to access physical cash because they live far from bank branches and ATMs. CBDC could be distributed easily on mobile phones, which would help address these problems.

2) Future-oriented monetary policy and regulatory tools

As noted, if central banks do not issue their own digital currency, then privately issued payment tokens, which for all intents and purposes are akin to digital cash, will be the only choice for payments. As if many believe digital solutions are better than banknotes, they would become very large and broad-based, and they potentially represent significant, systemically relevant portions of the economy.

Central banks also risk losing some of their ability to carry out their monetary policy and regulatory mandates. CBDC would mitigate this risk by giving central banks direct influence over all or a portion of the money supply in digital markets.

CBDC is also a tool to expand and reduce the supply of money. It could make it easier to employ innovative retail-oriented interventions. And it could help central banks fight against financial and social exclusion for individuals and enterprises that do not have access to commercial bank-created money, for instance, due to reasons of cost or availability. Finally, if structured in a way that allows the CBDC to be traced, it could be useful in more efficient sanctions and AML enforcement contexts.

3) Lower cross-border remittances

Cross-border payment transactions, whether for businesses or individuals, are very expensive. This is generally a function of the state of the developed cross-border payment technology that it did not allow for direct transfer without intermediaries. In the current financial system, a typical cross-border payment involves transfers through several different correspondent banks, with the attendant cost of transacting and reconciliation as well as significant wait times.

If a world where both the original currency and the destination currency are based on CBDCs, it is quite easy to imagine money transfer systems that are almost entirely automated and use cryptographic techniques to permit interoperability between different systems and distributed ledgers. Many financial actors can then connect to these ledgers and compete to offer the best price and service to customers, driving costs down and reducing delays. With the prevalence of mobile phones among all sections of the population, including in developing countries, such a system would also obviate the need for physical distribution outlets, further driving down costs.

4) Improve the settlement of interbank payments

Today the settlement of interbank transactions using central bank money is increasingly carried out on Real-Time Gross Settlement (RTGS) systems. These have the advantage of settling payments on an individual order basis between counterparties, instead of netting payments at the end of the day. The downside to these systems is that they rely on batch processing overnight and require collateral to cover the outstanding positions. Therefore, these systems do not completely eliminate settlement risk. Besides, many RTGS systems today still apply antiquated technology, including mainframes, older programming languages like Cobol, or messaging platforms like SWIFT, so they have a certain amount of operational risk.

With CBDC, interbank payments would be much more similar to the transfer of digital cash (albeit in very large amounts) and would be true real-time payments between counterparties with no settlement risk and greatly reduced operational risk.

5) Accelerate innovation in retail markets

Even though real-time money transfers can be made quite cheaply and almost realtime by centralized settlement platforms like SEPA, it does not mean that all consumers and businesses have access to real-time and low-cost remittances. In fact, many financial institutions charge their customers for real-time money transfers at rates well above the cost that they incur.

Additionally, in some developing countries, particularly in South East Asia, the fact that interbank payments are free, but transfer payments are not free or not realtime, has resulted in massive competitive advantage for the largest bank networks, which have disproportionate access to consumer deposits, which diminishes competition in the retail and SME banking sectors.

Therefore, the creation of central bank-sponsored digital currency, freely and quickly transferable between users, can be a way for regulators to set new market standards, encouraging retail financial institutions to improve their value proposition to consumers and SMEs. This could include extended operating hours, potentially 24/7, richer data in payment messages and transparency on processing status, higher interoperability between platforms and further supporting the development of programmable money, one of the great promises of blockchain.

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