Blockchain for Business Series:

Understanding Business and Technological Design Imperatives of Central Bank Digital Currency (CBDC)

By Nitin Gaur - Director, IBM WW Digital Asset Labs at IBM

This article originally appeared on LinkedIn, published February 28, 2020.

Image Credit: nanopay

I.             Introduction: What is Central Bank Digital Currency (CBDC) and Why Is It Important?

In this post we plan to expend some time and energy in understanding Central Bank Digital Currency or CBDC. While the notion of “Central Banks” implies centralized control and governance structure the term itself may be against the doctrine of decentralization which lays the foundation of the cryptocurrency framework. We will attempt to focus on the distributed or, one can say, a quasi-decentralized model that aims to provide a structure that not only preserves the supervisory role of the Central Bank, but also conforms to various regulatory, compliance, and monetary frameworks of a central banking as a system. The focus of this post to devise a model that factors into a payment modernization agenda while advocating for the right fit in blockchain technology design is driven by industry acumen as well as business design and economic imperatives.

CBDC has gained traction and a lot of attention primarily due to the rise of cryptocurrency and alternative payment instruments, but also CBDC is an integral part of payment systems and payment infrastructure modernization agendas. In an already complex and fragmented payment ecosystem, CBDC conversation adds to the payment modernization agenda with its own set of complexity and promise as an ultimate solution to the store of a value, fungible unit, and a settlement instrument.

While many CBDC conversations are addressing a domestic payment agenda, the implication and design imperatives extend beyond just the domestic payment systems. The solution design consideration includes (but is not limited to): cross-border payments, high value payments, securities settlements, and more. We also think it is important to compartmentalize various payment infrastructures and impacts of CBDC on them from the core conceptual elements of CBDC itself. CBDC in current parlance is broadly categorized into wholesale, which is Real Time Gross Settlements or RTGS systems which are primarily for interbank settlement and retail. These address the domestic payment systems reaching to the edges of the domestic and global economy with cash as an ultimate store of value and a fungible settlement instrument. While we may in this short post not be able to cover all aspects of CBDC, we will attempt to highlight the salient features, business, and technology considerations and structure and design criteria. Let’s explore below.

CBDCs can be defined as digitalized instruments issued by the Central Bank for payments and settlements. They can be described simply as an electronic extension of a form of cash. It is different from money held in Central Bank accounts, as the public may be able to access the CBDC, which remains a liability on the Central Bank balance sheet. 2.

In my post on Forging ahead with Blockchain, I cited tokenized fiat as one of the essential pillars needed for the industry to realize the promise of blockchain in value transfer. Essentially, if blockchain is a network that facilitates value transfer without intermediaries and resulting costs and friction, many of these value transfers will rely on the duality of a transaction—i.e., an exchange in some sort of a crypto asset or cash—i.e., fiat. Now, we all understand the challenges of money movement domestically and cross-border. It is an industry laden with heavy regulatory oversight, a series of intermediaries, and internal systems and processes chipping away at value at every stage of transfer by excessive fees and unrealized potential of locked capital. But cash or fiat provides ultimate fungibility to many products and services, be it natively digital (music, movies, gates, etc.) or tokenized assets (real estate, gold, silver, etc.), are essentially claims or IOUs of sorts. Cash or fiat also provides a definite unit of measurement of value to many products and services. Fiat or cash becomes essential to the movement of value as a fungible unit in a system, like our present economic and financial system. Fiat or cash in any system is a part of a Central Bank Agenda in that every country has a Central Bank that governs its monetary policy (money supply, interest rates, etc.), and it alone has the jurisdictional authority to issue fiat.

While many Central Banks in many countries are experimenting with blockchain as a technology platform to host applications such as a crypto assets, digital fiat, or Central Bank (issued) Digital Currency (CBDC) both at wholesale (RTGS systems) and retail (distribution through retail banks), as these experiments mature the Central Banks’ points of view at every stage of maturity, in the absence of a Central Bank issuing digital fiat, stablecoins fill in the gaps