What potential does regulated blockchain have in creating an ideal central bank digital currency (CBDC)?
Current problems with fiat currency
Some of the problems with using fiat currency faced by consumers are:
Lengthy transaction time: Most companies have to collaborate with other companies in different countries. Cross-border transactions can take a lot of time. In some cases, it can take 2–5 days before a payment is received. This slows business operations and leads to a loss of revenue.
Costly transaction charges: Cross-border payments, can be costly to businesses and individuals. For example, remittances can incur charges of up to 7% of the transferred amount becoming very costly to people who send remittances overseas and can often ill-afford those costs.
Risk of data breach and theft: Banks and financial institutions have a centralised databases for payments, meaning there are single points of failure. Worse, these databases hold sensitive information such as bank account numbers, transaction histories and more that can be lost or stolen during a breach. For example, Heartland Payment Systems, a payment processing firm, announced that a massive data breach in 2008 affected about 130 million customers.
Money laundering due to poor traceability: Criminals can use physical cash for money laundering purposes. Governments find it difficult to trace these types of criminal activities due to poor traceability of physical money.
Logistics problems: Printing, moving and storing physical cash can pose problems to both central banks and other financial institutions. Inevitably, logistics and cost issues will come up. For example, Korea spent 53.7 billion won ($47 million) on producing coins in 2016.
How blockchain that can be regulated can build the ideal central bank digital currency
While blockchain is a platform with many advantages, the traditional blockchain has two main problems that make it unsuitable for CBDCs: non-regulation and anonymity.
That’s why regulated blockchain can provide all the advantages as well as eliminate all the problems that come with traditional public blockchains. To have the authority of legal tender, CBDC has to be regulated by a central bank and other financial regulatory agencies. In comparison to legal tender and other financial assets, businesses are reluctant to use cryptocurrencies because of volatility that results from non-regulation.
A CBDC will be held with the central bank, as opposed to fiat money that’s usually held with commercial banks. Individuals can transfer their fiat money from commercial banks to the central bank in exchange for CBDC. This would further encourage competition between banks and bring costs down to attract the clients.
CBDC on a permissioned blockchain: As the CBDC will be hosted on a permissioned blockchain, participants have to be granted access before they can participate in the network and make or view transactions. This means a particular citizen will be vetted according to the central bank’s conditions before they can hold the CBDC. As a result, only accredited citizens and businesses will be able to hold the CBDC, which will curb criminal activities such as money laundering.
Three-level consensus mechanism: With access to a three-level consensus mechanism, central banks and financial regulatory agencies can authenticate transactions to ensure they’re legal. No side will be able to reverse any of the transactions.
Transaction anonymity: Each government can decide on the level of anonymity for transactions. Unlike transactions with fiat money, governments can limit the amount of information available for a transaction to only the information needed. To improve the security of user data, governments can hide information such as transaction history and personal information. While governments can hide users’ data, they have sufficient details to identify the parties involved in transactions. This can help to curb financial crimes such as money laundering.
Peer-to-peer transactions: As transactions will be peer-to-peer and won’t involve third parties, they will occur within a short time and at low or no transaction charges.
CBDC implementation: A CBDC can be a retail CBDC, meaning it will be available for general use, such as payments from consumers to merchants or other peer-to-peer payments. Otherwise, it can be a wholesale CBDC, which can be used by commercial banks and clearinghouses for more efficient interbank payments. Also, a CBDC can have both uses at a time. In a nutshell, each central bank will determine its CBDC implementation according to its needs.
Scalability: Efficient CBDC implementation is impossible without a scalable regulated blockchain platform. This means that due to the high numbers of transactions CBDC users will need to carry out, a regulated blockchain should be capable of conducting thousands of transactions per second. Currently, many blockchains lack this ability. L3COS however, with its ability to execute over 50 000 transactions per second, eliminates scalability issues for central banks and governments.
Central bank digital currencies have the potential to solve the problems that individuals and businesses presently face with fiat money. Although CBDC implementation will vary in different countries, most central banks are working on CBDCs to achieve efficient payments and reduce money laundering and other financial crimes.
To achieve this, central banks need a robust regulated blockchain platform. Contact L3COS to obtain more information on how we can create the ideal platform for a central bank digital currency.