CBDC Crash Course
What is a CBDC and what could it mean for the future?
What is a CBDC?
A Central Bank Digital Currency (CBDC) is a digital currency that could replace or supplement national currencies in circulation across the globe. Referred to as “GovCoins” in a 2022 Deloitte study, a CBDC is digital liability of a Central Bank. It is analogous to a form of digital money in that sense. These GovCoins leverage emerging technologies such as trustless transactions, distributed ledger technologies, and blockchains. While these technologies and concepts have been present in various research projects such as Project Hamilton, a US CBDC has not yet received a green light.
Although current federal financial research is typically tech-averse, it is likely that any US CBDC will be built on an immutable, scalable, and cryptographically protected database (AKA, a Blockchain).
Where are we now?
Currently, cash is used for 30% of all transactions in the United States. Cash transactions are categorically different from cryptocurrency transactions for a number of reasons, one of which being that unless a transaction is denominated in a privacy coin like Monero or zCash, the amount, wallet address, and often identity of the parties are traceable via the block explorer. After a cash transaction occurs there is relatively little that traditional financial institutions can do to track it.
A CBDC could provide a solution to governmental concerns about money laundering, inherently providing AML (Anti-Money Laundering) protections.
Stakeholders across the globe have varying opinions on matters of privacy. In fact, according to Deloitte’s Future of Money Banking, 2/3 Frenchman would be willing to forfeit a percentage of privacy rights in exchange for more personalized crypto-services.
Where is the rest of the world?
Though these concepts have only recently surged in popularity, governments across the world have been publicly - albeit quietly - researching and testing CBDCs for a hair shy of a decade. China began investing in and researching CBDCs as early as 2014 - Japan in 2016. Over 85% of the largest banks in the world are currently investigating and stress-testing CBDCs. These banks, in aggregate, control 91% of the global economy.
How does it work?
There are multiple architectural models involving central banks and commercial banks. At present, commercial banks and intermediaries perform KYC requirements and act as a buffer between end-users and federal institutions. Banks are required to report suspicious transactions to the Government.
A CBDC would come with many potential benefits, like the ability to program automatic payments or facilitate “micropayments”.
Micropayments are common on the internet, but most publicly available and mainstream blockchain networks fail to offer micropayments as a service. The security, decentralization, and scalability of a typical Blockchains prevents it from effectively providing this function. A CBDC may alleviate some of the utility issues of truly decentralized protocols, and have the capacity to perform transactions with low to no gas fees.
A CBDC will take one of three forms: direct, indirect, or hybrid models. A direct model would likely be considered the most drastic change from our current system. In this system, commercial banks cease to exist and pass on their KYC/AML responsibilities directly to the central bank. An Indirect model would include commercial banks who would continue to act as intermediaries between retail citizens and the central bank. In this model, commercial banks take CBDCs from the central bank and redistribute their own -fully backed digital assets to retail consumers. Finally, the hybrid model is one where the central bank would hold end-user accounts (like the direct model), but in this case intermediaries in the form of payment service providers would perform account opening, KYC, and payment execution services.
CBDC storage models differ between account-based and token-based storage models. Account-based models require all users to identify themselves with a digital ID to interact with the GovCoin’s network. On the other hand, a token-based model issued via a payment card or mobile app, and would permit users to be anonymous.
Data Privacy laws like General Data Protection Regulation (GDPR) and California Consumer Privacy Act (CCPA) play a crucial role in the architecture of any CBDC. The right to be forgotten among other digital rights will take on a new meaning when the central bank may have access to all citizens’ banking information in the case of retail CBDCs.
Additionally, Congressional findings from the CBDC Study Act of 2021 suggest that a CBDC could help to maintain the US Dollar’s status as the global reserve currency. As of 2019, the US share of Global Reserves was approximately $6,750,000,000,000 - 61.78% of all allocated reserves.
Where are we headed?
The nature of emerging tech like blockchain allows for the facilitation of trustless transactions and virtually eliminates the need for intermediaries. A GovCoin or CBDC could supplement or drastically change the relationship between consumers, banks, and the federal government.
If and when a CBDC will be introduced into the economy is not clear, with resistance from parties concerned with privacy and others opposed to change of any definition. The technical and economic architectures are still unclear as well. But despite the lack of clarity, it is becoming increasingly likely that a US CBDC is on the horizon, as the potential benefits of its implementation continue to stack up.
Conclusion
After reading this crash course on CBDCs, do you think the US would benefit from the implementation of a “GovCoin”?
For additional information, see:
Money and Payments: The U.S. Dollar in the Age of Digital Transformation (January 2022)
CBDC Study Act 2021
Proposed Amendments to the UCC for Emerging Technology
Deloitte - Future of Money Banking
This newsletter is written, curated, annotated, and edited by Christopher Foreman (Twitter - @CryptlessInSEA) and Kyler Wandler (Twitter - @KylerW56) with consultation and input from Jacob Robinson of the Law of Code Podcast, editing from TΞxas ₿l◎ckchain LawyΞr , in collaboration with Ann Sofie Cloots, and support from the Blockchain Barristers Law Student Collective.
The articles and opinions in this newsletter are not legal or financial advice. For legal and financial guidance, please consult a qualified attorney or financial advisor.
Special thanks: The Stetson Blockchain & Law Society; Coin Icon;
Edited by Kyler Wandler
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