Central Bank Digital Currencies On Ethereum Network
Introduction
Central bank digital currencies (CBDCs) are digital tokens that are issued by a central bank and recorded on a digital ledger. They are considered to be legal tender and are backed by the central bank, similar to physical cash. However, unlike electronic cash, which is issued by commercial banks and requires an intermediary, CBDCs are directly issued by the central bank and do not require an intermediary.
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The increasing digitization of economies and the demand for real-time payments and settlements have led to the development of CBDCs, which can facilitate more efficient domestic and cross-border monetary transactions.
China’s Digital Currency and Electronic Payments System (DCEP) is one of the most advanced large-scale digital currencies in the world, with live trials in major cities. The Bahamas, Jamaica, and Nigeria have also implemented digital currencies in their financial systems. The President of the European Central Bank, Christine Lagarde, has indicated that the institution may create a digital currency in the near future.
There are different approaches that central banks can take in implementing CBDCs, and this article will focus on those that utilize Ethereum Enterprise solutions.
What is Enterprise Ethereum?
Enterprise Ethereum is the private or permissioned blockchain version of the public Ethereum codebase. As the name suggests, permissioned blockchain requires access to be part of. In a permissioned chain, a control layer runs on top of the blockchain and supervises the actions taken by all of the authorized participants, and as such does not sacrifice the authority aspect seen in the traditional centralized systems.
More on Ethereum Enterprise solutions:
Types Of CBDCs
CBDCs can be used for both retail and wholesale payments. Retail CBDCs are digital versions of cash that are used for transactions between individuals and businesses, while wholesale CBDCs are used to facilitate interbank settlements, or payments between banks and other entities that have accounts at the central bank. Central banks that are testing CBDCs have been particularly interested in providing fast and low-cost payment options.
Benefits of Retail CBDC
Retail CBDCs are used for payments between individuals and businesses or other individuals, similar to digital bank notes. These types of CBDCs would typically have a daily volume of more than 100 million transactions.
There are several benefits to using retail CBDCs. They can increase the availability of digital currency by distributing it on mobile devices, streamline reconciliation by being natively digital and not requiring costly and time-consuming reconciliation processes, foster digital innovation by lowering barriers to entry for new firms in the payment sector, and enhance monetary policy by giving central banks direct influence over the money supply.
Benefits of Wholesale CBDC
Wholesale CBDCs are used to facilitate interbank settlements, or payments between banks and other entities that have accounts at the central bank. These types of CBDCs would typically have a daily volume of fewer than 100,000 transactions.
Wholesale CBDCs also have several benefits, including the ability to improve interbank payment settlement through automation and decentralized netting solutions, reduce counterparty risk by enabling payment-versus-payment settlement for cross-border payment transactions, participate in digital asset markets by providing a large-scale, decentralized clearing house and asset register, and stay competitive by allowing end users to benefit from streamlined banking infrastructure.
Drawbacks of CBDC
There are also some drawbacks to using CBDCs. These include currency expiration policy, where money in a CBDC account may expire if it is not spent by a certain deadline. According to a Wall Street Journal article in April 2021, China has tested expiry policies with its own CBDC.
Negative interest rates may also be implemented by central banks using CBDCs, encouraging people to use their money or lose it, in order to increase consumer spending. CBDCs may not allow for fully anonymous transactions, and may use some form of private ledger that offers “controllable anonymity” but traceability and transparency for central banks, meaning that all financial activity will be visible to central banks.
Central banks may also be able to tailor their monetary policies using a bank of Big Data on individual spending, saving, and investing habits, along with digital identification infrastructure.
CBDCs on Ethereum
Blockchain technologies bring unique advantages to a CBDC. Ethereum in particular is the most production-ready blockchain to support CBDC requirements in terms of scalability and privacy. It’s the largest blockchain ecosystem in the world, with over 350,000 developers.
Below are some of the nations that are currently exploring, developing and testing their own CBDCs utilizing Ethereum Enterprise solutions.
Thailand
Status: Pilot
Technology: Ethereum — Hyperledger Besu
Timeframe: This pilot will end in mid-2023.
Overview: The Bank of Thailand began exploring the domestic retail CBDC in 2020, and earlier phases of the project were focused on conditional payments and integration of different business platforms.
Since 2021, the BOT has been focusing on the issuance of the CBDC. In August 2022, Thailand confirmed that the pilot of its domestic retail CBDC will begin in late 2022. The pilot will include ten thousand participants who will test the deposit, transfer, and withdrawal functionalities of the wallet with three companies, Bank of Ayudhya Public Company Limited, Siam Commercial Bank Public Company Limited, and 2C2P (Thailand) Company Limited.
Australia
Status: Pilot
Technology: Ethereum — Quorum
Timeframe: To pilot a retail CBDC in early 2023.
Overview: The Reserve Bank of Australia announced in November 2020 that they have partnered with the Commonwealth Bank of Australia, National Australia Bank, Perpetual and ConsenSys software to explore a distributed ledger technology based CBDC.
This partnership will involve the creation of a proof-of-concept for the issuance of a tokenized form of CBDC that can be used by wholesale market participants for the funding, settlement and repayment of a tokenized syndicated loan on an Ethereum-based DLT platform. This was labeled as Project Atom.
Project Atom came to a conclusion in 2021, and the report provided technical and policy recommendations for wholesale CBDC payments. In August 2022, the RBA announced that it will conduct studies on gaps in the existing payments system and how a CBDC could fill them. As a part of the study, the RBA, in collaboration with Digital Finance Cooperative Research Centre (DFCRC), will create a limited pilot to explore innovative use cases for a CBDC.
In a white paper released in September 2022, RBA announced that it would test use-cases in November 2022, and conduct a pilot between January — April 2023. In November, it was announced that the open period for submitting use cases to the RBA, which has already received 140 submissions, was extended through March 2023.
In a speech by Governor Lowe in December, he laid out the case for a CBDC, and stated that the Bank is looking at a number of use-cases to progress with the pilot next year. He also stated that the bank will publish a report on their experiments next year.
Israel
Status: Development
Technology: Ethereum — Quorum
Timeframe: The Bank of Israel will continue examining various technological issues regarding the potential issuance of a digital shekel.
Overview: The Bank of Israel has been considering the issue of an e-shekel since 2017. In November 2018, a team from the Bank of Israel released a report that recommended holding off on issuing a digital currency in the near future. In May 2021, the bank announced that it would further its R&D efforts on a CBDC.
In June 2022, the Bank of Israel published the outline and main insights from the first technological experiment conducted as part of the project. The experiment was conducted under laboratory conditions, and involved the establishment of a distributed ledger technology (DLT) infrastructure on the cloud, and the application of a Quorum blockchain based on Ethereum.
The Bank of Israel “issued” the “digital shekels” using the ERC20 standard. The wallet identified the token representing the digital shekels in the experiment, and it was possible to make a transfer of digital shekels from one customer to another.
Bank of Israel also carried out a test case examining a situation in which a vehicle is sold in exchange for digital shekels. The experiment executed a process in which the car’s ownership was transferred simultaneously with the transfer of the payment. For that purpose, a nonfungible token (NFT) was issued with the ERC 721 standard, showing the sold vehicle, and a smart contract was written that activates three basic actions:
1. Offering the vehicle for sale: The seller, who owns the NFT showing ownership of the vehicle, offers the vehicle for sale in exchange for some amount. The NFT moves from the seller’s wallet to the smart contract’s wallet.
2. Purchase of the vehicle: The buyer, who holds digital shekels, agrees to purchase the vehicle for the amount proposed by the seller.
3. Cancellation: The seller cancels the sale if the conditions for upholding the transaction are not met (for instance, the buyer offers a lower amount than demanded by the seller), and the NFT showing the vehicle’s ownership leaves the smart wallet, returning the situation to the beginning.
The experiment described in this document is the first technological experiment carried out by the Bank of Israel’s work teams as part of the digital shekel project.
Norway
Status: Development
Technology: Ethereum — Nahmii
Timeframe: CBDC experimentation is set to conclude in June 2023.
Overview: In April 2021, the Norges Bank announced a plan for technical testing over the next two years. In 2017, the Bank established an internal working group to study digital currencies. In 2018, 2019, and 2021 they released reports on the results of their first three phases of study, mostly examining the purpose and consequences of a CBDC.
The fourth phase, involving technical testing, Norges Bank brought in vendor Nahmii to help with its sandbox project. Now, the open source code has been made available on GitHub, allowing for the testing of basic token management use cases, including minting, burning and transferring ERC-20 tokens.
In addition to deploying the appropriate smart contracts and access controls, the Norges Bank sandbox includes a custom front-end and network monitoring tools. The sandbox network sits behind basic authentication and is only accessible by users with the appropriate credentials, meaning transactions are private. Nahmii says more complex and interesting use cases, such as batch payments, security tokens and bridges will soon follow.
Singapore
Status: Pilot
Technology: Ethereum — Quorum
Timeframe: Retail CDBC — No urgent need for retail CBDC in Singapore for now, but to actively explore use cases for CBDC development in 2023 and 2024. Not ruled out of introduction of retail CBDC in the near future. Wholesale CBDC — MAS’ experiments to-date have primarily focused on wholesale cross-border transactions involving financial institutions. Following a four year development, Partior, homegrown blockchain platform for payments clearing and settlement that grew from Singapore’s Project Ubin collaboration, has gone live.
Overview: Wholesale CBDC — Project Ubin
Project Ubin was a Singapore research study undertaken to evaluate if blockchain and distributed ledger technology (DLT) could be used for settling payments and securities. The project started on November 2016 and ended in July 2020 with a research trial of almost 4 years.
Project Ubin focused on the potential of blockchain and distributed ledger technology to improve domestic transactions and cross-border payments and was carried out in 5 different phases.
Phase 1: Creating Tokenized SGD
The first phase of Project Ubin aimed to develop a proof-of-concept for conducting interbank payments. A prototype system based on the Bank of Canada’s Project Jasper was created and launched on a private Ethereum network. The prototype used a digital version of the Singapore dollar called SGD-on-Ledger, and the first phase concluded with the determination that a digital dollar was feasible for use in payments and transactions.
Phase 2: Feasibility of Distributed Ledger Technology (DLT) for Real-time Settlement
The second phase of Project Ubin focused on the ability of blockchain technology to maintain the privacy of banking transactions and its usefulness for daily transaction settlement. Three software prototypes were proposed by different blockchain companies, and each was evaluated based on six criteria: privacy of transactions, digitalization of payments, decentralized processing, payment queue handling, finality, and liquidity optimization. The prototypes were developed using Corda, Hyperledger Fabric, and Ethereum’s Quorum, and their functionality and performance were evaluated in terms of privacy, scalability, resilience, and finality.
Phase 3: Domestic Delivery versus Payment on Distributed Ledger Technology (DvP-on-DLT)
In the third phase of Project Ubin, the Monetary Authority of Singapore teamed up with the Singapore Exchange to explore the use of blockchain technology for domestic Delivery versus Payment (DvP) settlements on two separate platforms. DvP transactions involve the payment for a security being made before or upon its delivery.
To test the feasibility of conducting these transactions across different blockchains, three companies proposed their own prototypes on various platforms and were evaluated based on four objectives: interoperability between cash and securities ledgers, even if they were built on separate blockchains; risk reduction through the ability to recover assets on cash and securities ledgers; achievement of DvP settlement finality; and enhancement of investor confidence and user experience.
Anquan Capital, Deloitte, and Nasdaq each developed a prototype using Quorum, Ethereum and Hyperledger Fabric, and Chain Core and Hyperledger Fabric, respectively. After evaluating the different prototypes, the third phase of the project concluded that smart contracts could be used to maintain a fair and transparent marketplace, DLT could shorten the settlement process to real-time, smart contracts could be used as arbitrators to resolve disputes, and blockchain could allow for the verification of transactions without revealing the parties’ identities.
However, it also noted that the use of smart contracts could potentially impact liquidity, as assets are locked once the contract is executed and cannot be used or moved until it expires.
Phase 4: Cross-Border Payment versus Payment (PvP)
In the fourth phase of Project Ubin, the Monetary Authority of Singapore, the Bank of Canada, and the Bank of England in consultation from a group of commercial banks led by HSBC, collaborated to explore ways to improve cross-border payments and settlements using three recommended models.
The first two models aimed to enhance existing payment systems through improved SWIFT messaging, local real-time gross settlements (RTGS), and the ability for RTGS operators to act as “super correspondents” for their member banks.
The third model focused on using distributed ledger technology and CBDCs to facilitate cross-border payments, and proposed three potential scenarios: the creation of CBDCs that can only be used within their home jurisdictions, the creation of CBDCs that can be used beyond their home jurisdictions, and the creation of a universal CBDC accepted by all participating jurisdictions.
The study did not settle on a single model to develop further, but it provided a starting point for evaluating future models and raised questions about the policies that would need to be revised to accommodate new digital assets.
The report also noted that the overall value of cross-border payments is expected to rise by 5.5% per year from US$22 trillion in 2016 to US$30 trillion in 2022 across both retail and corporate payments, while the number of active correspondent banks declined globally by 8% per annum.
Phase 5: Enable Ecosystem Collaboration
Project Ubin wrapped up its final phase in 2020 with the creation of the Ubin V network.
The Monetary Authority of Singapore (MAS) teamed up with J.P. Morgan and Accenture to develop the Ubin V network, which was completed in the final phase of Project Ubin in 2020.
This blockchain network was designed to facilitate payments in various currencies and provide connectivity for digital assets. It was built on the Ethereum’s enterprise Quorum blockchain layer, which was chosen for its high performance, clarity in payment finality, transaction privacy, and voting-based mechanism.
Ubin V allows for easy, open access for participants, including currency issuers, third-party platforms, and users. MAS aims for the network to improve payment connectivity between users and their platforms, enable automated payments and processes with secure data exchange, and allow for the addition of more functionalities through smart contracts.
Outcome to Project Ubin — Launch of Partior
Project Ubin was first commenced in 2016 to explore the use of blockchain and distributed ledger technology for clearing and settlement services. This is the genesis of Partior, a homegrown blockchain-based technology provider for payments clearing and settlement. Partior is a joint venture by DBS Bank, JP Morgan, and Temasek, a Singapore’s sovereign wealth fund with $671 billion in assets under management as of December 2022.
Building on the success of the Ubin Project, it enables banks to settle cross-border payments of various currencies using commercial bank digital dollars or non-retail CBDCs. Within this year, Partior is looking to expand its end-to-end settlement currencies to eight from the current two of the Singapore dollar and US dollar.
While the platform is currently in its pilot phase, Partior is expected to enable financial institutions and developers to create applications that support FX Payment Versus Payment (PVP), Delivery Versus Payment (DVP) and Peer-to-Peer escrows to complement global financial ecosystems. The company also aims to expand service offerings to other markets and currencies, and is designed to complement ongoing CBDCs initiatives and use cases.
Following Project Ubin
There has been a number of new initiatives launched in Singapore to further pursue the use of blockchain in payments and settlements.
Ubin+
The Monetary Authority of Singapore (MAS) is launching Project Ubin+, a global initiative on the cross border exchange and settlement of foreign currency transactions using wholesale CBDC.
“Through Ubin+, MAS will collaborate with international partners to explore a broader range of atomic settlement solutions. MAS is working with the central banks of France and Switzerland and the BIS Innovation Hub to explore the exchange and settlement of wholesale CBDCs with an automated market maker. An automated market maker will enable the exchange and settlement of digital assets to be performed automatically with the smart contract technology.
MAS is also participating in SWIFT’s CBDC Sandbox, together with more than 18 central banks and global commercial banks, to explore cross-border interoperability across digital currencies based on DLT and non-DLT payment systems; and collaborating with the Federal Reserve to enhance designs for atomic settlement of cross-border cross-currency transactions, leveraging wholesale CBDC as a settlement asset.
Project Dunbar
Project Dunbar aims to create a multi-currency platform that operates across borders using wholesale CBDCs. The platform will be developed using distributed ledger technologies such as Corda and Quorum, which were thoroughly tested during Project Ubin.
The project will involve the Monetary Authority of Singapore collaborating with the Reserve Bank of Australia, the Central Bank of Malaysia, and the South African Reserve Bank, along with the Bank for International Settlements Innovation Hub, to test CBDCs for international settlements. This builds upon the ideas and recommendations for cross-border payments presented in Project Ubin.
Project Orchid
The Monetary Authority of Singapore (MAS) is exploring the potential of retail CBDCs through a technological initiative called Project Orchid. The main goal of this project is to collaborate with the private sector to develop the infrastructure and technical expertise necessary to issue a digital Singapore dollar. Following the research, MAS decided that for now retail CBDC is not urgent, but will be actively exploring use cases for retail CBDC development in 2023 and 2024. MAS have not ruled out of introduction of retail CBDC in the near future.
Project Guardian
MAS’ Project Guardian initiative aims to explore ways traditional financial institutions can leverage tokenized assets and decentralized finance (DeFi) protocols to execute financial transactions, among other use cases.
The Chief Fintech Officer of MAS, Sopnendu Mohanty, said the live pilots led by industry participants demonstrate that digital assets and DeFi have the potential to transform capital markets with the appropriate guardrails in place.
Calling it a big step towards facilitating “more efficient and integrated global financial networks,” Mohanty added that the Project Guardian has “deepened” the regulator’s understanding of the digital asset ecosystem and has contributed to the development of Singapore’s digital asset strategy.
For the first testing phase, JPM’s blockchain division for wholesale payments — Onyx — joined forces with Singapore’s DBS Bank, Japan’s SBI Digital, Singapore Exchange’s digital asset platform Marketnode and Temasek. The participants conducted a cross-border transaction with tokenized Japanese Yen and Singapore Dollar deposits and also a simulated trade of tokenized government bonds.
Confirming the development, Tyrone Lobban, Head of Onyx Digital Assets tweeted:
Lobban revealed that the banking giant wanted to carry out the trade on Ethereum but chose Polygon because of its cheap gas fees.
JPMorgan used Ethereum’s Aave protocol to utilize its permissioned pools concept and deployed a modified version of Aave Arc to set certain parameters such as interest rate and fx rates. Additionally, the bank issued a tokenized Singapore Dollar (TSD) deposit for the Japanese Yen. TSD is a “native deposit token with stable on-chain value without the scalability issues plaguing stablecoin.”
Why Use A Decentralized Ledger for Central Bank Digital Currencies?
According to Monetary Authority of Singapore, which noted in its Phase 5 of Project Ubin report, one of the main obstacles to establishing a universal platform for cross-border payments is the issue of governance and ownership. In domestic contexts, there is typically a trusted central party, such as a central bank, which is responsible for issuing the domestic currency and maintaining a record of the assets held by transacting parties. In an international setting, the network would involve central banks and banks from various countries conducting transactions using multiple currencies on a shared platform.
Central banks may be hesitant to allow their currencies, which represent their liability, to be issued and recorded by a third party that is outside of their control. This raises concerns about who would have the authority to make decisions about the network and how it would be governed.
In a traditional architecture, a single entity controls all elements of the solution stack right down to the physical hardware layer. However, in a decentralized ledger, where different components of the solution are provided by different parties, the concept of centralized control becomes much less relevant.
Ironically, it all comes down to the original ethos of Bitcoin’s network “don’t trust, verify”.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.
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