Central bank digital currency: pursuing minimally invasive technology solutions

The central bank digital currency (CBDC) should become a universal payment method provided by the central bank in the digital age. At the same time, the design of CBDC must protect consumer privacy and maintain the existing financial system. To this end, the Bank for International Settlements (BIS) has formulated a “minimally invasive” (“minimally invasive”, or minimization of negative impact) design requirements for CBDC, which retains the private sector’s main role in retail payments and financial intermediation. And discussed the influence of CBDC underlying technology. The Institute of Financial Technology, Renmin University of China (WeChat ID: ruc_fintech) compiled the core content of this article.

The central bank digital currency (CBDC) should become a universal payment method provided by the central bank in the digital age. At the same time, the design of CBDC must protect consumer privacy and maintain the existing financial system. To this end, we have formulated a “minimally invasive” (“minimally invasive”, or minimized negative impact) design requirement for CBDC, which retains the main role of the private sector in retail payments and financial intermediaries, and discussed the underlying CBDC The impact of technology. The current popular cryptocurrency system does not meet the “minimally invasive” requirements. CBDC should refer to the design model of cash, and emphasize the use of CBDC as a medium of exchange at the economic design level, but it needs to limit its attractiveness as a savings tool. In this process, central banks need to make new trade-offs: they can design complex technological infrastructures as well as complex regulatory systems. But all require the central bank to conduct research and master key technologies.

Central banks have only recently begun to consider issuing their own central bank digital currency (CBDC), but the ideas behind it can be traced back decades. David Chaum proposed his vision of anonymous electronic cash 35 years ago, Tobin et al. In 1987, I suggested that the central bank issue electronic money, although the central bank itself was slow to accept this view. But since then, as the times have changed, by 2021, 86% of central banks stated that they have conducted research on central bank digital currency issuance, more than 46% of central banks have issued design reports or prototypes, and major central banks around the world have begun to jointly develop Core Principles of Issuance…

Central bank digital currency: pursuing minimally invasive technology solutions

Figure 1: Research progress of CBDC in various countries

The design of the central bank’s digital currency must be based on the central bank’s core mission, which is to provide a flexible and generally accepted means of payment. For centuries, cash has assumed this function. However, in the digital age, the use of cash as a means of payment has become less frequent, and the surge in online commerce during the Covid-19 pandemic has accelerated this trend. If cash is no longer generally accepted, central banks will have to develop a digital form of payment as a supplement to cash.

The key difference between cash and current electronic retail money is that the latter represents a claim on the middleman, while the former is a direct claim on the central bank. This raises several questions, as intermediaries may go bankrupt, interrupted, or suffer technical attacks. Looking ahead, a worrying issue is that if the use of cash is further reduced to the point that it loses universal acceptability, then a financial crisis may come and cause serious damage to the financial system, causing some financial institutions to have to freeze it. Deposits of retail customers, making it impossible for customers to pay their bills. In Sweden, the use of cash has fallen sharply. Based on these considerations, many central banks have proposed to the government that the digital central bank currency held by the public should also be given the status of legal tender.

At the same time, CBDC should never replace the private sector in financial intermediation or retail payments. The first consideration here is the balance sheet. The economic design of CBDC should not lead to large-scale redistribution of funds from commercial banks to the central bank, nor does it mean that the central bank should provide personal savings accounts for the entire economy; the second consideration Involving the operation and efficiency of payment systems, retail payment services are mainly customer-oriented, including payment account registration, authorization, clearing, settlement, dispute resolution, compliance with anti-money laundering (AML) and counter-terrorism financing (CFT) rules. These are a The huge business can be handled by the private sector better than the central bank.

Therefore, in this article, we put forward the technical and economic requirements of “minimally invasive” design, that is, the issuance of central bank digital currency to meet the needs of the 21st century without destroying the two-tier structure of the current monetary system.

Economic Design of Retail CBDC: Cash as a Model

To start designing a CBDC, one must first determine the problems it should solve and which aspects of the monetary system it should retain. Let us consider these in reverse, using cash as an analogy. Cash has achieved an important balance: it is a safe and useful means of payment, but its use as a savings tool is limited. CBDC can become a digital equivalent.

In terms of payment, cash is unique among all retail payment options because it is a direct legal reimbursement to the central bank. Cash (including banknotes and coins) is recognized as “legal tender”, which usually means that they must be accepted when repaying debts. In contrast, deposits are claims on commercial banks. Bank transfers, check settlements or debit card charges from A to B only change one or two commercial banks’ commitments on who can withdraw as much cash as required. Every commercial bank uses central bank reserves to support these commitments (as shown below). This, like bank equity, increases the confidence of depositors and makes them believe that a large number of withdrawal requests can be met, but there will always be a risk of not being met, because such value support will not be sufficient, and commercial banks may encounter In the event of temporary solvency problems or bankruptcy, the claims may not be fully fulfilled, or even if there is deposit insurance, the legal procedures for recovering funds or compensation from deposit insurance may take time.

Central bank digital currency: pursuing minimally invasive technology solutions

Figure 2: The difference between cash and deposit

This shows the essential difference between CBDC and existing electronic payment tools. CBDC does not depend on the development of commercial banks, so it can be used as an anchor of trust, far beyond the variants of known electronic payment tools operated by central banks. But the concern that follows is that positioning CBDC as the safest digital payment tool may also make it attractive as a savings tool. Households’ demand for central bank digital currency storage may significantly increase the central bank’s balance sheet and crowd out the deposits of commercial banks. Therefore, the business model of commercial banks may be at risk because their funding sources will become scarcer or completely depleted. From this perspective, CBDC may have a negative impact on the economy.

These considerations highlight that, although cash is useful for payments, it has limited appeal as a store of value. This is an inherent problem of physical cash. It does not carry interest, and is expensive when stored in large quantities and for long periods of time, and there is a risk of damage, loss or theft. Therefore, the total stock of banknotes in circulation has always remained at a medium scale, such as US$5,200 per capita in the United States or 3,600 euros in the Eurozone. In contrast, private households hold a large amount of wealth in the form of commercial bank deposits. For example, the average American is 38,000 U.S. dollars and the Eurozone is 53,000 Euros (see the figure below).

Central bank digital currency: pursuing minimally invasive technology solutions

Figure 3: Comparison of cash and deposits in various countries

In addition, the current monetary system divides responsibilities between the central bank and commercial banks. The central bank is responsible for the stability of the banking system, and commercial banks are responsible for all consumer-oriented activities. This two-tier system structure has a good reason for existence. It has evolved from a long-term institutional arrangement. Maintaining this convention is conducive to sound governance. The experience of the Great Depression of the last century also shows that the value of currency is best guaranteed by an institution that is responsible to the public rather than private investors. The primary task of this institution is to stabilize the monetary system. The design of CBDC should maintain this two-tier system.

The rationale for the private sector’s involvement is to provide market-based solutions: good investment decisions often require specific knowledge, and effective service delivery requires open and competitive markets. One aspect is that banks that invest through loans must know or be able to estimate the solvency of creditors in order to price related risks. Public sector institutions may not have the kind of knowledge that local and professional private investors have-this is the core assumption of the Hayek free market case. On the other hand, the market is also competitive, and allowing many companies to compete can improve economic efficiency. A corollary of the free market concept is that continuous innovation in the monetary and financial fields and services to the public are best left to the private sector. Therefore, the economic design of CBDC should allow commercial banks to maintain their intermediary role between depositors and investors.

The second consideration in the minimally invasive design of CBDC is the operational level and efficiency of the payment system. Since the customer-facing side of retail payments is better handled by the private sector than the central bank, the fundamental question is how to balance the CBDC’s direct claims on the central bank and private sector payment service provider (PSP) operational participation. At the same time, the design of CBDC should pursue “cash similarity” in multiple dimensions: transaction records will be tamper-proof, CBDC is unforgeable, CBDC means direct claims to the central bank, and intermediaries face technological disruption or financial pressure CBDC can still be used for exchange. The design of the CBDC will keep the central bank’s operational burden at a low level and allow the private sector to play an important role in all customer-facing activities, just like in today’s system.

From the design requirements to operate: CBDC architectures structure

How do these CBDC requirements affect the technical infrastructure? Technically, every form of digital currency requires a distributed record keeping system. Here, distributed means that it is implemented in many different places. For example, merchant terminals and consumer devices that carry records are all part of this system. This record-keeping system updates a shared state, which encodes how a given number of currency units are allocated to holders, and ensures that the information stored by each component of the distributed system is up-to-date, or at least related to that component The shared status part of is up to date. For example, consumers may not know the balance of other wallets, but must know the current balance of their digital wallet. In order to ensure the operation of this system, relevant laws must be formulated to ensure that the information encoded under the CBDC system is mapped to the ownership of claims against the central bank.

The technical architecture of CBDC is defined by the components of the distributed record-keeping system, the communication relationship between them, and the question of who controls each component. The figure below outlines the possible architecture of CBDCs. These examples differ in the structure required by the law and the records kept by the central bank. We first discuss extreme solutions, either to realize the direct claims of the central bank, or the private sector is mainly responsible, and then discuss a more promising solution that combines the two.

Central bank digital currency: pursuing minimally invasive technology solutions

Central bank digital currency: pursuing minimally invasive technology solutions

Figure 4: Possible technical architecture of CBDC

In the direct CBDC model (the first in the figure above), CBDC is a direct claim against the central bank, and the central bank also processes all payments in real time, thereby storing records of all personal holdings. The hybrid CBDC system structure adopts a two-tier structure, and claims directly to the central bank, while real-time payments are handled by intermediaries. Several variants of the hybrid architecture can be envisaged. The central bank can keep a copy of all retail CBDC holdings (the second type above), or just run the wholesale ledger (the third one above). In the indirect structure (the fourth type in the figure above), the central bank only issues and redempts central bank bonds, and the intermediary institutes claim against consumers. The intermediary institution must pay the full deposit to the CBDC held by the central bank, while the central bank Only operate wholesale payment systems.

If the central bank runs the system on its own to process all payments and update the status directly after each transaction. Even if the central bank has to build the necessary infrastructure, the resulting CBDC may not be as attractive to consumers as today’s retail payment system. This is because real-world payment systems must handle connection interruptions or offline payments. The CAP theorem in computer science tells us that when a part of a distributed system is disconnected, it cannot be available and consistent. Many existing electronic payment systems have resolved this technical deadlock, such as credit card networks, where intermediaries assume financial risks due to potential inconsistencies in the status update process and charge fees for this service. If the central bank is to manage this system on its own, it must bear this risk. However, the main concern of this “direct CBDC” structure is that it may marginalize the participation of the private sector.

In contrast, consider another option for the issuance of retail CBDC: the simple requirement is to repay the payment account in full with reserves at the central bank (the fourth in the figure above). This proposal is made in many names; it can be seen as a narrow payment bank, or even a “rigid stable currency” backed by 100% of central bank reserves. Although some central banks believe that it is not worthy of the “CBDC” label, we call it an “indirect” architecture. This model has many regulatory and supervisory issues, as well as issues related to deposit insurance.

In general, we believe that the credibility of direct claims to the central bank should be combined with the convenience of private sector payment services. One possible structure is called a “hybrid CBDC”. A key factor is the legal framework that supports direct claims to the central bank. That is, CBDC has never appeared on the balance sheet of the payment service provider (PSP), so it is not affected by bankruptcy. . In this way, in the case of PSP bankruptcy, the CBDC held by consumers will not be affected.

Hybrid CBDC achieves technical flexibility through the central bank’s operation of backup infrastructure (hence it is called hybrid-a payment system that can run on public or private infrastructure). If the PSP fails financially or technically, the central bank must have A clear way to honor claims and, ideally, to resume payments to customers who have failed transactions without delay. This ability depends on the information about retail accounts available to the central bank in this situation . Although the central bank does not operate a retail payment business, it keeps a copy of the balance in order to restart payments in the event of an intermediary’s bankruptcy or technical interruption. The central bank’s technical ability to restore retail balances can be achieved by maintaining a digitally signed payment confirmation with the intermediary and the retail account holder itself, or by maintaining a lower frequency with the central bank itself. Since digital signatures are undeniable, the central bank can redeem digitally signed claims regardless of where these records are kept.

We have noticed that some central banks may avoid running all retail data records, for example due to privacy and data security issues. Such central banks may consider adopting an “intermediate” CBDC structure, where the central bank only records wholesale balances. The advantage of a central bank with less payment data is that it is less vulnerable to malicious attacks than a hybrid (or direct) architecture. This reduces the risk and impact of central bank data breaches. However, the disadvantage of the intermediate CBDC structure is that the central bank needs to honor its claim that there is no transaction record. Therefore, it must rely on the integrity and availability of records kept by third parties. Therefore, in order to maintain a cash-like reputation, the PSP will need close supervision to ensure that the wholesale holdings they communicate to the central bank are indeed equal to the sum of all retail accounts. Some of these problems can be solved by cryptographic technology, although higher technical complexity and lower speed are required when processing payments. This is an ongoing technical research area, mainly for distributed ledgers, and we believe that this is not necessarily the best choice for building CBDC infrastructure. It remains to be seen which new achievements in cryptography can stand the test of time and can be effectively applied in an architecture suitable for CBDC.

In short, both the hybrid CBDC and intermediate CBDC architectures have better financial flexibility. For the central bank, these options seem to be easier to operate than “direct CBDC”. Since the central bank does not directly interact with retail users, it can focus on a limited number of core responsibilities, while competing intermediaries are responsible for the operations. Technically speaking, many different infrastructures can support this division of responsibilities according to the required level of flexibility, but the central bank needs to be aware of the implicit technical requirements set by its operations.

The trade-off between regulatory complexity and operational complexity

The above discussion of the structure of the intermediate and hybrid central bank systems embodies a basic trade-off for the central bank: it can choose to keep records directly or outsource them to the private sector and supervise them. At the technical level, to establish credible direct claims in electronic form, it is enough as long as the central bank can obtain and view the data from authoritative information sources. Record keeping can be delegated to the private sector. The figure below conceptually illustrates this trade-off by placing the advanced options of the central bank information set in a complete order (left). The triangle on the right shows that as the integrity of the system, especially the ability to honor claims, grows, it increasingly relies on the availability of consistent and truthful information from private entities, and accordingly, regulatory requirements are also growing.

Central bank digital currency: pursuing minimally invasive technology solutions

Figure 5: New trade-offs between central bank supervision and data in the future

The orange scale on the left shows the central bank’s information set, from complete transaction details (top) to a single total number of transactions (bottom). By observing transaction data, the central bank can obtain a chart of capital flows, which is the most sensitive in terms of privacy but also the most useful for crime prevention. In contrast, just knowing the account balance does not necessarily reveal the payment relationship, especially when the balance update is postponed until a period of time (such as one hour or one day) is completed. From a regulatory perspective, the less information shared with the central bank, the greater the need for supervision of intermediaries to ensure that relevant information can be retrieved from private sector entities when necessary. This is shown by the red scale on the right. The red circle indicates the level of information corresponding to the CBDC architecture outlined in this article. The gray circle shows a hypothetical situation. If the only information available to the central bank is the amount of currency in circulation, such a variant will allow the central bank to focus on its core task-monetary policy, and hand over all payment operations to the private sector Strict supervision.

Importantly, this kind of supervision is different from traditional bank supervision, which focuses on the integrity of accounting. Recall that the hybrid architecture maintains the off-balance sheet cycle of the PSP, but the information in their record keeping system is crucial. Therefore, supervision must focus on more technical aspects and occur more frequently than current bank supervision (possibly in real-time). Supervisors must also put aspects such as integrity, consistency, information security and privacy at the center. .

Implementing CBDC: Cryptocurrency is not a good reference model

The above discussion of the operational architecture and the potential trade-offs between operational and management complexity raise the issue of appropriate technical implementation. Many methods proposed by the industry envisage payment systems characterized by intermediaries, but try to reduce dependence on intermediaries. For example, many CBDC prototypes are built on enterprise versions of distributed ledgers, such as Corda, Hyperledger, or Quorum. These platforms are inspired by cryptocurrencies and borrow design ideas from cryptocurrencies. However, most central bank projects have good reasons to run CBDCs with redundant but centrally controlled databases rather than Bitcoin-like systems.

Some scholars have suggested that the selection principle of decentralized cryptocurrency should be applied to the use case of CBDC. For CBDC, it is unthinkable for the central bank to allow unidentified or unconstrained parties to manage key records. If the CBDC architecture uses designated intermediaries, these intermediaries will be composed of regulated banks, mature payment service providers, or regulated technology companies. Therefore, we believe that the record-keeping system needs to be sufficient to ensure that complete malicious behavior can be detected and recovery is smooth.

Another aspect of the implementation involves end-user devices that can access the CBDC. They must also be suitable for users with lower technical levels. Since CBDC may be beneficial to the unbanked and elderly population, this requirement cannot be overemphasized. Many technical solutions adopt the Bitcoin method and only authorize transactions through digital signatures. Therefore, the security of assets depends on the confidentiality of the private key. Given that skilled cryptocurrency users will continue to lose their wealth due to lost and stolen keys, there is no reason for people to directly use cryptographic technology to make CBDC payments. In this regard, Bitcoin is a technology designed to circumvent authority and is obviously not the best blueprint for public goods provided by the central authority.

Acceleration: Payment and the future central bank

The decline in the availability of physical cash has led more and more central banks to consider issuing retail CBDCs. In this article, we believe that it is not easy to imitate all the convenient attributes of cash. We try to put forward requirements for the CBDC-based payment system, and explore suitable operating architecture and technical implementation. CBDC should allow the central bank to provide a universal payment method for the digital age, while protecting consumer privacy and maintaining the private sector’s main role in retail payments and financial intermediaries. Therefore, we believe that it should reflect a “minimally invasive” design idea to achieve the established goal of providing cash-like digital payment options without disrupting the currency and financial system.

In terms of technology, we believe that a two-tier CBDC design in which retail payments are processed by private sector intermediaries is a viable option. However, a series of different business arrangements are conceivable. In some countries, the central bank has a database of retail balances, while in other countries, the central bank only tracks wholesale balances. In this design space, a new trade-off has emerged for central banks of various countries: they can operate both complex technical infrastructure and complex regulatory systems. There are many methods for both options, but they all require central banks to deepen their technical expertise. There are several similar discussions that we haven’t touched on yet: one is the trade-off between accessibility and the security of electronic payment devices, and the other is that no CBDC design can be exactly like cash, because users must rely on technological foundations. Facilities, and may need to check for intermediary failures, or at least respond to notifications. The third problem—perhaps the most important—is the privacy design of CBDC. In any electronic money technology, privacy is a function that must be carefully designed, not an inherent feature of the record storage system. Looking to the future, research on anonymous protection in the computer science community will need to accompany the development of CBDC.

Due to copy all the attributes of cash technology does not yet exist, the transition to the CBDC may change today’s monetary system, in view of the society relies heavily on an efficient and predictable monetary system, we call for the use of a minimally invasive technology solutions: one for the Consumers provide a digital supplement of cash, while retaining the two-tier currency system and the private sector’s important role in it.


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