Digital currencies, blockchain and how central banks accelerate their innovation

The coronavirus (COVID-19) continues to spread around the world and reaches more than 3,344,000 people worldwide. Health restrictions to contain the virus are forcing the world to switch entirely to digital. For this reason, central banks are exploring the possibilities that digital currencies and blockchain-based systems offer and expect a rapid phase of transformation of the traditional financial system.

Argentina is at the forefront in Latin America as the Central Bank of the Argentine Republic (BCRA) introduces new technologies and the proof of concept of the Interbank platform based on intelligent contracts, on RSKThe company has six nodes, one for each participating institution, including Banco Santander, BBVA, Bancor, ICBC, Interbanking and Bolsas y Mercados Argentinos (BYMA). The system for processing claims for unauthorized debits and returned checks is the first step in integrating DLT (Distributed Ledger Technology) or blockchain into the local financial system.

The French central bank also wants to experiment with the integration of digital currencies, recently published a request to receive suggestions for experimental applications with this type of currency. These projects will help the financial institution understand the risks and mechanisms of CBDCs. They will also contribute to the conversation about digital money in Europe.

The announcement by the French central bank puts the country at the forefront of this debate as it is a member of the European Zone The most outstanding thing was to start an experiment with CBDC together with Sweden, whose Riksbank is also experimenting with the digitization of the coin and preparing for the start of Krona.

Already since last year, as reported by CryptoNews, the European Union endorsed central bank issuance of digital currenciesHe even suggested creating a legal framework that would not only target the spending of these types of assets, but also private initiatives.

China has also been working on its national digital currency (DCEP) It will be distributed to local government officials in Suzhou City this May. The digital currency is issued by four state-owned banks, including the Agricultural Bank of China, the Industrial and Commercial Bank of China, the Bank of China, and the China Construction Bank.

In addition to these cases, world-famous banking giants such as the Spanish company Santander have settled bonds through the Ethereum network. Fiat funds were paid in by one of the group’s subsidiaries.

The central banks’ innovative step

In a document published by R3, entitled “Central Bank Digital Currency: An Innovation in Payments”, the growing interest in blockchain-based central bank digital currencies (CBDCs) around the world examines advances to date and shows the models under which the system will work, as well as a variety of implementations.

The report contains elements that contribute to understanding the significant benefits of blockchain-based digital currencies for general use and adds that central banks’ motivation to promote their development is based specifically on the fact that CBDCs are an alternative to cash and the modernization of payment systems in the structure of a digital economy.

As part of the structure of a digital economy, a blockchain is crucial for Enable token conversion for payment assets and enable peer-to-peer transactions and distributed custody. The system will also be used to increase the efficiency of cross-border payments. Also to conduct atomic transactions, which means that any delivery versus payment scenario can occur in real time without the risk of part of the transaction being executed before the other, as described in the report.

The document adds that by using blockchain and digital currencies, liquidity-saving mechanisms can be more effective in reducing bottlenecks that are currently causing delays. While The system can allow banks to increase their effectiveness and liquidity over what they currently have. “Each bank could have better control and transparency in real time about how their payments are remunerated across the network, reducing the dependency on the central operator for this remuneration calculation. Greater control and flexibility in liquidity would benefit all market participants, “he stresses.

The report divides digital currency projects into two categories: wholesalers issued by commercial banks and institutions; while retailers are connected to small businesses. He presents a number of pilot projects from the former, while clarifying from the latter that none currently exist. However, an investigation and a PoC proof of concept of the European System of Central Banks (ESCB) show this It is possible to build a simplified CBDC payment system that gives users a degree of privacy for transactions with lower value.

Even this PoC has several novel features such as a user identity procedure and a transaction history They cannot be seen by the central bank or intermediaries other than those selected by the user. The app enables the automation of anonymous electronic transactions, with additional checks being delegated to an AML (Anti Money Laundering) authority. This is achieved using “anonymity vouchers” that allow users to anonymously transfer a limited amount of CBDC for a defined period of time.

How will the system work?

To demonstrate how the system will work, the report describes a CBCD implementation method with three different types of participants: central banks, financial institutions with access to central bank balance sheets, and retail institutions without access to the central bank. This model can be used to understand the wholesale and retail use cases described above.

The model shows a two-tier system with API accounts Each participant has access to the distributed general ledger. There are three types of participants. Since not all participants have access to their own CBDC or want to be administrators of their own CBDC, the system contains API accounts. API accounts are a mechanism by which a node acts on behalf of users who can communicate with the node through an API. In practice, each node (a network participant) manages an account for each user it represents. This is similar to the bank accounts we use today.

The report clarifies that all examples still have governance issues to answer, and their responses depend on each central bank. The questions that remain open are: What are the privacy policy for payments? Will CBDC remain anonymous as cash or is there some level of information for large transactions? What are the network boundaries for CBDC?