Since the publication of Satoshi Nakamoto’s white paper in November 2008, “Bitcoin: A Peer-to-Peer E-Cash System”, the term “blockchain” has been synonymous with digital currencies in the sense of the underlying technology that supports it enables value transfer, peer-to-peer.
It is interesting that the term “blockchain” is not even used in this whitepaper. The purpose of the paper was to propose a solution to the core problem of the double issuance of a digital currency, which is the representation of a transfer of value directly between the transaction parties without the use of a central trustworthy third party.
By definition, currencies are a medium of exchange for goods and services, a unit of account and a store of value. In the traditional sense, money fulfills all of these three elements.
Central bank digital currency
There is currently still a lot of interest in central bank digital currencies (CBDCs) – not from the blockchain and crypto community, but from a core group of some of the most influential central banks, including the Bank of England, the Swiss National Bank, the European Central Bank, the Bank of Japan, the Bank of Canada, the Swedish Riksbank and the Bank for International Settlements.
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Confirmation from the UK Chancellor of the Exchequer (Head of Her Majesty’s Treasury) at the end of 2020 says the UK will be drafting regulations on private stablecoins and research CBDCs to demonstrate the dynamism of this issue. China has undoubtedly emerged as a leader in the development of CBDCs, recently suggesting that there be a global set of rules that addresses issues such as interoperability between jurisdictions.
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Central to any national monetary policy and financial stability is public confidence in the central banks and confidence that the money provided by the central bank fulfills these three key elements of a currency – regardless of whether it is issued in physical or digital form. A central bank digital currency is neither a stable coin nor a digital asset, but a digital representation of cash – meaning that a digital pound is the same value this morning and its purchasing power (what the holder can buy) does not fluctuate beyond certain thresholds .
The European Central Bank’s proposal for a digital euro is based on the premise of complementing the current system of central bank deposits for cash and wholesale. It is seen as a way to ensure that European citizens have access to a secure form of money in a rapidly changing digital world, while actively encouraging innovations in retail payments, supporting societal vulnerabilities and reducing their potential financial exclusion become. A digital euro is also seen as an option to reduce the overall cost and environmental footprint of the current monetary and payment system.
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In the economies that are currently developing ideas about central bank issues, stable coins, or private digital currencies, the experience has been roughly the same as previous monetary innovations: coins, bills, checks, and credit cards. Many see blockchain and distributed ledger technology (DLT) as the mechanism to replace electronic currencies in conventional bank accounts. Just as paper money followed gold and silver, electronic transfers could replace paper money.
The rise of digital currencies
The current COVID-19 pandemic has sparked the motivation for cashless transactions and has impacted the way society interacts financially, which has accelerated the concept of digital currencies in people’s minds. As there are fewer cash transactions, businesses and consumers are more aware of the properties and benefits of digital currencies.
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Central banks already work with other qualified financial institutions, mostly clearing banks, through electronic central bank deposits. In addition to this system, they also issue banknotes and coins to the public. The move to digital versions of these banknotes and coins is a natural progression in our more digitalized world.
However, this trend could lead to an unintended consequence: In a cashless society where the public no longer has access to a government-guaranteed payment system, the private sector would control access to, development and pricing of alternative payment methods. Unless governments issue digital currencies to the public through their respective central banks. In a system in which the central banks could have a direct relationship with each individual, however, there would be considerable disruptions in the commercial banking market, including the problems of considerable data retention and the associated data protection. Do citizens want the central bank to be informed of every transaction they make?
To enable CBDC, the technology platform should meet certain key characteristics:
- Convenience: The proliferation of smartphones in modern society enables a well-understood “tap-to-pay” system or a QR code-based system.
- Security and resilience: Current sophisticated cryptographic techniques offer users data protection. either software-based or hardware-based enforcement of data protection. The resilience of a 24/7/365 infrastructure is critical to the performance of a CBDC.
- Speed and Scalability: Transaction volume and throughput must be maintained at a reasonable cost. Current centralized card networks show that very high transaction capacities are possible. Eligible DLT networks could be an equivalent replacement for traditional technologies.
- Interoperability: The use of application programming interfaces, or APIs, is well established to help technologies work together and facilitate transactions between accounts. Common data standards will also play a role in interoperability.
Using the example of Bitcoin (BTC), the blockchain infrastructure offers a completely decentralized, completely permissionless public network over which theoretically no one, no entity or authority has control. In the same way, blockchain and / or DLTs can provide a similar network to support the problem of CBDCs in a national population.
However, the more popular framework for digital currencies is a centralized, licensed network that gives the issuing authority, which is usually the national central bank, a degree of control and better control over the “blockchain” that transacts with records digital currencies. This centralized, distributed ledger with authority could address these key attributes.
For some commentators, the ability of central banks to issue programmable CBDCs on a centralized blockchain with permissions is a positive development – for example, defining and controlling the use of the digital money spent so that it can only be used for food, not alcohol or cigarettes, or Gambling. There are also transparency benefits that allow governments to access tax evasion and other criminal activity by accessing the underlying transaction data.
The original rationale for Satoshi’s whitepaper was to create a protocol that would enable peer-to-peer digital value sharing without the trust or need for a central authority.
It is ironic that central banks are now considering the benefits Satoshi explained in this white paper as they study and consider how the technology could support a new digitally issued currency. The two concepts entered everyday conversation almost simultaneously, creating the impression that they are interwoven. However, both the technology and the use case can exist separately.
Digital Isle of Man, an executive agency of the Isle of Man government, continues to promote and support research into the issuance and use of digital currencies in all their forms, including stablecoins and CBDCs. Soramitsu, a fintech firm providing blockchain-based solutions to businesses and governments and currently a member of the agency’s accelerator program, recently announced its partnership with the National Bank of Cambodia to provide a secure, standardized digital currency alternative to paper banknotes on paper establish single payment platform. The Bakong system is based on the Hyperledger Iroha DLT, which is integrated with the traditional banking system, allowing users easy access through scanning ID documents, reviewing photos and biometric recognition. This international experience offers the island important insights into a possible future implementation of digital currencies.
Of course, there are a number of technical, economic, financial, and legal issues, including the impact of a digital currency on monetary policy, financial stability, and the business models of banks, that are unfortunately beyond the scope of this article.
The views, thoughts, and opinions expressed here are the sole rights of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Steve Billinghurst is Head of Regulatory Affairs at Digital Isle of Man, responsible for working with companies and individuals who want to understand how the island’s financial services regulatory framework affects their digital business offerings. Steve’s role has also expanded to maintaining awareness and understanding of international crypto-financing developments in major competitor jurisdictions and securing the Isle of Man’s competitive position by continuously reviewing and updating its own legal framework.