Anyone who can string sentences together seem to be writing papers on Central Bank Digital Currencies (CBDCs). Announcements of new CBDC projects are being issued almost daily. The SWIFT paper on CBDCs, the Digital Dollar Project announcement of CBDC use cases, the BIS papers on CBDC and multi-CBDC architecture written by economists, papers by Bank of Japan, Bank of Korea. Only the a few of these papers focus on real pilots and technical details. In this crowded field the paper from Bison Trails on the “Infrastructure and Design of Central Bank Digital Currencies” is notable for a few reasons. The first is the word “Infrastructure”. This recognizes the fact that CBDCs are an important part of the renewal of the Digital Infrastructure underpinning the economic life of any country. Bison Trails is a company that focuses on Blockchain Infrastructure. There are numerous other reasons why this paper stands out from the rest of the herd which are explored below.
Bison Trails appeared in the spotlight of the blockchain world when they were listed as one of companies on the announcement of the Libra project by Facebook a couple of years ago. They are still toiling on that project, now rebranded Diem. Libra shook up the staid world of central bankers, as the scale, ambition and capability of the main animator of the project surpassed even the biggest central banks in the world, they had direct and daily access to almost one-third of the world’s population and that too a key demographic of digitally forward people. Libra launched a thousand CBDC projects. Faced with a real prospect of losing monetary sovereignty, central bankers denounced the project at first; trying to smother Libra with regulations, threats and appeal to nationalism. Later the Central Bankers realized that they needed to offer real alternatives to what Libra was offering. As a blockchain infrastructure company, Bison Trails is following with their expertise. Coinbase, inhabiting the uneasy no-mans land between public crypto-currencies and traditional financial infrastructure, with an overflowing treasure chest from the volatility in crypto-prices, bought Bison Trails in January 2021, giving them the backing of one of the giants in the crypto-sphere.
The turmoil and the opportunity generated by the pandemic, which allowed the rise of Biden has brought back that unsexy word “Infrastructure” into focus, is a motive for CBDC projects. Rather than tomorrow’s returns, companies’ attention and public sentiment are trained on the long term at least for a short while. The term infrastructure occurs 76 times in the Bison Trails whitepaper. CBDCs representing a digital central bank currency, have the potential to rework all payment systems from retail to securities settlement to global trade. There is a unique mix of monetary policy and fiscal policy considerations to be examined for CBDCs. The threat of cyber-risk, hacks that disrupt entire economies are the downside considerations. The paper opens on a familiar note. The four technical and functional choices: account or token based; wholesale, retail or general use; direct, indirect or hybrid issuance; will the network be decentralized or centralized are brought up and each axis and its infrastructural implications are examined in turn.
The current system of creation of money in most countries is decentralized. Eighty percent of money in modern systems are generated by commercial banks in conjunction with willing borrowers. This is a decentralized system. This fact is forgotten through the lens of dimly remembered economics lessons on Fractional Reserve Banking and the myth of Central Banks “printing” money. Central banks do have a high degree of control over commercial banks that create this money and can control their behavior through monetary policy. In this sense, the creation of money can be said to be centralized. The binary choice decentralized/centralized cannot be applied unthinkingly. Governance of the central bank digital currency is what has to be decentralized, to a degree by the programmability of money and the transparency of this mechanism to the observer. Blockchains while not necessary for any CBDC solution, embed these features in the basic building blocks. Listing current projects which use private blockchains the paper starts out advocating public permissionless blockchains mainly for interoperability. Bison Trails lists their expertise with diverse blockchains, the varying governance, algorithms, and application interfaces as an essential skill in creating CBDCs that can interoperate. The paper continues with a brief survey of eleven familiar blockchain projects. e-Krona (Sweden), e-Peso (Uruguay), e-Hryvnia (Ukraine), Sand Dollar (the Bahamas), DCash (Eastern Caribbean), Project Stella (EU & Japan), Singapore Dollar (Singapore), Digital Yuan (China), SOV (Marshall Islands), RBA DLT (Australia), m-CBDC Bridge (Thailand, Hong Kong, UAE, China). This is quite an eclectic mix, from half-baked to influential and transformative with some striking omissions.
The paper examines motivations for the sudden increase in CBDC projects, from the Diem project mentioned earlier to DCEP (Digital Currency Electronic Payments) which is another name for the Digital Yuan from China are recognized as drivers. Bison Trails’ own special experience with the technical infrastructure of Diem, built to be auditable and controlled transactions give them a unique perspective. The deep intertwining of technical decisions and expertise with the desirable features of a CBDC and its ultimate success are brought to the foreground.
The next section examines the four axes mentioned earlier. The first axis is whether accounts or tokens are used for the modeling of the CBDC. The paper starts off by saying that this distinction is not purely binary. The New York Fed defines the distinction as “an account-based system requires verifying the identity of the payer, while a token-based system requires verifying the validity of the object used to pay.” The IMF says the difference is ‘I am therefore I own’ vs. ‘I know therefore I own’. Account based models are more appropriate for wholesale CBDCs and regulated ownership with proper eKYC and enforcement using smart contracts, properly secured and regulated vs a Token based one with more privacy. Self-custody and the attendant perils of loss, just like cash are the hallmarks of Token based systems. The DCEP project from China seems to have implemented this using tiered wallets, with higher amounts in account based wallets and lesser amounts in Token based wallets. Whilst the Token based model, at least in the Bison Trails and many other descriptions can escape from the spoor of a public key providing a correlation attack on the transactions to erode privacy, it affords a certain sense of privacy with the anonymity of a self-custodied private key. Some of the existing CBDC solutions are looked at from this perspective: Account or Token Based. The Sand Dollar is examined as an example of an account based model. Details of the Sand Dollar project are in an article written by me many months ago. Focus is on financial inclusion and reach across a vast archipelago.
The other axes are examined in turn, each of which focuses on a specific project such as Project Khokha for wholesale, DCEP for an indirect model, Bank of England for the Hybrid model. Many of the familair tropes and concerns are brought up, discussed and highlighted. There are no major revelations or ideas in this section, this can function as a useful survey of many of the important projects in this space.
The paper with its focus on practical interoperation, operations and technology practice, is a welcome change from the CBDC papers produced by lawyers and economists. The call for public-private partnerships for implementation and to re-use existing public platforms while not earthshaking, are important points that advance the CBDC conversation.