When Consensys published its whitepaper, “Central Banks and the Future of Digital Currency,” at the World Economic Forum in January 2020, the backdrop was a dramatic shift in the mechanics of money. Since then, this shift has only magnified, both with privately issued stablecoins nearly doubling in market capitalization to $23B USD, and the COVID-19 pandemic accelerating technological changes to how money moves. If 2019 was the year that central banks began to react to the challenge of privately-issued digital currency seriously due to the introduction of Facecbook’s Libra, the 2020 story is that central banks are now very actively studying and piloting wholesale and retail CBDCs.
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 four major cities. The Bahamas and Cambodia became the first nations to use digital currencies in their financial infrastructure. Last week, European Central Bank President Christine Lagarde signalled that her institution could create a digital currency within years, and that policy makers intend to decide around mid-2021 whether to prepare for a possible launch. And if you’ve been following Consensys news over the past month, we announced four separate CBDC projects with the Hong Kong Monetary Authority, Société Générale - Forge, the Bank of Thailand, and the Australian Reserve Bank.
The economic and political rationale for issuing central bank digital currencies can differ greatly per jurisdiction. China’s head of the central bank’s digital currency research Mu Changchun recently said that China’s DCEP’s, “centralized management will be good to fight against cryptocurrencies and global stablecoins,” and a former central bank governor claimed a digital yuan for consumers could “halt US dollarization.” The Bank of International Settlements indicated that COVID-19 has led to “new government-to-person payment schemes” which have further sped up the shift toward digital payments. Of the central banks that Consensys has been in consultation with, this acceleration means not only needing expertise on the fast changing industry of the digitization of money, but making sure any newly adopted system can work with existing financial stakeholders and improve payment rails. Central banks now seek to understand how decentralized ledger technologies work in practice, their respective trade-offs, and whether or not they meet their needs and requirements. In other words, they are ready to get their hands dirty.
In this article, we explore the four recent Consensys CBDC pilots; their design expectations and technical approaches. While we urge you to read our CBDC whitepaper and check out Codefi Payments for more detailed analysis on how a CBDC could be designed and built on Ethereum technology, this blog post aims to clarify whether the pilots are wholesale (security settlement between financial institutions), retail (used by the general public), and the specific problems they are trying to solve, such as delivery vs. payment, or cross border foreign exchange.
Hong Kong Monetary Authority
Consensys announced on September 25th that it would work on a second implementation phase of a Hong Kong - Thailand cross-border CBDC project. For the first phase in May 2019, the Hong Kong Monetary Authority (HKMA) and the Bank of Thailand (BOT) initiated Project Inthanon-LionRock to study the application of a central bank digital currency (CBDC) for cross-border payments. The second phase will further study the use of CBDC to solve issues such as high cost, inefficiencies, and delays in cross-border payments.
Building on pain points and actual business cases, the first phase of the proof of concept designed a cross-border network, where funds transfers occur instantaneously on a peer-to-peer basis. The design allows foreign exchange (FX) price discovery and enables on-demand FX conversion and FX settlement in an atomic payment-versus-payment (PvP). According to the Bank of International Settlements, PvP is “a settlement mechanism that ensures that the final transfer of a payment in one currency occurs if and only if the final transfer of a payment in another currency or currencies takes place.”
The proof of concept focuses on CBDC purely as a payment instrument for potential applications in trade settlement and cross-border capital market transactions, covering only wholesale participants, such as banks, non-bank financial institutions and large corporates. The two authorities also intend to enhance the cross-border network prototype to support CBDCs of other central banks in the region. They will soon bring banks and large corporates into trials using actual trade transactions.
Bank of Thailand
On October 28th, Consensys announced that it joined the Bank of Thailand to explore a retail Central Bank Digital Currency (CBDC) project, alongside Siam Cement Group (SCG) and Digital Ventures (DV). Unlike the HKMA proof of concept, a retail CBDC is a currency that can be used by the general public, like cash and China’s DCEP. Wholesale CBDCs on the other hand, are only used by permitted institutions as a settlement asset in the interbank market.
The Bank of Thailand CBDC will run on a private-permissioned Hyperledger Besu network, and will be designed to meet both the functional and non-functional requirements of a retail CBDC. One of the business cases will test the use of a CBDC on B2P, Blockchain Solution for Procure-to-Pay, developed by Digital Ventures, to simulate commerce transactions, support procurement, invoice placement, and automated payments. In the exploration, CBDC will be tested and issued using an ERC-20 standard, the most adopted token standard worldwide, enabling digital asset issuance and transfers between network participants. In partnership with Thailand partner Atato, Consensys will support a solution using its Enterprise Ethereum stack, including Codefi and MetaMask as a user facing wallet.
Société Générale - Forge
Also on October 28th, Societe Generale – Forge, the digital ledger technology platform of the Societe Generale Group, selected Consensys to provide technology and services as part of its ongoing Central Bank Digital Currency (CBDC) pilot activities. In 2019, Société Générale – Forge issued a €100 million ($112m) covered bond on the public Ethereum blockchain, and in 2020 issued a €40 million Euro bond settled with a CBDC as a joint project with the Banque de France.
Consensys will provide technology and expertise to Societe Generale – Forge, focusing in particular on CBDC issuance and management, delivery vs. payment, and cross-ledger interoperability. In this case, delivery vs. payment describes the lengthy process of reconciling deposits and trades between central banks and financial institutions, which typically takes two days.
Reserve Bank of Australia
On November 1st, the Reserve Bank of Australia announced a collaborative project to explore the potential use and implications of a wholesale CBDC in collaboration with Commonwealth Bank of Australia, National Australia Bank, Australia-based financial services firm Perpetual, and Consensys. The project will involve the development of a POC 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 Ethereum, specifically using Consensys Quorum, Codefi Assets, and Codefi Orchestrate.
Like the pilot with Societe Generale - Forge, the project will explore the implications of “atomic” delivery versus payment settlement on a DLT platform, private transactions, as well as other potential programmability and automation features of tokenized CBDC and financial assets. Michele Bullock, Assistant Governor (Financial System) of the Reserve Bank of Australia said, “With this project, we are aiming to explore the implications of a CBDC for efficiency, risk management, and innovation in wholesale financial market transactions.” The project is expected to be completed around the end of 2020 and the parties intend to publish a report on the project and its main findings during the first half of 2021.
Consensys’ CBDC Approach
Each of these proofs of concept show that in 2020, central banks are interested in receiving expertise and support from the private sector. They are also interested in piloting concrete use cases that will significantly benefit the efficiency and resources required to transfer assets and reconcile accounts, such as the Reserve Bank of Australia and Société Générale - Forge focusing on using CBDCs for the settlement of digital securities.
Consensys’ CBDC offering is based on Consensys Quorum, which was recently acquired from JP Morgan. Quorum is an open-source Ethereum client, optimized for enterprises and institutions needing permissioning capabilities, instant finality, privacy and monitoring capabilities and Enterprise support. Consensys Quorum is environmentally friendly as it doesn't use the Proof-of-Work (PoW) consensus algorithm, but a Proof of Authority (IBFT). Consensys Quorum is used by a third of blockchain projects globally, including 25 of the world’s largest banks, and 400 institutions globally. Despite blockchain being a nascent technology, Enterprise Ethereum is proving to be the most adopted and battle-tested platform, and importantly, has organically attracted the largest developer community. Over the last year, the advancements in public Ethereum, namely private stablecoins and decentralized finance (DeFi) show the technology is mature enough to address the needs and requirements of central banks, when it comes to security, reliability, privacy, and scalability. It is expected that $1T worth of public assets will be settled on public Ethereum by the end of 2020.
The advantages for wholesale CBDC built on Ethereum include instant settlement, enhanced monetary controls, simplified distribution, and operational efficiency. Interbank payment settlement eliminates the hazards of overnight processing and reduces the counterparty risks involved in cross-border transfers. With programmable digital assets, central banks can have greater controls over money supply and taxes on transactions. Central banks can also deliver government funds directly to authorized entities and streamline banking infrastructure and offer competitive rates to end users. Retail CBDCs built on Ethereum pave the way for a fast, low-cost, universally accessible peer-to-peer payment system. They can increase financial accessibility using digital currencies that can be distributed via mobile devices and reach people in remote areas with limited access to banks and physical cash. On a network level, we can use Consensys Quorum or Hyperledger Besu, and on the front-end application side Codefi Payments provides a simple to use platform for issuance, interbank payments and transfers, liquidity management, identity onboarding, and analytics.
While CBDC approaches are still new, each of these projects asks the question: what does an economy using a CBDC on a permissioned version of Ethereum look like? How can this new architecture work with commercial banks and payment service providers? What is the impact on the economy? It’s not just about proving a bank can issue a tokenized bond on a blockchain; it’s about enabling private transactions at scale, onboarding established financial institutions, and being able to connect between blockchain-based and traditional payment rails.
And still, each of these pilots are learning journeys for the central banks and the private sector together. We don’t expect any of these pilots to lead to a hasty announcement plan for them to go live in the short term. At this point, most central banks just want to be ready to issue a CBDC if necessitated. Most of them plan to share their findings with other central banks, payment service providers, and technology companies. This will help the entire CBDC research community and technology specialists to improve upon what others have done. At Consensys we think blockchains present a compelling architecture not just for how money moves, but also what types of beneficial applications can be built on those same rails.