How to Issue a Central Bank Digital Currency

[Music] thank you very much victoria i'm definitely a fan of yours and danielle so it's a pleasure to speak here at the at the ebc once more so i will talk good afternoon to everyone else from uh from switzerland from my home office i have some some slides to share and let me put them up so i'm talking about how to issue a central bank digital currency and let's start again with what is uh what is central bank money because that's important when we come to central bank digital currency so currently central banks issue two types of money and those are here on this slide in blue these are on the lower left bank notes you're all familiar with that's when you you can pay with a banknote that's the only central bank money that's available for the public the other type of central bank money is in the upper right that's central bank deposits but it's only commercial banks basically or selected financial market participants that can have an account at the central bank these accounts are sometimes also called reserves but they are not for the public so only commercial banks can have them commercial banks themselves then again provide deposits for the public and that's the the commercial bank deposits that most of us use when we when we make payments so that the type of money available for the public are the bank notes from the central bank and the commercial bank deposits from the commercial banks and this is private basically private money while the bank notes is state money now for the central bank to digitize its money or tokenize its money as you want there are two ways of course you can either do that with the central bank deposits and then you would get something called a wholesale cbdc that would be something only available for the commercial banks or you could digitize the banknotes and then you would get a retail cbdc and already here you see if the central bank would tokenize the the central bank deposits there is no competition here it's only the central bank that can do that that's also why the effects or the impact that you would have would not be that that's drastic uh why would you do that why would you do a wholesale cbdc that you would do if the financial market infrastructure that we have nowadays would become dlt based then you need to get somehow central bank money on that financial infrastructure and that's when you need a wholesale cbdc that was for instance the the pilot that we did on the proof of concept with the swiss digital exchange the so-called project helvetia you can all read about that on on the website if you're interested in that now much more impact would the tokenization of banknotes have the retail cbdc and that's also why central banks have been much more cautious with this because you can see already from this picture you would get into competition with commercial bank deposits and one specific theories if people would stop holding commercial bank deposits and put all their cash into retail cbdc then you would have an issue that is often called the risk of disintermediation of the banking sector namely that banks could lose a very important source of funding with possible adverse effects for the economy now if you go into the literature on on this risk then you also find a lot of counter arguments and i just give you a flavor here of these counter arguments some say well central banks could just step in and replace the deposit funding with central bank funding so basically this type of argument say well it's not such a big deal central banks just provide the funding to the commercial banks and then there are other lines of argument that say well actually that could even be a good thing because in order for the commercial banks to keep the funding they would have to change their business model especially they would have to become less risky and that would actually improve the stability of the entire system and then finally there are third lines of argument that say well you know we can't just design it in a way that uh that mitigates that risk namely by making hoarding of cbdc less attractive so that the seat the retail cbdc is only used to make payments but not as a store of value not to hoard uh money and you just do that for instance by making it less attractive a negative interest rate would be one possibility or you somehow limit the possibilities to convert bank deposits to cbdc so you have you know different opinions here in the literature another another concern that some central banks have is that they say well what's really the value added of a retail cbdc nowadays you have the commercial bank deposits you can basically make all the payments you want to make so why do you need it now arguments would be you can say well you know a central bank money because it's a liability of the central bank doesn't have a counterparty risk the central bank cannot go bankrupt and it doesn't have a liquidity risk you cannot redeem or exchange it for anything else unlike your commercial bank deposits where the commercial bank can go bankrupt and where the commercial bank can have a problem in exchanging your deposit into for instance into cash but of course also here we have deposit insurance and so on another possible argument why a retail cbdc would be needed you can say well you know there are additional possibilities i mean one of them would be that you can make payments on a blockchain others would be going much further saying well you can start programming the money but that's now something that that is still far out there a third issue might be privacy concerns and you have some people who say well we do not want to have all this information about payments what you pay what you buy where you are at a certain time of the day to have that all centralized in a central bank so these are different different uh concerns here now on the privacy you also find actually counter arguments people saying well you know it should be the central bank we do not want to have all this data in the with a commercial uh provider uh we rather have it with the central bank so this is an issue that um that is uh has many facets in the in the discussion now i want to go a little bit deeper into that and talk about two different types of payment systems namely account based systems and token based systems now account based systems that's exactly the the classical commercial bank uh account and when you pay something here uh basically you just credit one account you debit the other one uh and so that's the that's how the payment is made so what's important here if you have an account based system if you make a payment through accounts then you need the people that are involved in the transaction you need to somehow identify them you have to link them to the accounts in order to make the payment now this can be real identities but it could also be pseudonyms you could have number accounts or something like that but but you need to somehow identify the people involved in a token based system and think here banknotes there the payment or the transfer occurs by by handing over that token the value itself the bank note and in such a payment no one needs to be identified you don't need to identify the payer you don't need to identify the pay you only need to be sure that the token the banknote is not fake that this is real so there are people who say in the digital world this differentiation doesn't doesn't matter or is not applicable but here i think there is a big difference namely exactly what i said uh about this identity so in account based system also in the digital world the question is what information is connected with the information assets so in an account based system the asset the account is somehow associated with a transaction history in a token based system the the asset the token carries the information only about its value and then the entity that issued it but nothing about the persons involved in the transaction and here an important point i would argue that distributed ledger is an account based system just the difference to the traditional account based system is that the ledger is distributed decentralized but you also have for instance in bitcoins that people are identified through their addresses that are made from the public keys that basically give a given identification to the accounts now how how could we do how could we issue a cbdc so along those lines i mean that the most simple uh way to do it would be you say okay let's just have an account at the central bank for everyone so instead of just having commercial banks having deposit accounts at central bank everyone could do that so there are some proposals that go in that direction there would be a very simple way to do it the problem here is that the central bank becomes responsible for kyc know your customer and aml anti-money laundering and cfd counter-fighting terrorism legislation now you could say okay that could be outsourced so if it does central bank doesn't want to deal with that he could be outsourced another concern with this system is exactly what i mentioned before mass surveillance would become extremely easy if everyone would have an account at the central bank now you could say okay the central bank is independent it's not the data will not be politically abused but it could be a threat to central bank independence if the government or government agencies would like to have that data and of course the other thing is if you can open an account at the central bank directly that's a direct competition to commercial banks you can choose whether you want to have your account with the commercial bank or with the central bank that's where i guess the risk of this intermediation would be highest now the other way to do it would be a token based cbdc now the problem if you have a really a purely token based system is that given that this the digital token that you have to somehow ensure that this token cannot be easily copied and that is something that is almost impossible to do there are hardware based solutions but you can tamper with the hardware and this is something that it's basically it's the double spending uh problem that's that's very difficult to solve in a token-based system the other difficulty in a purely token-based system is of course how do you apply this anti-money laundering i know your customer laws that's exactly what you also see with cash that's a challenge here now the the the usual way to go that most central banks look at is of course to have a dlt which is account based but it is distributed the double spending is there um taken care of through a consensus mechanism now here the i guess well-known blockchain trilemma i think it was first uh formulated by vitalik buterin that shows you the problem with the blockchain uh this trilemma says that you have these three objectives decentralization security and scalability sometimes also efficiency where scalability is and you can only achieve with blockchain two of these objectives at the same time so the big issue here is uh bitcoin chose decentralization it's very decentralized and security it's very secure but it's not very scalable so these are the famous seven transactions on the chain per per a second while in a retail cbdc you need ten thousands of transactions per second now there are of course scaling solutions that's the big issue that's where a lot of work is being done at the moment so there are different solutions to to address this issue uh the solution that most in industry blockchains have uh have taken is that you just close the network you have a closed network not an open network like on bitcoin or ethereum you have only a few nodes it's a permission ledger and that makes it much easier you know you you probably even know the identity of the notes you do not need a complicated consensus mechanism so basically you achieve scalability and security by sacrificing decentralization now another way to do it is of course you do that's currently done especially with the with the public blockchains ethereum is going through a big update right now that is if you try to change uh somehow the protocol layer you change the consensus mechanism you go from proof of work to proof of stake for instance you introduce sharding and so on these are very interesting projects going on right now especially with the room it will be interesting to see but basically there you you do not sacrifice decentralization uh but you try to achieve scalability uh arguably by lowering a little bit the security now a third way to do it is you you change not the protocol layer itself but you make changes at the second layer and basically uh very simply said is you move stuff off the blockchain or at least off the main chain um the bitcoin lightning network would be an example or roll ups in ethereum uh interestingly if you look at what central banks are proposing uh for for cbdc's you have a combination of closed networks these are permission ledgers and they're also moving some of the retail stuff for all of the retail payments off the chain so that's that's how to go now a fourth solution and that's almost heretical to say that at the blockchain convention is is to do it without the blockchain i mean it's good to have central bank money on the blockchain do you can issue it on the blockchain somewhere just like for instance stablecoins are issued on a blockchain but if you just want to do a retail cbdc you do not need necessarily a blockchain my understanding is that for instance the chinese cbdc does not use a blockchain you have an example in uruguay that doesn't use a blockchain so that's one way to go and that's a proposal that we made uh which is a it's a working paper that's available at the website of the swiss national bank it's uh done with my co-authors david charm and christian gothoff and that has the same title as this lecture so what we do there we propose a retail cbdc that is based on david jones original ecash idea david xiaom who is uh quasi the father of uh cryptocurrencies the first one who had the idea to connect cryptography with with digital money uh christian grotov did um improve together with his doctoral students that system and we showed in this paper showing this paper how he could be used to issue a central bank digital currency so what are these what are the features of that proposal first of all it's uh centrally issued so there is no dlt involved but you gain with that is very high scalability and very high cost efficiency so the trials that we did with that is you can make several ten thousands of transactions per second and they cost you each transaction uh just uh i think it's somewhere around 0.00 so extremely cost effective extremely scalable second it's token based which allows you to provide guaranteed privacy for the payer so it's not promised privacy it's guaranteed through cryptography but with the architecture that we propose combined with kyc aml cft compliance and income transparency to promote tax compliance i'll show you that in a second and also the the way we propose it uh it's designed to be really the equivalent of banknotes so it should have no material impact on monetary policy and financial stability it's not competing with bank accounts it's competing with banknotes and the fourth issue not often discussed we think it would be open to important for a cbdc to be implemented as an open source actually as even going a little bit further floss uh software and the proposal we make is part of the new project most of you probably economists and data scientists know the new project through the the software are that would be an example what you gain with that is you have a transparency you you showed the source code it also has security advantages through that but also it encourages interoperability people can use the code they can change it they can work with it they it's much easier to to add to that so that would be the proposal and i let me show you the overall big picture and as i said if you're interested in the details go on the website of the swiss national bank and you will find that the full working paper there so overall architecture is like that let's start on the lower bottom left so a customer would like to get a cbdc so i said before it's designed just like a banknote so just like you go to a atm to get your bank note uh you would do you would do the same here meaning also you need to have an account at the commercial bank so you can transfer your commercial bank deposit into the cbdc just like you do with your banknote you need to have an account and that's actually how we make sure that the kyc aml cft regulation is taken care of it's basically delegated to the intermediaries they have to make sure that they have the information but what's special about the proposal is if you withdraw your cbdc then we use blind signatures so the customer uh is blinding the coin what the central bank does the central bank provides key pairs uh that that give you different values five frank ten franc or or euro or dollar or whatever you use this public keys that are published to to to make your coin but it's the customer who lines the coin the serial number basically of the coin if you want so that no one sees uh what number that is withdrawn and that blind uh that blinded number is then signed by the central bank that's the blind signature so no one can trace that number uh to that person withdrawing the cbdc the customer then unblinds the the the signature the coin and can use it if she spends it no one can trace that coin back to her now there's an incentive mechanism here if the merchant receives that cbdc the merchant it's in the incentive of the merchant to immediately deposit it why uh as i said before tokens can easily be copied the double spending in this scheme is uh solved by the the merchant depositing the coin and then the central bank is just checking whether this coin has already been spent so the central bank keeps a list of already spent coins checks whether the coin is already been spent if yes then the the signal comes back not valid if not then it's valid that's how the double spending issue is solved in that scheme so there is no attempt to try to prevent people from copying the coin but double spending is checked by the central bank at the time of depositing now important here uh it's uh that doesn't mean that you cannot receive coins without depositing especially for instance in a situation where a parent gives a coin to a child the child doesn't have to worry that the parent has already spent that or will spend the same coin somewhere else the same with the state um who would uh the state that would give money to to some money as a transfer also there you could have people receiving such cbdc without having an account and then when they spend it again buy something then the merchant would deposit it with his or her commercial bank now let me stop here to have enough time to maybe get some questions thank you very much thomas thank you so i'll start reading a question here so lorenzo is now talking about uh from the perspective of the european central bank how does the european central bank for example expect to counteract the effect of the global crypto market when they issue the central bank digital currency so i'm not you know i'm not familiar with the inner thinking of the european central bank but i think all central banks are really studying uh the issuance of uh cbdc and um there are different ways to do it i mean most of the central banks look at somehow a dlt solution but a permissioned ledger there are different ways to do it but in the end i think you know so my my position is that you can do a cbdc without the blockchain but blockchains in the end need cbdcs and you see that from the big demand for stablecoins you know stablecoins wouldn't be in such big demand if uh customers and people wouldn't want to have some type of stable money on the blockchain thank you thomas there is a comment here from paul he says the account should not be in the central banks or in the commercial banks they should be on the infra infrastructure that all parties connect to so automatically owned by the individuals or companies that hold the assets what do you think about that comment i think that's a very you know i mean that's a a good proposal that has been the original idea of bitcoin what you see is that you know a lot of people do not want to be their own bank uh that's a fact you know some do and it's good if they have the possibility but a lot of people want to have an intermediary media to do all the things that they don't want to do also for convenience or for security reasons a lot of people who hold bitcoin they are not running a note on the blockchain they are buying a bitcoin through coinbase or another exchange a lot of times they have the bitcoin uh you know someone else a wallet provider is uh is holding the bitcoin for them so that's a lot of people actually want to have intermediaries thank you thomas and last question so ricardo asked what is the final role of commercial banks in the proposed team i believe it's in your proposed paper exactly so there's i mean an important role and the problem that that we have in the in the dlt blockchain area is how to uh how to make sure that regulation is uh is adhered to and there might be some cryptographic ways to do it uh which is difficult you know but maybe we will get there that we can somehow embed the regulation in the tokens but a very easy solution that's what we propose in our paper is to use the banks as intermediaries being responsible for uh making sure that the regulation is applied so that's that's one uh one important role to have in our scheme thank you thank you thomas okay we need to finish now but the good thing is thomas you'll be back on wednesday in our panel on central bank currencies from the perspective of central banks so thomas thank you so much for your presentation today you