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Feb 09, 2021

Key Design Principles for a Successful CBDC Deployment

By: Andrea Civelli

Central Bank Digital Currencies (CBDCs) could represent the most exciting innovation seen in central banking in many decades. CBDCs embed the attempt at replacing cash with a more efficient, modern type of money. CBDC initiatives are rapidly multiplying, and the large majority of Central Banks around the world, from the People’s Bank of China to the European Central Bank, have planned proofs of concept or launched experimentations to test the feasibility of a CBDC.

CBDC as an Infrastructure, not just a New Form of Payment

The challenges that CBDCs pose to Central Banks, however, are numerous. What is the best way to design a CBDC? What digital infrastructure is best suited for a CBDC? Should the CBDC be deployed on a centralized or decentralized system? What are the policy implications of CBDCs? How will design choices affect the economic and policy goals of Central Banks adopting a CBDC?

It would be a significant understatement to consider CBDCs as just a new method of payment. A CBDC model that embeds the correct economic and technological principles would provide a country with a new general-purpose digital infrastructure, one of which payments is one component. 

Centralized financial and payment systems serve as the foundation of our global economy today and ensure trusted transactions for the creation, management, and exchange of value. But they are built on legacy technology and systems that can no longer keep up with the pace and accessibility requirements of all participants. 

The introduction of a blockchain-based CBDC, on the contrary, represents the opportunity to overhaul the entire payment system and make it more efficient, accessible, and secure. A decentralized CBDC approach allows Central Banks to build modernized infrastructures around key design goals that only systems based on the most advanced next-gen blockchain technology.

Decentralization provides resilience against the single point of failure problem, which affects centralized systems. Compared to a centralized model, a blockchain system relies on modern cryptography to guarantee in a less expensive and more flexible way the level of security a CBDC would require. A blockchain-based CBDC can serve a broader set of users and use cases than a legacy payment system, promoting innovation directly from its ecosystem and future-proofing. Finally, decentralized systems based on advanced blockchain technology can nowadays ensure global scalability and full Central Bank’s control of both CBDC infrastructures and CBDC policies at par with traditional centralized ones.

Design Principles

Below are five main design principles that allow for successful deployments of a CBDC: 

1. The decentralized system must guarantee security, without compromising performance

For CBDCs to move from experimentation to real-world implementation, advanced technology is required that can scale to meet the needs of global adoption. Working with a blockchain that provides global-scale performance on par with centralized solutions, while also delivering the safety, security, and resilience of a truly decentralized system is key. A successful CBDC must rely on a blockchain that never forks, and will be secure even when quantum computer technology is in place.

2. The CBDC infrastructure must promote competition and innovation by its users

A broader and inclusive access to the CBDC infrastructure will allow Central Banks to better serve their constituents by promoting competition and innovation faster than centralized or wall-garden systems. The development of new applications and use cases ultimately drives the costs of the system down. A successful CBDC model must then follow an open system design, with an open-source blockchain at its core. Unlike many enterprise blockchain providers who effectively build a walled-garden and lock central banks to a single solution provider, choosing a system designed to easily develop applications integrated with Layer-1 functionalities and security is a must-have.

3. An economical and inclusive approach is required

The CBDC model should offer a two-tier, retail system in which licensed service providers, such as commercial banks and other fintech companies, can facilitate the distribution and day-to-day management of the CBDC. Central Banks maintain full control of the CBDC, but can decide to delegate customer service responsibilities to institutions with that capability. Compared to a traditional account-based digital currency, this CBDC design is simpler and more economical to implement and manage for Central Banks at scale. It also presents the advantage of allowing for an explicit role of the bank sector in the CBDC infrastructure. Compared to traditional bank accounts, a blockchain-based retail CBDC can reach a broader base of consumers, including those in the informal economy who might face difficulty opening a conventional bank account and using digital services offered by banks.

4. The model must provide Central Banks with full control of the system

While fostering open innovation from the technology community, a Central Bank must retain full control of the CBDC policies, and of its private CBDC network validators and geographic location. A good CBDC model should be built on an open-source, but not an open-access, system. Central Banks must be able to programmatically control the conditions under which individuals join the network, create a CBDC account, participate in CBDC activities, such as peer-to-peer transactions or lending.

5. A flexible digital infrastructure must ensure integration and interoperability

A successful CBDC infrastructure must allow for simple integration with pre-existing national real-time gross settlement (RTGS) payment systems and must be able to work alongside physical cash if necessary. Furthermore, national CBDC infrastructures must be able to easily communicate with each other in order to support cross-border transactions.

Algorand Can Meet all these Requirements to Deploy a Successful CBDC

The model we propose for a retail CBDC is a hybrid, two-tier system built on a private, permissioned instance of the public Algorand blockchain. This model offers an economical and inclusive approach to successful retail CBDCs. With Algorand, Central Banks can deploy a decentralized system that guarantees security, without compromising performance thanks to Algorand’s Pure Proof-of-Stake consensus protocol. Algorand blockchain never forks and is also secure against quantum computing technology.

Algorand Standard Asset functionalities provide simple “Role Based Access Controls” which embedded in the CBDC itself give Central Banks full control of their private, permissioned instance of the Algorand blockchain. Algorand provides the infrastructure that can promote both competition and innovation; designed to easily develop applications directly integrated with Algorand’s Layer-1 Smart Contracts, Standard Assets, and Atomic Transfers. 

Finally, a CBDC based on the Algorand technology ensures full integration with national RTGS systems, regardless of the regulatory and technical specificities of a country. Algorand’s standards would also allow the CBDC and RTGS systems to exchange information and instructions programmatically. Moreover, the Algorand technology would support the interoperability of the CBDC systems with the broader ecosystem of the Algorand public domain, including all the other CBDC and private infrastructures connected to the Algorand network, at the complete discretion of a Central Bank.

Conclusion

The Algorand CBDC model has been designed by a multidisciplinary team that includes cryptographers, economists, technology, and policy experts, which embodies Algorand’s commitment to finding the most innovative and effective solutions for a frictionless economy.

As our experience here at Algorand has grown with national digital currencies projects (Algorand, for example, is the infrastructure behind the SOV - the Marshall Islands’ new digital currency), we have developed the original and thorough model of CBDC introduced in this post, which is inspired by the unique foundational values and features of our technology, such as true decentralization, performance, openness, and flexibility of ecosystems.

If you are interested in learning more about the Algorand CBDC model, download the full “Issuing CBDC using Algorand” report below.

Download: Issuing CBDC using Algorand Report

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