Apr 01, 2021
By: Andrea Civelli
In this blog post we elaborate on one of the principles of designing a successful Central Bank Digital Currency (CBDC) introduced in our first post about CBDCs: the governance of the CBDC system.
In our previous post we discussed the numerous advantages of adopting a decentralized model for the CBDC system in terms of stability and security of the network, cost reduction, and innovation. A common question, however, that people have when decentralization is proposed for a CBDC is: Isn’t decentralization going to put Central Banks’ control of their digital currencies at risk?
The answer to this question is no, if the correct design choices of the CBDC governance are put in place. The thing is, only advanced next-gen blockchain technology can support these design features. Under these conditions, the case can be made that the control of the CBDC system, the monitoring capabilities of a Central Bank, as well as the flexibility of policy implementation are even increased by a blockchain based approach.
Let’s take a closer look at the desirable design characteristics of CBDC governance:
The alternative scenario to a two-tier system is a synthetic CBDC in which private banks and LSPs act as issuing authorities. This solution may limit the risk of disintermediation of the bank sector by involving the banks more directly in the creation of the CBDC, but it would make ensuring the effectiveness of monetary policy decisions more difficult for the Central Bank because the control of the CBDC supply would be subject to banks’ behavior. In some sense, it would be similar to a system in which banks issue private bank currency within the parameters specified by the central bank by using bank deposits to collateralize the issuance of CBDC.
While Algorand’s consensus protocol facilitates the spontaneous formation of trust in a new CBDC instrument by guaranteeing immediate settlement finality, Algorand is also uniquely positioned to empower strong CBDC implementations by providing Central Banks with full flexibility in CDBC governance and full control of the CBDC system.
Algorand's proposed model leverages four main features to achieve the above properties:
ASC1 are elemental programs directly operating on Layer-1 of the Algorand blockchain, which can be used to programmatically create more advanced operations and processes. For example, relying on ASC1, Central Banks can programmatically implement rules to prevent transfers to a wallet exceeding a desired limit or not complying with specific AML requirements.
ASA are standardized, Layer-1 features used to represent any type of asset on the Algorand blockchain. ASA include Role-Based Access Control (RBAC) functions, flexible asset controls used to issue and manage ASA requirements. Since RBAC are going to be embedded in CBDCs issued on the Algorand blockchain, they can be used by Central Banks, for example, to program minting activities or to endow appropriate agencies and users in the system with specific supervisory powers.
ASC1 and ASA together will support any governance model and policy objective set by the Central Bank issuing the CBDC in a fully programmatic and simplified fashion.
Our hybrid, two-tier approach allows for a partitioned system where transfer of CBDC from the central bank to end-users is handled separately from CBDC interactions between end-users, providing Central Banks with a protected and independent CBDC distribution mechanism. This mechanism is independently designed and administered by the Central Bank, and requires the Central Bank to grant access to the national RTGS. For example, distribution could initially rely only on banks and gradually extended to other LSPs if desired.
Moreover, the entire supply of tokens is generated during the instantiation period of the CBDC and locked in a vault under the sole control of the Central Bank, which can issue and recall tokens from circulation in function of its monetary policy decisions. As such, the Algorand CBDC model is neutral to the monetary policy stance of the central bank.
Finally, building a CBDC system on a private, permissioned instance of the public Algorand blockchain ensures Central Banks would be able to independently choose all the aspects of the governance of their CBDC network, setting roles and rules for service providers and end-users who want to take part in the CBDC system.
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 the Future of Finance (FutureFi) 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 which we have discussed in a series of recent posts.