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Blockchain Explained

CBDCs: What Happens When Fiat Currency Lands On Public Ethereum?

Public Ethereum already has digital dollars -- more than $30B worth. What might it look like for a Central Bank Digital Currency on the Ethereum mainnet?
by Mattison AsherFebruary 19, 2021
Q4 2020 DEFI REPORT blog  7

This is part of a series of articles from ConsenSys Codefi’s Q4 2020 Ethereum DeFi Report. Download the full report to learn more about token standards for assets and payments, NFT marketplaces, social and community tokens, flash loans, wrapped Bitcoin and Filecoin, lending projects and more.

Public Ethereum already has private digital dollars  — more than $30 billion.

Total issuance of stablecoins on Ethereum. Source: Dune Analytics

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, ConsenSys announced four distinct Central Bank Digital Currency (CBDC) projects with the Hong Kong Monetary Authority, Bank of Thailand, Australian Reserve Bank, and Societe Generale. Each of these projects uses ConsenSys Quorum, a variant of the Ethereum mainnet which allows for permissioned networks, built-in privacy, and higher transaction throughput. What might it look like for a CBDC to be deployed on the Ethereum mainnet? 

The design decision around designing CBDCs often splits into (1) wholesale CBDCs, which largely reinforce and optimize the role of banking institutions relative to the central bank’s money management authority for interbank settlement and cross-border payments, (2) retail CBDCs, which would utilize Payment Service Providers like commercial bands and Codefi to be distributed into the digital wallets of consumers. The first option is about efficiency and industry cost mutualization. The second is more deeply transformative, and analogizes more closely to owning an Ethereum token and using it to transact.

Potential Pitfalls of China’s CBDC

China’s own CBDC project (they call it a Digital Currency and Electronic Payments System or DCEP) is an interesting example of what a digital currency could look like that is managed by a DLT; as digital yuan are transferred to different phone-based wallets and commerce sites, the total circulating supply would be reconciled with a database held by China’s central bank. This is not too different from the ways in which financial institutions already hold accounts at central banks. There are ways in which programmable assets themselves, like a digital yuan could be disruptive — you could build taxation directly into consumer transaction flows, or implement universal basic income, or deliver Covid-related distributions with ease. But at its essence, the data by which the system relies on is only responsible for settling digital yuan. 

There are some issues with having such a closed system. For example, such the private network would not naturally be able to interact with the existing Ethereum ecosystem without regulatory approval, meaning that Chinese citizens would not easily be able to access the various new financial services enabled by DeFi. Decentralized lending, exchange, and derivatives would have to connect with APIs approved by China’s DCEP architecture in order to interact with China’s CBDC because of its private nature.

In order for payment service providers and banks to build financial applications and services on top of a private network, they would need a way to interact with China’s CBDC network. One project started by China’s State Information Center is the Blockchain-based Services Network (or BSN). China will have two BSNs: one for international transactions and one for domestic transactions. While the international BSN will be able to interact with public networks such as Ethereum, the domestic BSN will not.

The international BSN is a service infrastructure that allows developers to build decentralized applications on top of both public and permissioned blockchains that it supports, such as Ethereum and Polkadot. Separately, ConsenSys recently announced that ConsenSys Quorum would become available in about 80 different cities through the domestic BSN’s public city nodes throughout mainland China.

Another way China and other governments could create more interoperable networks is through utilizing the Codefi Asset Sandbox. Codefi allows governments to experiment with CBDC issuance. Additionally, the sandbox enables governments to introduce various financial instruments into the ecosystem such as debt capital market instruments. Furthermore, the sandbox gives governments the ability to effectively track all participants in the network, ensuring that regulatory compliance is always maintained in every transaction. Finally, the sandbox ensures that governments around the world can test how their CBDCs will interact with Ethereum in a test environment.

Governments around the world testing out CBDCs using ConsenSys Quorum and Codefi

Governments around the world have been working with ConsenSys to test out their emergent CBDC networks. For example, ConsenSys is working with Hong Kong and Thailand on a cross-border wholesale CBDC project. In this experiment, Hong Kong and Thailand were able solve issues with cross border payments such as high costs, inefficiencies, and delays.

ConsenSys is also working with the Bank of Thailand on testing a retail CBDC. This test involved Thailand’s CBDC running on a private-permissioned Hyperledger Besu network, and was designed to meet both the functional and non-functional requirements of a retail CBDC. This experiment simulated commerce transactions, support procurement, invoice placement, and automated payments.

With programmable token standards on Ethereum, new types of business logic can be incorporated directly in Ethereum, rather than sitting as applications outside of the network. The CBDC projects today ask the question of how to move money around. Bitcoin has answered this question, and perhaps an applied architecture like permissioned Ethereum will solve this for national currencies. The deeper question is — what does an economy connected to a CBDC look like? What is the shape of merchants and applications that accept digital currency? Where do they perform their economic functions? If we think the venue for computing will increasingly be on blockchains, that suggests that CBDC rails should come not just with pre-installed national money, but also pre-installed applications for the use of that money. A payment rail will only be adopted if it is useful, and if it is applicable to a meaningful portion of human economic activity. Would you rather store value, or create it?