Why CBDCs Are Really Game-Changing

Central bank currencies are more than payment systems. They are programmable networks for verifiable commerce, says EY's blockchain leader.

AccessTimeIconMar 4, 2021 at 4:24 p.m. UTC
Updated Sep 14, 2021 at 12:21 p.m. UTC
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There are a number of countries around the world that are in the process of deploying or testing tokenized national currencies, in both blockchain technology systems and other formats. These initiatives are often talked about in the context of digitizing the money supply, but this is misleading. More than 90% of all money is already digital, with only about 10% of the money in most industrial countries taking the form of physical cash.

Not only is most money already digital, but most payments are as well – processed by bank transfers, credit cards, debit cards and other services. Indeed, central banks are making enormous investments in further accelerating and streamlining the digital payment process, an endeavor that is entirely independent of approaches to tokenization or blockchains. 

Paul Brody is EY's global innovation leader for blockchain and a CoinDesk columnist.

In the U.S., the Federal Reserve will shortly be releasing a new solution – FedNow – that will support near real-time digital payments nationally. In doing so, the Fed will join a number of other countries that have also built and deployed similar infrastructure, including the U.K., Australia, Mexico and Nigeria.

So, if most money and payments are already digital and many governments are investing in even faster real-time payments systems, then what is the value of blockchain-style tokenization? 

The answer is programmability. Payment systems today operate independently from the business agreements that drive those payments. This makes things much more complex and far less reliable than they seem when you keep a narrow focus on the payment alone.

When you walk into a store and walk out with a soda, you have entered into an agreement to exchange money for a product. While the payment may be digital, the agreement isn’t. In a retail setting, there is no written agreement as such. In a business environment, the agreements are almost always written and explicit about the exchange of money for products and services.

With tokenized financial instruments, we can directly link the transfer of financial assets to the performance of specific work, or the creation of a specific asset. This makes reconciling payments between parties automatic because there is a fully integrated digital trail between the agreement, the creation of the asset that would be represented by a digital token, and the payment for that asset or service as represented by the transfer of tokenized money.

Not only would this hugely simplify the execution of business agreements, it would also allow for a much better understanding of risk in the economy. Smart contracts that link financial assets with complex behaviors, like derivatives with tokenized money, would allow regulators to see just how much money was tied up in these contracts, and even simulate what would happen in the event of significant price changes.

Because programmability represents both the single biggest source of value and the largest source of risk for central banks, its introduction is likely to be very gradual.

Since most payments are made by consumers and are not executed as part of a contracted agreement (like a mortgage or car loan), it seems that tokenized, programmable fiat currencies will not add significant value to the consumer economy in those cases. One clear exception is the countries where there is very little competition between payment systems, so having a nationally underwritten digital currency system accessible to all banks and retailers could spur significant cost reductions through an increase in competition. The line between more competition and central banks competing with the private sector will also have to be managed carefully.

In the case of business-to-business transactions, the value proposition for tokenized fiat currencies would appear to be much larger in both financial and industrial settings. However, to make that work, central banks will have to allow for a high level of programmability, something that they may not be comfortable with – at least not early on. 

The early history of decentralized finance (DeFi) on Ethereum should serve as a reminder that the early days of any programmable system are often an era of extensive real-world security testing. That’s a polite way of saying there are lots of security flaws to be uncovered and ruthlessly exploited. In the context of a $15 trillion economy, for example, all the ups and downs in Ethereum DeFi amount to a low-cost experiment.

Because programmability represents both the single biggest source of value and the largest source of risk for central banks, its introduction is likely to be very gradual. One option is to deploy the currency first and then add programmability. 

A second option is to allow experimentation on public blockchains and then to create a regulatory framework that allows banks and other parties to issue tokens on public chains that are backed by insured bank deposits. Both such experiments are underway and it will be a few years before the results can be fully assessed.

With more than $100 billion now locked in DeFi on Ethereum, we can at least draw some early conclusions from one of these experiments: tech-savvy consumers are not deterred by hacking events and are willing to bear some of the costs of proving the technology.

If DeFi providers can implement privacy systems, then we may also get a look at how much programmability enterprise users are interested in, and what kinds of precautions will be needed to get them on board. For the risk averse, this is a good time to grab some popcorn and pull up a seat, as the show has already started.

The views expressed in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.


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