There is a widespread assumption that central bank digital currencies (CBDCs) will be built on blockchain, or at least on the underlying distributed ledger technology (DLT).
However, some central banks and CBDC designers are increasingly questioning the need for technology built for Bitcoin, pointing out that existing technology could work just as well and that blockchain has several weaknesses.
That’s the conclusion reached in recent papers by the Bank for International Settlements (BIS) and the World Bank, which focused primarily on CBDCs as a tool for financial inclusion, but it’s also being reached by a growing number of central banks working with the Massachusetts Institute of Technology’s (MIT) Digital Currency Initiative on CBDC design.
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It's still too early to say that blockchain will offer any definitive benefits, Dinesh Shah, director of fintech research at the Bank of Canada, told crypto industry news outlet The Block last week.
Shah said that blockchain is “not a given” when it comes to the design of a CBDC, but it’s still on the list of possibilities, and has expressed skepticism of the technology underlying cryptocurrencies in the past.
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This is broadly consistent with the conclusion reached by MIT researchers in collaboration with the Federal Reserve Bank of Boston in February when they tested the technology, finding that blockchain-based platforms performed far worse in head-to-head tests of bare-bones CBDC designs.
Blockchain-based platforms have run into bottlenecks due to the need for a single, complete record of transactions in the order they are processed, meaning they only achieve 10% of the scalability of non-DLT systems.
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Shah said this is especially noteworthy because the Bank of Canada is conducting this research in collaboration with the Boston Fed and the Bank of England (which are also MIT partners).
In addition, the BIS coordinates a group of six banks that jointly collect research results – the other members are the Bank of Japan, the European Central Bank, Sweden's Sveriges Riksbank and the Swiss National Bank.
This has led to studies questioning the merits of introducing a crypto-based CBDC into the heart of many financial powers.
Inefficient as the scale increases?
Questions about blockchain’s efficiency are also a conclusion reached by the Swiss National Bank last summer, the bank’s chief economist, Carlos Lenz, told The Local.
“But blockchain is very inefficient,” he said. “I don't think a decentralized solution is ideal.”
In a paper published this week by the BIS Financial Stability Institute titled, “Central Bank Digital Currencies: A New Tool in the Financial Inclusion Toolkit?”, researchers came to broadly similar conclusions based on interviews with nine central banks involved in designing CBDCs.
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Because DLT-based systems require the ledger to be managed collaboratively and in a decentralized manner by multiple organizations, “each ledger change must be synchronized across all entities' nodes, which takes time. As a result, transaction throughput in DLT is lower than traditional designs,” they say.
Additionally, the report at least raised the question of whether CBDCs would actually bring tangible benefits beyond enhanced financial inclusion and greater security.
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The report notes that a cryptocurrency-style “token-based CBDC could enable payments in new contexts such as the Internet of Things, and through programmability, could embed payment services into commercial and social interactions,” but adds that many of the features that CBDC proponents claim a digital dollar or euro would bring “could be provided by other payment innovations alone, and many gaps could be addressed through regulation and sound oversight.”
This was also the conclusion reached by at least one influential member of the Swiss National Bank’s executive board, Thomas Moser, two and a half years ago, crypto news source Cointelegraph reported.
Moser said that all of the major use cases for blockchain are focused on providing trust without putting a trusted third party at the center of the transaction.
“I think Bitcoin, for example, is a very good use case for blockchain,” he said, adding that a central bank's involvement in a CBDC gives it trust. “But when you have a central bank, it's a central player. And if you trust that central player, I don't think it's a no-brainer to decide you need blockchain.”
