Takings from and Makings of Central Bank Digital Currency
Transforming the Paper Money to Digital
Dr. Jamaluddin Ahmed FCA PhD
Chairman of Emerging Credit Rating Limited and Tier 1 Solutions Limited, ex-President of ICAB, ex-member of the Board of Directors of Bangladesh Bank, ex-Chairman of Janata Bank Limited, and ex-General Secretary of Bangladesh Economic Association.
The identity privacy could be known to the central bank, intermediated, or none, depending on what aspects of identity are kept private/confidential, from whom, and under what circumstances. The remediation on ledger vs off ledgers should consider chargeback and liens, whether they are facilitated through core CBDC system functionality, mandated through an external governance process, who authorizes these actions, and what transparency is provided. The design choice benefits and drawbacks have been described for on-ledger, off-ledger, security PKC with ZKPs, and secure hardware-more hardware-based vs more software-based. The transaction execution has been elaborated as signature-based vs no-signature vs single-signature vs multi-signature signing. The transaction privacy with more private vs more observable transaction vs layering has been discussed for policy decisions made by the competent authority.
The offline transaction procedure could be online only or both online and offline, and the transaction programmability could be supported or not supported. If transaction programmability is not supported, the data model-unspent transaction outputs vs account balances are described. The ledger history could be none, centralized, or distributed, taking into account the adjustments that can be proposed in the CBDC system to facilitate a number of financial design choices, such as special purpose CBDC, holding limits, fees, interest, etc.
The legal aspects of Central Bank Digital Currency are important to consider. To qualify as a currency, a means of payment must be recognized as such by monetary law. Can monetary law consider CBDC to be a currency. If so, what are the legal consequences of CBDC issuance. If not, what does this mean for CBDC. The answers to these questions are critical in discerning the role CBDC could play as a means of payment and extinguishing monetary obligations. These two issues are the subject of analysis in this area, including whether central bank laws authorize the creation of central bank liabilities and issuance of currency, particularly in digital form. In the absence of a clear answer, CBDC would not have a robust legal basis and its issuance should be reconsidered. The legal definitions of currency, money, and payment instruments have been explained, and economic theory is unlikely to assist lawyers to any appreciable extent. There is no universally accepted legal definition of money, but it is widely accepted that legal money is broader. The definition of legal money varies from one jurisdiction to another depending on the use of technology in the monetary and payment systems, including the level of financial system development.
This analysis draws on a very long strand of literature in monetary economics. The design features and legal implications of CBDC have been analyzed for different forms of money. The legal distinction between cash accounts and ledger accounts has been explained. The relevance of CBDC in central bank law has been revisited. Central banks and the principle of attribution of power have been analyzed, including central functions for validating the legal justifications for the inclusion of CBDC. The central bank law for token-based CBDC indirect provision pertaining to the issuance of currency, the central bank law for account-based CBDC, the need for central bank law reform, the relevance of monetary law for CBDC, and the official monetary unit and official means of payment currency are highlighted. The comparative position on the issuance of money by the monopoly of the state is reported. CBDC, as the official means of payment, should be covered by the monetary law of the country intending to enact CBDC before it moves for CBDC introduction. Thus, the monetary law of the country needs to be reformed to cover CBDC as the official means of payment.
The position of countries on CBDC varies. In 2022, the IMF conducted a study titled “Towards Digital Currency in the Asia Pacific-Regional Survey on the Status of Introducing the Central Bank Digital Currency.” The study categorized countries into four groups: advanced economies (7), emerging market economies (11), low-income countries (7), and Pacific Island countries (11). The first group includes Australia, Hong Kong, Japan, South Korea, Macao, and New Zealand. The second group includes Brunei, China, India, Indonesia, Malaysia, Maldives, Mongolia, Philippines, Sri Lanka, Thailand, and Timor-Leste. The low-income countries group includes Bangladesh, Bhutan, Cambodia, Lao PDR, Nepal, Papua New Guinea, and Vietnam. The Pacific Island countries group includes Fiji, Kiribati, Marshall Islands, Micronesia, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu. The IMF study grouped the countries into seven categories. The first group was identified as first movers, including China and Hong Kong. The second group included India and Thailand, while the third group comprised Australia, Japan, Korea, and Singapore, which were considered to have strong R&D. The study found that Bangladesh had no initiative for CBDC.
Regardless of the motivation, any approach to issuing a CBDC will naturally be cautious, incremental, and collaborative. Yet, at the same time, debates over CBDCs have matured, and there is significant common policy ground among central banks. To further advance understanding, a continued and deepened shift in emphasis towards practical policy research and applied technical experimentation is underway. Given the speed of innovation in payments and financial technology, this paper recognizes the need to prioritize this work appropriately and proceed quickly. As a result, we recommend that this group of central banks, together with the BIS, continue to work actively and collaboratively on CBDCs, without prejudging any decision whether or not to introduce CBDCs in our jurisdictions. We will further explore the practical implications of the core features set out in this paper while advancing our understanding around other open questions (such as the trade-offs in CBDC designs that aim to mitigate financial stability risks); practical issues and challenges for cross-border transfer of domestic CBDCs; and contribute to these international workstreams. In particular, we support the G20 roadmap on cross-border payments and subsequent work on building block 19 on CBDCs (“factor an international dimension into CBDC designs”), led by the CPMI and the BIS.
We invite the BIS to continue promoting information-sharing and collaboration between central banks on CBDC research. We also invite the BIS Innovation Hub to further explore technological experiments that could support our work, and we support their plans to investigate the technologies that could facilitate interoperability and cross-border transactions between domestic CBDCs. Furthermore, we will continue our efforts to reach out to domestic stakeholders and foster an open and informed dialogue on CBDC in our jurisdictions. We will provide opportunities for domestic stakeholders to participate in this dialogue, and we will also reach out to other central banks, including those in developing economies, as well as international organizations.
Finally, this paper recommends 11 design choices for Central Bank Digital Currency, including policy and technical considerations:
Benefits & Risks: Efficiency, Broader Tax Base, Flexible Monetary Policy, Payment Backstop, Financial Inclusion, Disintermediation of Banking System, Miscalibration of Government Involvement, Financial Risk due to Lack of Regulatory Expertise and Capacity, Loss of Privacy, Technological Vulnerability or Entrenched Design Mistakes, and Charting the Roadmap.
Looking from a Banking Perspective: Technical justification for issuing CBDC and its implications for the international monetary system.
Ledger Infrastructure: Information Security Infrastructure, Distribution and Decentralization, Distributed System Decentralized System, Role Separation, Trust Disposal, Threshold Trust, State Machine Replication for Distributed Ledger, Centralized Ledger, Centralized but Verifiable Ledger, Semi-Centralized Ledger, Decentralized Ledgers with Central Bank Monetary Control, and Scalability to Large Transaction Values.
Account Identity: Account Identity Management, Who Manages Accounts, Accounts in Cryptocurrencies, Cryptocurrency Exchanges, Delegated Management in CBDCs, and Approaches to Digital Identity Verification such as In-Person Identity Checking, Online Identity Checking, Weak Identity Proxies, Biometric Identity, Social Trust Networks, and Self-Sovereign Identity.
Approaches to Digital Identity Verification, including In-Person Identity Checking, Online Identity Checking, Weak Identity Proxies, Biometric Identity, Social Trust Networks, and Self-Sovereign Identity.
Privacy and Transparency: This section covers the following topics: identity privacy, solutions for privacy concerns, active probing attackers, transaction privacy, data privacy, program privacy, decentralization of privacy, role separation, trust disposal, threshold trust, and privacy competence challenges.
Smart Contracts Background: This section discusses the following topics: striking a balance between safety and extensibility, the need for program verification, support for verification analysis, expressiveness, restrictiveness and domain-specific languages, support for upgrades, reversibility, and redactions, handling contentions and concurrency in transitions, the potential of smart contracts to accelerate systemic risk, limitations of enforcing policies through restrictions at the platform level, off-chain protocols and advanced cryptography, and smart contracts as a two-layer architecture.
Secure Hardware: This section provides a brief introduction to secure hardware and discusses secure hardware variants, security properties, limitations of secure hardware technology, software-based side channels, physical tampering, trust concerns, problems of sample use, sample design, main problems, better ways of leveraging secure hardware, infrastructure hardening, simplified and efficient privacy, complementary privacy, compliance rules, lightweight clients, hardware wallets, and smart contracts.
Opportunity for Novel Financial Technology: This section discusses the potential benefits of implementing CBDC, such as the ability to implement monetary policy, transparency, non-fungible money, monetary transmission, smart contracts for other novel capabilities, privacy concerns, and micro-management. It also highlights the challenges and questions of accountability, oversight, functionality, and intervention.
Legal Considerations: This section covers legal considerations such as jurisdictions, compliance, privacy, designers’ security, legislative changes, purpose limitations, disclosure limitations, access portability, rectification, security branch notices, fraud and mistake, disloyal agents, impersonalization, mistakes, fraud in the factum, fraud in the inducement, liens, collection, locking, notice, tracing, and taxation.
For Bangladesh: This section recommends the formation of a task force comprising cross-professionals to define specific terms and reference the economic justification, architectural design of CBDC with technology, operating manual, and implementation plan with a specified timeline. This will place Bangladesh in a comparable and competitive global scenario and ensure the country is equipped with an efficient CBDC. The section also highlights the need to address economic justifications, finalize the choice of technology, settle legal issues, study the comparative position of CBDC, and detail progress updates and comparative analysis between countries. Additionally, the experience of ongoing digital payment systems, countrywide electricity generation capacity, grid, and distribution system, and progress in biometric national ID are positive factors for Bangladesh to embark for CBDC.
Issues on CBDC Benefits, Risks, and Policy Considerations for Bangladesh
1. What additional potential benefits, policy considerations, or risks of a CBDC may exist that have not been raised in this paper.
2. Could some or all of the potential benefits of a CBDC be better achieved in a different way.
3. Could a CBDC affect financial inclusion. Would the net effect be positive or negative for inclusion.
4. How might a Bangladesh CBDC affect the Central Bank’s ability to effectively implement monetary policy in the pursuit of its maximum employment and price stability goals.
5. How could a CBDC affect financial stability. Would the net effect be positive or negative for stability.
6. Could a Bangladesh CBDC adversely affect the financial sector. How might a CBDC affect the financial sector differently from stablecoins or other nonbank money.
7. What tools could be considered to mitigate any adverse impact of Bangladesh CBDC on the financial sector. Would some of these tools diminish the potential benefits of a CBDC.
8. If cash usage declines, is it important to preserve the general public’s access to a form of central bank money that can be used widely for payments.
9. How might domestic and cross-border digital payments evolve in the absence of a Bangladesh CBDC.
10. How should decisions by other large economy nations to issue CBDCs influence the decision whether the Bangladesh should do so
11. Are there additional ways to manage potential risks associated with Bangladesh CBDC that were not raised in this paper.
12. How could a Bangladesh CBDC provide privacy to consumers without providing complete anonymity and facilitating illicit financial activity.
13. How could a Bangladesh CBDC be designed to foster operational and cyber resiliency. What operational or cyber risks might be unavoidable.
14. Should a Bangladesh CBDC be legal tender.
16. Should the amount of Bangladesh CBDC held by a single end user be subject to quantity limits
17. What types of firms should serve as intermediaries for Bangladesh CBDC. What should be the role and regulatory structure for these intermediaries
18. Should a Bangladesh CBDC have “offline” capabilities. If so, how might that be achieved
19. Should a Bangladesh CBDC be designed to maximize ease of use and acceptance at the point of sale. If so, how.
20. How could a Bangladesh CBDC be designed to achieve transferability across multiple payment platforms. Would new technology or technical standards be needed.
21. How might future technological innovations affect design and policy choices related to Bangladesh CBDC.
22. Are there additional design principles that should be considered. Are there trade-offs around any of the identified design principles, especially in trying to achieve the potential benefits of a Bangladesh CBDC.
Although CBDC is defined as the digital form fiat currency issued and regulated by the central bank programmable, can be used to surveil each transaction. It deters money laundering, illegal transactions, tax evasion and illicit transfer of money from one country to the others. As of today, 114 countries are developing CBDCs. President Biden signed executive order 14067 in March 2022 laying ground work for a US-CBDC. In November 2022 developed CBDC in cross broader transactions (Richard Werner, 2022, KITCO News). BDC is the Bank Digital Currency have been conducting 90% as digital for the last century.
Settlement system was slow and expensive is central comes in for decentral, and decentral, and centralized system. This centralization of payment systems resulted in 10,000 banks died down. Centralized system looks like centralized system. Central plan decisions are done by central authority, and under decentralized system, decisions are form groups of people. Bank regulator takes position on decision making like the bureaucracy under command economy rather than combined decision under democratic pluralism. In a situation where top authority central bank is selected from the civil service cadre denying skilled career central bankers by doing, the novel intention surrounding CBDC economic benefits stated in this paper would be doubtful of implementation. If anyone carefully look to Bangladesh, Pakistan, Sri Lanka, India will get information on ineffectiveness of central banks in steering leadership of an economic Nucleus (central bank) of these countries in last 70 years. National authority takes decision allowed under programmability to monitor each transaction, intervened and followed from central planning dept. This considered to control from central command and violating the privacy of the transaction. Totalitarian authority takes over the financial system. Many argue, that currently prevailing bank digital currency can carry out the job through digitization of the system. We need to ask the bureaucracy how to make transactions. This indicates that too much power of absolute which re-establish absolute corruption possibilities under CBDC run and operated by the centralized bureaucracy and non-elected officials.