Central Bank Digital Currency

Another year, another Davos. The BIG item for me was the publication of the excellent Central Bank Digitial Currency Policy-Maker Toolkit. It is a sober, hyperbole-free, assessment of the pros and cons for issuing central bank money on DLT (a.k.a blockchain) either directly to retail (i.e. any person) or wholesale (e.g. banks).

It asks the obvious question - why has this not been done already using non-DLT technology, and how does DLT and un-related macro paradigm shifts change the calculus. I will not list them here, instead, I suggest you read the toolkit itself.

WEF proposes three forms of CBDC: retail, wholesale and hybrid. The retail form has direct and two-tiered issuance versions. In the retail two-tiered issuance form, the central bank issues CDBC to intermediaries, who distribute it to the public. In the hybrid form, the reserves are held at central bank, and issuers issue tokens to the public.

The hybrid model is largely achievable today with no regulatory changes by issuing e-money on DLT. It helps to introduce stable currencies to DLT networks for cross-asset settlement by does not address potential central bank policy requirements e.g. decreasing dependency on existing rails to improve overall resiliency. The wholesale model is already being addressed by projects like Fnality.

The two-tiered retail is, in my opinion, the more interesting form that is being proposed outside of wholesale use case. It introduces genuinely new rails into financial infrastructures but provides safeguards. What the toolkit does not talk about is what the distribution intermediary looks like. Such whitespace may tempt policymakers to consider the "safer" hybrid model. But what the may not realise, is that the technical elements of the two-tiered retail form are already being practised to some degree in the wild.

For this form to function, there is a need for an intermediary to offer on-ramp and off-ramp services to retail users. This means performing know your client and transaction (KYC and KYT) checks to comply with AML regulations, whilst offering some form of wallet service to receive, hold and send tokens. This largely maps on to EU's 5AML directive obligations placed on a custodian wallet provider - an "entity that provides services to safeguard private cryptographic keys on behalf of their customers, to hold, store and transfer virtual currencies."

This regulation has been on the cards for some time, hence startups in this space, including Trustology, have been performing KYC/KYT checks for some time already in their custodial wallet offerings. Most also offer wallet integrated fiat on-ramp or off-ramp services too. In other words, there is now a solid body of knowledge and experience on how an analogous version the two-tiered retail form of CDBC works in practice. And that, in my opinion, de-risks the unknown and paves the way for this new exciting form of money! Look forward to some very interesting conversations.