Welcome to the 3C Decade and the age of Distributed Ledger Technology and CBDCs

dlt and cbdc

We are entering the age of Distributed Ledger Technology and CBDCs (Central Bank Digital Currencies) in the new 3C Decade

You might not have been paying attention because of the pandemic, but central banks have been working furiously on Distributed Ledger Technology and CBDC’s. What does that mean for Blockchain and Cryptos? They are entering into the new 3C decade.

Over the next decade we will see accelerated Consolidation of the digital currency market, regulated Centralization of DLT / digital currency development and complete Control of the digital money market by central banks. Unless you slept through the last decade, we were also in the midst of another 3Cs era. The change, complexity and competition especially in finance gave birth to the popular acronyms such as FinTech, InsurTech, Cloud, Blockchain, Bitcoin etc. The 3Cs from the last decade will pale in comparison to the new decade that we are entering.

Distributed Ledger Technology and CBDCs will give way to Consolidation of digital currency payments

The heavy investment in Blockchain research and pilot projects in DLT was crucial for the central banks to set in motion the chain of events that will ultimately ushed in the DLT and CBDC age.

Distributed Ledger Technology and CBDC
Copyright: BearingPoint Software Solutions 

What is Distributed Ledger Technology (DLT)?

Distributed Ledger Technology (DLT) is a network that offers a special form of electronic data processing and storage that utilizes a decentralized database where the participants in the network (called a distributed ledger) are allowed write and read authorization.

  • In contrast to a centrally managed database, DLT does not require a central instance to make new entries in the database. Participants can add new data sets themselves at any time. 
  • A subsequent update process ensures that all participants have the latest version of the database. Blockchain is essentially a special form of DLT.

How are Distributed Ledger Technologies (DLTs) designed?

  • Depending on the access options of the participants in a network, distributed ledgers can be divided into “permissioned” and “unpermissioned” ledgers. While the latter are openly accessible to everyone (such as the Blockchain in the Bitcoin network), access to the ledger is regulated in the former. 
  • Proof-of-work mechanisms are primarily used for “unpermissioned” ledgers, since the participants do not need to be trusted to validate entries. In the case of permissioned ledgers, on the other hand, proof-of-stake or PBFT consensus mechanisms, which require less computing capacity, are used more frequently. In this case, a basis of trust is created when the participants are admitted to the network.
  • Participants in networks with permissioned ledgers are usually registered and meet certain requirements for access to the ledger. The choice of the consensus mechanism is connected with the choice of the group of authorized users (open or restricted group of participants). 
Understanding Distributed Ledger Technology (DLT)

What is the difference between Blockchain and Distributed Ledger Technology (DLT)?

Blockchain FeaturesDLT (Distributed Ledger Technology) Features
• It is a specific type of DLT that uses cryptography to make it hard for a malicious user to manipulate the results in their favor• It is a way to construct a ledger in a decentralized way to achieve consensus among participants who don’t trust each other
• Blockchain provides a way to implement a distributed ledger. However, not all distributed ledgers necessarily employ Blockchains• DLT allows a participant to record new information in real time but only add new entries if consensus among participants is confirmed.
• Blockchain is a form of DLT that comprises of immutable, digitally recorded data stored in packages called blocks• DLT is a record of consensus maintained and validated by multiple parties/nodes with entries are automatically time-stamped using a unique cryptographic signature

What is a CBDC?

A CBDC is a Central Bank-issued Digital Currency.

Banks have put in a lot of effort over the last 5 years to come up with stable viable DLT and CBDCs (central bank digital currencies. Emerging market economies seem to be spearheading this effort. Most of them have moved from conceptual research to intensive practical development. In comparison to advanced economies, they are ready to issue CBDCs in the first half of this decade.

80% of the world’s central banks are exploring the idea of issuing currency in the digital form – Jerome Powell, Chairman of the Fed, 19th October 2020

What is the difference between Bitcoin and Central Bank Digital Currencies (CBDCs)?

Bitcoin FeaturesCBDC Features
• Bitcoin functions on a “permissionless Blockchain – it allows anyone to run the software and participate in sending transactions on the network. No central entity can turn users away.• CBDCs are a “permissioned Blockchain” – Instead of one central database storing all the financial records of people, DLT is composed of several copies of this transaction history, each stored and managed by a separate financial entity, and usually managed from the top by the country’s central bank. These financial entities share DLT together in a distributed manner.
• Supply – Bitcoin has a limit of 21 million bitcoins built into the protocol, and it is very hard, perhaps impossible, to change this limit.• Supply: To regulate monetary policy in a digital world, central banks need the ability to choose when to remove or add money to the supply, such as to stimulate the economy in troubled times, and set national interest rates, among other tasks. These roles aren’t going to change with CBDCs.
• Who runs it – With Bitcoin, everyone can run the software and get access without without permission.• Who runs it – A central entity will choose which financial entities participate in managing the distributed ledger.

The “given” reasons for the introduction of CBDC’s

  • For the emerging market, it’s a good tool for financial inclusion and reducing the use of cash
  • For the advanced economies, it’s more about making sure that they will keep the link between citizens and the central bank in the face of the disappearing use of cash.

Banks are now testing general purpose CBDCs

As banks started to experiment on CBDCs, they initially focused on so-called “wholesale” CBDCs. After successful experiments, they are now shifting investments into “general purpose” CBDCs.

What is the difference between “wholesale” and “general purpose” CBDCs?

  • A “wholesale” CBDC is a restricted-access digital token that central banks will use for wholesale settlements such as interbank payments, or securities settlement. This “token-based” CBDC will replace current technologies with the aim of realizing efficiency gains
  • A “general purpose” CBDC is a token-based or account-based CBDC that central banks will make available to the general public) for broader use including retail transactions (but would also be available for broader use). Most central banks are yet to define how they will distribute the CBDC.

Central banks across the globe are in a race to issue a CBDC to counter the risks of reserve currencies issuing a CBDC before them. This heavy investment in reaerch and testing is driven by fear of what people are starting to refer as “digital dollarisation”. This might have yield socalled Digital Currency Areas (DCA) as described here.

Distributed Ledger Technology and CBDCs complexity will give way to Centralization

We are going to see a centralization of CBDC’s

This will see a shift away from the Bitcoin and heavy investment into permissionless Blockchain. Additionally, decentralization will eventually be relegated to being an infractructure for other assets such as Bitcoin. Distributed Ledger Technology and CBDCs offer more functionality than the decentralized Blockchain and it is ready to be deployed on a global scale with the backing of central bacnks. This will offer central banks the three things that they will use to justify its use:

  • Privacy
  • Security
  • Scalability

4 reason why Distributed Ledger Technology will become the standard in digital payments

Unlike Bitcoin and or Ethereum, DLT is perfectly primed for global dominance and centralization because it has 4 qualities that central banks will need in order to introduce compatible CBDCs:

  1. It is programmable – As central banks start to shift towards CBDCs, the CBDC rules will be heavily compliance dependent. That means DLT will need to be extremely programmable to allow the rules to be hard-coded to facilitate compliance.
  1. It offers trust in the system – For central banks to guarantee acceptance, they will need to demonstrate and prove that the system works before the public can jump on board. A DLT system offers central banks what they really crave; the ability to control a digital currency while demonstrating that it can protect the privacy and independence of the CBDCs use to the public. This is especially important since other non-state actors and intermediaries will also be utilizing the system and using the CBDC.
  2. It can continuously support new innovations – As central banks start to shift towards digital currencies, they will incorporate new innovations to replace existing practices. This will require a greater number of developers and support to maintain. If you look at the DLT stakeholders in consultation with the central banks, the scope of what is in planning is amazing.
  3. It offers uninterrupted access – On top of ensuring data availability, trust and transparency around transaction history, a central bank DLT will also need to demonstrate that it can support larger networks and exponential growth in users. The tests conducted so far indicate that DLT has the capacity to support larger networks and users.

10 reasons why most central banks have chosen DLT over other Blockchains such as Ethereum

  1. Retail / general purpose Central Bank Digital Currency (CBDC) – The “general purpose” Central bank-issued digital currency that is operated and settled in a peer-to-peer and decentralized manner (no intermediary), widely available for consumer use. Serves as a complement or substitute for physical cash and alternative to traditional bank deposits.
  • Wholesale Central Bank Digital Currency (CBDC) – Central bank-issued digital currency that is operated and settled in a peer-to-peer and decentralized manner (no intermediary), available only for commercial banks and clearing houses for use in the wholesale interbank market.
  • Interbank securities settlement – A focused application of blockchain-based digital currency, including CBDC, enabling the rapid interbank clearing and settlement of securities for cash. Can achieve “delivery versus payment” interbank systems where two parties trading an asset, such as a security for cash, can conduct the payment for and delivery of the asset simultaneously.
  • Payment system resiliency and contingency – The use of DLT in a primary or back-up domestic interbank payment and settlement system to provide safety and continuity from threats, including technical or network failure, natural disaster, cybercrime, and other threats. Often, this use case is coupled with others as part of the set of benefits that a DLT implementation could potentially offer.
  • Bond issuance and lifecycle management – The use of DLT in the bond auction, issuance, or other lifecycle processes to reduce costs and increase efficiency. May be applied to bonds issued and managed by sovereign states, international organizations or government agencies. Central banks or government regulators could be “observer nodes” to monitor activity where relevant.
  • Know-your-customer and anti-money-laundering – Digital KYC/AML processes that leverage DLT to track and share relevant customer payment and identity information to streamline processes. May connect to a digital national identity platform or plug into pre-existing e-KYC or AML systems. Could potentially interact with CBDC as part of payments and financial activity tracking.
  • Information exchange and data sharing – The use of distributed or decentralized databases to create alternative systems for information and data sharing between or within related government or private sector institutions.
  • Trade finance – The employment of a decentralized database and functionality to enable faster, more efficient and more inclusive trade financing. Improves on today’s trade finance processes which are often paper-based, labour-intensive and time-intensive. Customer information and transaction histories are shared between participants in the decentralized database while maintaining privacy and confidentiality where needed.  
  • Cash money supply chain – The use of DLT for issuing, tracking and managing the delivery and movement of cash from production facilities to the central bank and commercial bank branches; could include the ordering, depositing or movement of funds, and could simplify regulatory reporting.
  1. Customer SEPA Creditor Identifier (SCI) provisioning – Blockchain-based decentralized sharing repository for SEPA credit identifiers managed by the central bank and commercial banks in the SEPA debiting scheme. Faster, streamlined and decentralized system for identity provisioning and sharing. Can replace preexisting manual and centralized processes that are time and resource-intensive. The best example is the Bank of France’s Project MADRE implementation.
Source: World Economic Forum

Contingency planning for the introduction of CBDCs is underway

Most central banks across the world are creating and fine-tuning their contingency plans for the eventual introduction of CBDCs.

This statement from the Bank of Canada is a telling sign:

“The Bank currently has no plans to launch a CBDC. Rather, the Bank will build the capacity to issue a general purpose, cash-like CBDC should the need to implement one arise. Because it will take several years to build this capacity, the Bank cannot wait until the need is evident before launching preparatory work.” Bank of Canada

Central banks are coordinating their decision making

When taken together, seemingly random statements high-level policy makers suggest that there is a global coordination to issue a compatible CBDC:

From the Bank of Canada Website:

Key steps in building capabilities for a CBDC include:

  • monitoring and assessing developments in the payment sector;
  • engaging external stakeholders to identify further policy objectives and obtain legal authority to issue a CBDC;
  • communicating openly with the public and stakeholders to solicit input and raise awareness; and
  • increasing technical research, in collaboration with partners from the private and public (e.g., other Canadian agencies and foreign central banks) sectors, to select and test an appropriate technology.
Christine Lagarde, former Managing Director of the International Monetary Fund (IMF) talking about the coming CBDC age

Statement from Jerome Powell, the Chairman of the FED, on the 19th October 2020:

We have been actively participating with the other central banks and the BIS … we have not made a decision to issue a CBDC and we feel that there is a great deal of work to be done as well as extensive pubic consultations with all stakeholders.

Remarks by Mark Carney, the former Governor of the Bank of England at the Jackson Hole Economic Symposium 2019

The Bank of England and other regulators have been clear that unlike in social media, for which standards and regulations are only now being developed after the technologies have been adopted by billions of users, the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.
As a consequence, it is an open question whether such a new Synthetic Hegemonic Currency (SHC) would be best provided by the public sector, perhaps through a network of central bank digital currencies.

Andréa M Maechler, Member of the Governing Board of the SNB
Irrespective of which technologies the financial markets adopt next, the safety and reliability of Swiss financial infrastructure must be preserved. If DLT can deliver significant improvements in securities trading and settlement, then the SNB will be prepared.

Distributed Ledger Technology and CBDCs competition will give way to Control

Are we ready for a Global Digital ID System?

The question that will be central to the “smooth” and manageable introduction of the DLT-based general purpose CBDCs will hinge on explaining to the public WHY a global digital ID system will be necessary. Unlike true permisssionless Blockchains which are decentralized and anonymous usage is the norm, Distributed Ledger Technology -based networks that will underpin the general purpose CBDCs will require a global ID system especially if you are talking about cross-border payments. Listen to this interesting October 2020 IMF discussion on cross-border payments moderated by Kristalina Georgieva, the managing director of IMF to get a sense of the coming age of CBDCs and its implications.

So what could or might happen to Bitcoin in the next decade?

Bitcoin will remain viable as an asset to store value but it will lose its attractiveness as a payment mechanism due to diminished investment in technical enhancements in its ecosystem which will be triggered mainly by regulation spurred on by the introduction of Distributed Ledger Technology-backed CBDCs. In this decade central banks will manage to control digital currencies, the same way banks were able to tame FinTechs through collaborations and funding.

Regulation of Bitcoin and other Blockchain-based digital currencies will come under the guise of money laundering/terrorist financing regulation which will be the backdoor for central banks to introduce compartible general purpose CBDCs.

About Kevin Moseri 65 Articles
He has experience in developing online marketing campaigns, online & mobile product launches, and EU funding regulation. He is an active FinTech & MarTech blogger with interests in online banking, mobile banking, mobile payment, and insurance

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