Federal Reserve Bank of Boston are examining the Central Bank Digital Currency (CBDC) for U.S.


In collaboration with a team at the Federal Reserve Bank of Boston, MIT experts have begun designing and testing technical research through which further examination of a Central Bank Digital Currency (CBDC) can be performed in the U.S.

The effort, known as Project Hamilton, is in an exploratory phase, and the research is not intended as a pilot or for public deployment. Instead, the researchers have explored two different approaches that could be used to process transactions, and thus could indicate the technical feasibility of a potential CBDC model.

In a process involving significant design flexibility, the MIT group tested factors such as the volume and speed of transactions, and the resilience of the systems in general, among other requirements for a viable digital currency.

“The core of what we built is a high-speed transaction processor for a centralized digital currency, to demonstrate the throughput, latency, and resilience of a system that could support a payment economy at the scale of the United States,” says Neha Narula, director of MIT’s Digital Currency Initiative and a research scientist at the MIT Media Lab, who led the effort with the Boston Fed.

“It is important to note that this project is not a comment on whether or not the U.S. should issue a CBDC—but work like this is vital to help determine the answer to that question.

This project serves as a platform for creating and comparing more viable designs, and provides a place to experiment and collaborate on more advanced digital currency functionality.”

The researchers developed two complete sets of computing source code, or “codebases,” for the software systems. One codebase was capable of handling 1.7 million transactions per second, with 99 percent of those transactions finishing in less than a second—well above the basic benchmark of 100,000 transactions per second they sought to achieve.

The other codebase was able to process about 170,000 transactions per second. That level of throughput would help finalize every transaction at a central bank, while enabling the growth of other machine-to-machine transactions—both of which would be vital to a potential CBDC.

Those findings have been released in a paper titled, “A High Performance Payment Processing System Designed for Central Bank Digital Currencies,” released by MIT and the Federal Reserve Bank of Boston. The Project Hamilton software, called OpenCBDC, has been released under an MIT open-source license as well. It is one piece of work among others being done on CBDC issues in the Federal Reserve system.

To be sure, any steps toward a digital version of currency would involve many additional policy decisions and software features that would need to be settled by the U.S. Congress and other regulatory experts. As the team points out in the paper’s executive summary, “several technical design questions remain open for investigation. The answers to these questions will have meaningful implications and consequences for what options are, or are not, available for policymakers.”

Indeed, Narula emphasizes, “The policy conversation around central bank digital currency is still in its infancy.” And in relation to that, she adds, “There are many research questions left to answer that we haven’t gotten to yet, such as the roles of intermediaries, how to promote access securely, and how to design for those who might not have smartphones or consistent internet access.”

Still, many countries are displaying interest in the concept of a CBDC: The Central Bank of the Bahamas, the Eastern Caribbean Central Bank, and the Central Bank of Nigeria have already issued CBDCs, and China is running a late-stage CBDC pilot project. The new research is a step toward a robust hypothetical CBDC model, at a scale that could be used by an economy the size of the U.S.

The Project Hamilton research collaboration between MIT and the Boston Fed began in August 2020, as an initiative to examine a hypothetical CBDC model. The work conducted so far represents phase one of the project, an evaluation of the fundamentals of transaction processing.

“We believe that even before the policy discussions begin in earnest, it is important to dive deeply into the technology questions, and this research was designed with that in mind,” says Jim Cunha, executive vice president of the Federal Reserve Bank of Boston. “While policy decisions impact system design, we also believe groundbreaking research can inform policy makers on what is possible.”

A feasible option

In each of the two digital currency designs the MIT and Boston Fed teams tested, users interact with a centrally administered transaction processor, using digital wallets with individual, cryptographic signatures that authorize the movement of funds. One ledger, which keeps a complete record of transactions in the order they were processed, turned out to be the slower of the two systems. “We found that it had pretty significant bottlenecks,” Narula says.

The researchers also note that the faster system, the one processing 1.7 million transactions per second, the transaction quantity “appears to scale linearly with the addition of more servers,” which would sustain an even larger volume of activity.

The team was aware that consumer privacy would likely be an essential consideration in the design of a working U.S. digital currency, and they designed relatively streamlined systems with that issue in mind.

“We created architectures where the central bank didn’t necessarily need to see or store [much] user information,” Narula says, while noting that ultimately CBDC privacy practices would be informed by policy choices.

The question of system resilience is also critical to any CBDC. In this case, modeling by the Project Hamilton researchers showed that if two large regions of the U.S. lost connectivity, the digital currency system could continue to operate elsewhere and would not suffer any data loss or system disruption.

Officials with the Boston Fed say the work represents an important step in evaluating the potential of a CBDC.

“Researching a hypothetical U.S. CBDC means you need to think about the highest possible stakes,” says Robert Bench, assistant vice president in the Secure Payments group of the Boston Fed.

“The technical stress on a theoretical future digital dollar would be immense. We’re proud of the work by our team and MIT to build a processing engine which provides both the functionality and flexibility to understand how money may work for decades to come.”

The way forward

As Narula emphasizes, there remains a wide array of questions about a CBDC that would need to be discussed among government officials, in public policy forums, and among software engineers, to determine the viability of a central bank digital currency and whether it could be built in a way that satisfies concerns about accessibility and inclusion.

The technical research can support different CBDC approaches, including direct-to-consumer models, while the government would likely have to determine whether financial institutions would play a role as well.

And, as Narula pointed out in testimony last June before the U.S. House of Representatives Committee on Financial Services, about 36 percent of people in the U.S. who do not have bank accounts also do not own smartphones. In this and other areas, policy decisions and technology design are overlapping matters.

Releasing the Project Hamilton software under its open-source license could help people collaborate further on CBDC research.

“It’s clearly an important way to build, implement, and potentially launch, in large part because monetary systems benefit from transparency and verifiability, and open-source offers those two things,” Narula says.

The researchers involved in Project Hamilton are now pursuing another phase of their research, in which they will analyze additional types of functionality related to a hypothetical digital currency. These could potentially include the tools needed for both privacy and compliance, matters relating to smart contracts and numerous other specified uses, auditability, and more.

“There are many important design questions that have not yet been resolved, and we look forward to doing more research to address those issues,” Narula says.

CBDCs explained

Cryptocurrencies, as we know them today, are extremely volatile and lack government backing — CBDCs overcome these concerns while using the same underlying distributed ledger technology of cryptocurrencies. Governments recognize CBDCs as legal tender in the issuing central bank’s jurisdiction, meaning anyone can use them for payments and every merchant must accept them.

In simpler terms, CBDC is short for Central Bank Digital Currency, an electronic form of central bank money that citizens can use to make digital payments and store value. A CBDC offers three main elements:

  • A digital currency
  • Issued by the central bank
  • Universally accessible

But why should a government issue a CBDC when fiat currency exists?

Why issue a CBDC?

If a country issues a CBDC, its government will consider it to be legal tender, just like fiat currencies; both CBDC and physical cash would be legally acknowledged as a form of payment and act as a claim on the central bank or government.

A central bank digital currency increases the safety and efficiency of both wholesale and retail payment systems. On the wholesale side, a central bank digital currency facilitates quick settlement of retail payments. It could improve the efficiency of making payments at the point of sale or between two parties (p2p).

No physical coins or notes are available to individuals in a digital society, and all money is exchanged in a digital format. If a country intends to become a cashless society, a digital currency with government / central bank backing is a credible alternative. The pressure for governments to adopt a CBDC is strong, as the market for private e-money is on the rise. If it becomes mainstream, beneficiaries are at a disadvantage because e-money providers aim to maximize their profits instead of the general public’s. Issuing a CBDC would give governments an edge over the competition from private e-money.

In addition to domestic transactions, the current cross-jurisdiction payments’ model depends heavily on central banks operating the real-time gross settlement (RTGS) infrastructure within which all local banks’ obligations must settle. Since time lags exist in cross-border payments, participating parties are exposed to settlement and credit risk. A CBDC is available around the clock, while privacy is taken into account to eliminate counterparty credit risk.

Different types of CBDCs

CBDCs are categorized into two different proposals based on the targeted users:

Retail Central Bank Digital Currency

Retail CBDC, based on distributed ledger technology, is traceable, anonymous, and available around the clock. It offers possibilities for interest rate applications, as well. Due to these advantages, a retail central bank digital currency focuses, in particular, on supporting the general public. Additionally, it helps lower the cost of cash printing and promotes financial inclusion.

Wholesale Central Bank Digital Currency

Wholesale CBDC increases payments and security settlement efficiency while resolving liquidity and counterparty risk issues. It’s a great fit for financial institutions which have reserves deposited in a central bank. With their capability to improve wholesale financial systems’ speed and security, even central banks consider wholesale central bank digital currency a favored alternative to existing systems today.

Countries experimenting with CBDCs

China: Digital Yuan

The People’s Bank of China is one of the first central banks to develop a CBDC. They deployed a special task force in 2014 to research and implement a digital Yuan. It gained traction in 2020 when China announced the testing of a CBDC prototype. The first trial of digital Yuan was held in October 2020 in the Luohu district of Shenzhen. The second pilot program took place in Suzhou City at the beginning of 2021. As per reports, the Chinese digital Yuan will impact the $27 trillion payment market in China.

Sweden: e-krona

In 2017, the world’s oldest bank, Swedish Riksbank, began its CBDC project called e-krona. In collaboration with Accenture PLC, a pilot took place from 2020 until February 2021, and the project was extended until February 2022. E-krona intends to offer a robust alternative in case of emergency or turmoil of private payment service providers, thereby ensuring the Swedish payment system remains stable.

Bahamas: Sand Dollar

In 2019, the Bahamas also began their CBDC project called “Sand Dollar” — it was fully deployed in October 2020. The project was initiated in two districts: Exuma and Abaco Islands. Each Sand Dollar constitutes an additional digital variant to the Bahamanian dollar, which is, in turn, kept at a 1:1 peg with 1 US dollar. The project delivers inclusive access to financial services and regulated payments.

Eastern Caribbean Area: DXCD

The monetary authority for the Organization of Eastern Caribbean States members, the Eastern Caribbean Central Bank, began their work on a CBDC project called DXCD to reach financially excluded parts of the population. Its prototype is being tested in Antigua, Barbuda, Grenada, Saint Lucia, St. Kitts, and Nevis. The main goal of DXCD is to be a retail payment system for citizens without credit cards, for merchant and e-commerce payments at low costs.

Marshall Islands: Sovereign

In 2018, the Republic of the Marshall Islands shared plans for launching a CBDC called Sovereign (SOV). Currently, the US dollar acts as legal tender on the island, mainly because its population is only 58,729 and the cost of cash printing exceeded its benefits. RMI plans to introduce SOV as alternative digital money as a legal tender to improve the efficiency of RMI’s current payment systems.

CBDC’s path to mass adoption

Decentralized blockchains today have a “user beware” attitude: all transactions are irrevocable once settled and assets cannot be recovered if the transacting party is unwilling to cooperate with legal authorities. This is not a viable option for a CBDC aiming for mass adoption.

Moreover, no existing non-banking payment system has this kind of treatment under existing laws. Nor is it possible for legal authorities to compel cooperation, since the recipient could be an unknown person from overseas not subject to abide by the laws and regulations of the CBDC’s jurisdiction. Instead, CBDC issuers should modify their state under banking, property, payment, and contract law. This is possible only with hybrid two-layer designs that address two distinct problems:

  1. A CBDC needs a proper management infrastructure, wherein transactions can be first verified and then modified under the jurisdiction’s law. A dispute resolution system has security, compliance, and auditing processes. With Hedera acting as a publicly verifiable log of transactions for CBDCs that live in permissioned blockchain frameworks, banks that layer customer services on top of the payment layer can trust and verify that transaction information is accurate.
  2. A CBDC also needs to report its state (account balances, transactions, etc.) to relevant regulatory bodies, which can be more than just the state of the transactions — this includes things like information on IP addresses or account IDs. This information is vital in dispute resolution for payment systems. Using Hedera as a public record, authorities could directly inspect a CBDC’s state, including the details of how users have interacted with it.

Closing thoughts on CBDCs

Given the considerable efforts and attention that central banks are dedicating to central bank digital currencies, they will become a reality soon. Introducing CBDCs to the world will help boost crypto adoption as people will have access to the platforms to convert cryptocurrencies into legal tenders. Moreover, it will also help in the financial inclusion of the bankless population.

CBDCs will have far-reaching implications on the future of finance, including the buying and selling of digital assets and securities. However, the question is when? This answer will rely on the foundations of a dedicated legal framework to facilitate the transparency, distribution, and issuance of a digital form of money by global governments. As regulators and central banks take concrete steps in the direction of establishing CBDCs, the world will begin to embrace digital currencies as a standard.

reference link : More information: A High Performance Payment Processing System Designed for Central Bank Digital Currencies. dci.mit.edu/opencbdc


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