Long-Term Security Solutions for CBDCs

Sep 28, 2022 • Ting Wang

Stablecoins are cryptocurrencies that are collateralized by fiat money, commodities or other cryptocurrencies and have reached a record high market capitalization of over $180B in 2022. Even during the bear market, stablecoin market capitalization has remained around $150B and has retained over 15% of the market share of the total digital currency market as of July 2022. The rapid growth of digital currency assets such as stablecoins has motivated central banks to research and validate Central Bank Digital Currency (CBDC) solutions.

Stablecoin market cap since 2017Stablecoin market cap since 2017

What is a CBDC?

A CBDC is the digital money that is issued by a central bank. CBDCs are seen as another form of fiat currency. There are 2 use cases of a CBDC – retail and wholesale. Retail CBDCs are open to the general public and intended to be a digital version of cash. Wholesale CBDCs are more similar to today’s settlement accounts within central banks and intended for settling large amounts of interbank payments. As reported by the Bank for International Settlements (BIS) in 2021, 86% of the central banks around the world are looking into both retail and wholesale CBDC solutions with the majority already in the proof-of-concept phase.

Central banks work on advancing CBDC furtherCentral banks work on advancing CBDC further

Why issue a CBDC?

There are a number of reasons for a central bank to issue a CBDC. If parts of a country are left unbanked or underbanked, a central bank is more likely to issue a CBDC to improve inclusive financing and implement monetary reform. A CBDC also helps improve payment efficiency, regardless of whether it's domestic or cross-border. If cash were phased out for any reason, CBDCs can ensure that legal digital currencies are still accessible. CBDCs can also serve as a pathway forward when an economy is transitioning towards a less-cash or cashless society without the government losing control of their financial system. Last but not least, CBDCs allow the central bank-backed digital currency to compete with private or non-regulated digital currencies, which in many cases include cryptocurrencies.

Current stage of CBDCs

As of July 2022, there have been 4 CBDC projects officially launched in 10 countries – The Bahamas, Nigeria, Jamaica, and 7 countries in Eastern Caribbean Currency Union. There are an additional 39 countries in the development or pilot stage according to the Atlantic Council, a nonpartisan organization based in the U.S. The latest BIS annual report also states that more central banks’ CBDC projects have been announced. We will discuss some of the most notable CBDC projects below.

The Bahamas

In 2020, The Central Bank of The Bahamas has officially launched their retail CBDC — Bahamian Sand Dollar — the world’s first CBDC. In 2021, Mastercard announced rolling out prepaid cards that can be loaded with the Bahamian Sand Dollar, allowing people to convert the digital Bahamian Sand Dollar to traditional Bahamian dollars on the instant and pay with Mastercard. It is worth noting that The Bahamas have strong reasons to launch a CBDC. Given that there are hundreds of islands within the Bahamas with not every island being banked, it is costly to hold cash because of the lack of financial infrastructure. However, 90% Bahamian people have digital devices like smartphones, so it is just natural that The Bahamas, as well as other countries in Eastern Caribbean Currency Union which have similar challenges with financial inclusion, have decided to embrace CBDCs.

China

People’s Bank of China, has the pilot projects on both retail and wholesale use cases of CBDC. The central bank states that e-CNY, the CBDC of China, has been used and tested for over 264 million payments since 2020, and it is set to expand more test sites in 2023. In China, digital payment services are dominated by specific companies like Weixin and Alipay, therefore, it is very likely that the central bank wants to hold back the domination and take control of the e-payment market by boosting the development of e-CNY. Other reasons for China’s central bank to issue a CBDC are reducing the counterfeit money and making their own currencies to compete with USD.

United States

The world is especially watching the US Federal Reserve Board on their actions for CBDC. In 2022, the Fed released a report on the potential for a CBDC. In this report, it gives the reasons why it is staying neutral for issuing a CBDC. First, FedNow, the Fed’s real-time payments system, is scheduled to be released in 2023, and it has many of the same advantages offered by a CBDC. Secondly, right now the Fed is mandated by Congress to only interact with banks, not with individuals, so it’s not possible to directly make every American own a digital dollar account at the Fed. It would require the law to change. The Fed is definitely keeping an eye on the crypto market, and instead of offering another crypto-like currency, it prefers the CBDC to act as a complement of the existing means of payment without compromising the privacy of individuals or the stability of the financial systems.

Cumulative CBDC projects growing YoYCumulative CBDC projects growing YoY

Long-term security solutions for CBDCs

Technologies such as DLT (Distributed ledger technology), ZKP (Zero-knowledge proof), IBC (Inter-blockchain communication protocol), and various kinds of consensus algorithms make CBDCs technically feasible. However, when considering the long-term security for CBDC projects, central banks will face considerable challenges to create a reliable CBDC system that can survive decades of new technologies and attacks.

A quantum computer is one of the most urgent risks that financial systems will face in the near future. There exist known quantum algorithms capable of breaking the cryptography that is fundamental to digital signatures and public-key management. In 2021, the Central Bank of England has concluded that quantum computing should be factored into the design and operation of a CBDC. A central bank will be more likely to survive quantum attacks if properly equipped with post-quantum cryptographic solutions.

The risks of quantum computing to CBDCs, stablecoins and cryptocurrencies are not only recognized by central banks. During the July 2022 Ethereum Community Conference (EthCC), Ethereum co-founder Vitalik Buterin revealed his latest roadmap which includes integrating post-quantum security solutions in the Splurge phase of future upgrades to Ethereum. BTQ is dedicated to working on post-quantum security solutions to mitigate the risks of quantum computers. We are at the forefront of implementing post-quantum cryptography in blockchains and are working to ensure the long-term security of CBDCs, stablecoins and cryptocurrencies.