Now You Understand: Central Bank Digital Currency (CBDC)—Explanation and Usage, Part 2

This is a continuation of my article on CBDC (Central Bank Digital Currency) from the “Now You Understand” series.

In the first part, I looked at what a CBDC is, and how this form of digital currency can be used, how it differs from stablecoins, and why private rather than public blockchains are used to implement CBDC solutions.

You can read it here ⬇️

In this part, I will look at what solutions are being used in different states to implement CBDCs, take a closer look at the Brazilian DREX case study, and follow the dynamics of CBDC implementation around the world.

Enjoy reading!

What solutions are countries using to implement CBDC?

To implement CBDC, central banks will need a blockchain infrastructure. In this section, we’ll discuss the technical characteristics of the most common blockchain platforms for implementing digital currencies.

During the research for this article, I conducted a thorough analysis of different solutions and platforms. My findings show that a few select blockchain platforms will be used prominently in various countries for CBDC implementation. Based on the data and sources studied, it is evident that Hyperledger Blockchain is emerging as a dominant tool in this domain.

In addition, notable platforms such as Quorum and R3 Corda are actively used in significant projects (e.g., Dunbar, Jura).

The selection of these platforms is driven by their popularity and track record, particularly in facilitating CBDC implementation.

Hyperledger Besu

Besu is an EVM-compatible blockchain platform with additional functionality to provide privacy capabilities. It supports private smart contracts and transactions. In the corporate sector, this is a must-have for technology adoption at all stages.

Privacy became possible here due to a separate set of nodes that is responsible for encrypting private transactions.

The Besu client does not include built-in private key management. External tools, such as Ethereum-compatible wallets, are used to manage private keys and sign transactions. This provides a greater level of security and flexibility.

Besu is a permissioned network. It allows you to list approved accounts and deny all transactions from accounts that are not on the list. It allows you to determine which nodes can connect and participate in the network and which cannot. This is also achieved by adding nodes to the list of approved nodes, if a node is not on this list it is denied access to the network.

This increases overall security and access control as well. Since only selected members can participate in the network, it significantly increases throughput.

Hyperledger Fabric

Fabric is a private blockchain platform designed for enterprise use, with a focus on privacy. It was initially developed by IBM and was transferred to the Linux Foundation in 2015.

Unlike Besu, Fabric is not an EVM-compliant platform and has a different architecture, smart contracts are called chaincodes which are developed using Go, JS/TS, and Java.

Fabric architecture includes a special type of node that is responsible for transaction processing, computation, and state management, they are called endorsers/committers. Another type of node called Orderers is responsible for reaching consensus, sequencing transactions, and placing them into blocks.

For a higher level of privacy, another element called channels is implemented. Channels are represented as subnets in which only participating nodes have access to chain codes and transactions, while participants outside the channel are unaware of their existence, providing a high level of privacy and confidentiality. This functionality can be especially useful when there is a requirement to separate several directions and isolate them from each other.

In Fabric, private transactions are also possible through direct P2P communications. In this scenario, only the hashes of the input data of the transaction are shared with the Orderers nodes and written to the ledger along with the transaction.

Fabric supports pluggable consensus mechanisms, which means there is flexibility to choose the most suitable option for specific challenges and requirements.

As Fabris is a private solution, this also means that a node in this network can only be started with the permission of authorized entities, which restricts the network participants.

Hyperledger Iroha

Launched in 2019, Iroha is a private blockchain platform that is also focused on enterprise use. The difference is that it has a simpler design and is easier to integrate thanks to its modular architecture. It also supports smart contracts. This platform is primarily performance-oriented with its own fault-tolerant consensus algorithm under the hood.

It provides high throughput and low delay in transaction processing. A node can only be launched on this network with the permission of authorized entities.

On this platform, Cambodia launched Bakong, a project controlled by the Central Bank of Cambodia, which is designed for mobile payments and banking. There was a problem with the coverage of banking services, and this project solved that problem by allowing all citizens to open an account and make cashless and secure payments. And for banks, it opened up the possibility of interbank transfers at a lower cost. This project is not entirely a CBDC, although it is administered by the Central Bank, but rather a tokenized deposit system.

Quorum

Quorum is an enterprise blockchain platform that is based on Ethereum but extended with functionality customized to the specific requirements of corporate clients. The platform was founded by J. P. Morgan Chase in 2016.

In 2020, Consensys bought Quorum and now supports and develops the platform. The special feature of this platform is that it has a built-in privacy functionality, which opens up opportunities for corporate use. For example, there is the option for private transactions. This is very important compared to an open network because when we transfer money, we don't want anyone to know about it.

The control of this platform is based on consensus mechanisms which assume that only selected participants are allowed to participate and maintain control of the network. For example, governance may be centralized at the Central Bank.

Such a mechanism not only consolidates power in the system, but also provides a number of benefits, such as increased throughput and transaction speed. This is achieved by the fact that the number of nodes to reach a consensus between is minimal and limited. There is no need to wait for a large number of participants to agree. Unlike Ethereum, Quorum has zero gas costs, which means you don't need to pay for gas for transactions.

As Quorum is based on Ethereum, it supports smart contracts in Solidity. Smart contracts open up the possibility of creating their applications, e.g. by commercial banks with permission from central banks.

Smart contracts in Quorum can be as private as transactions. Similarly to a regular contract, for confidentiality reasons, it is necessary that they are not available to anyone.

When we buy or sell a property, we don't want anyone to know the terms of the transaction and its participants. Smart contracts are deployed on the blockchain and are always available for interaction, the code is executed when called, so there is no need for a third party.

For example, when we make a transaction, we have to wait for a third party, such as a bank, to execute it. In the case of smart contracts, we have no such need because everything is done by the executable code. Such interaction is always available 24/7, unlike standard organizations. They are also an excellent way to tokenize assets or access rights.

Corda

Corda platform is based on distributed ledger technology (DLT), but it is not a blockchain. That's why it's different from all the others. This platform is fully focused on privacy and by default all transactions are private. It does not have a global shared ledger and only supports transactions in which only counterparties are involved. Transactions are only related to bilateral or multilateral agreements between counterparties.

Here each node maintains its own register of transactions, where they are linked to each other and complete in real time since there is no blockchain. But in this case the issue of double spending and others arise. Here this is solved by installing a notary which is a third party and controls the validity of transactions. Notary is a separate set of nodes and the level of decentralization is directly related to Notary.

The model is based on strict confidentiality and each node must prove that it has been validly connected to the network using a certificate from authorized members. The signature capability here exists only on the nodes. Each application here exists only in the nodes of the network as well as the ability to sign transactions.

This is significantly different from the standard Ethereum model where signature control is maintained by the client wallets. In fact, they simply run the process and control its execution. Here these applications are called CorDapp.

Drex (Digital Brazilian Real): Example of a CBDC implementation

Brazil has launched its own CBDC called Drex (Digital Brazilian Real) in pilot mode on the Hyperledger Besu platform.

As we know, it is an EVM-compliant blockchain, which means that it supports smart contracts in Solidity. The control architecture of the network is structured in such a way that it is centralized at the Central Bank and therefore managed completely privately. A node can only launch on this network with the permission of the Central Bank.

End users can only have custodial wallets managed by an organization that has been authorized by the Central Bank, such as a commercial bank. There are retail and wholesale forms of CBDC.

The wholesale form is intended only for high-volume transactions, such as between banks, cooperatives and possibly with the participation of large corporations. The retail form is designed for payments and transfers between individuals and businesses of any size and can be used for everyday financial transactions in any value range.

In this implementation, CBDCs are smart contracts on Solidity ERC-20 standards, there are two main ones: RealDigital and RealTokenizado.

The main token is RealDigital, which is controlled by the central bank. Other participants in the system, such as commercial banks and other financial institutions control their own token, RealTokenizado, which actually extends the RealDigital contract and its functionality.

RealTokenizado is used to manage deposits and accounts. RealDigital itself stands as a reserve for all tokens of other participants. As we have different ERC-20 tokens for each participant they cannot be transferred directly, for this purpose swap contracts are used additionally. Therefore, when different tokens (RealTokenizado) are transferred between participants, it looks this way: RealTokenizado tokens (of one participant) are burned from the sender, RealDigital tokens (represent a reserve) are transferred from the sender to the receiver and RealTokenizado tokens (of another participant) are issued to the receiver.

In this architecture there are also roles responsible for issuing, burning, moving and freezing funds.

It is also important to say that participants, such as commercial banks, operate through a special account established by the Central Bank and cannot independently issue or burn RealTokenizado tokens.

Stages of CBDC implementation worldwide

In the first half of 2021, only 74 countries were interested in CBDC. Of these, only 3 decided not to develop this direction, 28 countries were in the research stage, 14 countries were in the development stage, 18 countries launched their own CBDCs in pilot mode and 1 country completely launched.

By mid-2023, the picture has changed significantly, from the key parameters - now 130 countries have expressed interest, of which 46 are in the research stage and 32 are in the development stage. Pilot mode has been launched in 21 countries and 11 countries have fully launched.

It is important to note that these 130 countries that are expressing interest in CBDC represent 98% of the world's GDP. From this we can conclude that this direction is of interest to the majority of countries in the world and has huge potential, and the active growth in the rate of research and development indicate that it is likely to be realised on a grand scale.

The world situation at the moment is as follows:

My opinion on CBDCs

Even though many crypto enthusiasts believe that current CBDC implementations by central banks are not in line with the basic principles of the crypto community, I suppose that CBDC implementations should not be measured by public blockchains.

CBDC implementations most often have fully centralized control, which crypto enthusiasts are against, but it should be understood that CBDCs cannot and should not be implemented otherwise. This is due to many considerations, including privacy and legality of transactions.  Yes, such a centralized implementation loses some of the advantages of public blockchains, but at the same time, it solves more important country-specific issues and reduces risks.

Conclusion

There is a significant global interest in CBDC implementation, which indicates a high promise of changing the traditional system towards CBDC and tokenization of assets.

For CBDC implementation, private solutions are used that provide privacy control and centralized control over the Central Bank. They also support a high level of programmability, which makes it possible to create your own rules for CBDC. Unlike public networks, there are no transaction fees. Because transactions occur according to programmed rules - there is no need for a third party to verify them, and therefore these solutions are available 24/7.

Control over the private network is limited to selected members and there is no need to wait for the majority to agree as in the case of public networks. CBDCs enable the tokenization of assets and property, optimizing the costs of the current registry infrastructure and increasing security, speed, and cost of transactions. Smart contracts in CBDCs open up opportunities to automate many processes and increase their security, including cross-border payments.

Digitizing money makes it more transparent, efficient, controllable and accessible, removing vulnerabilities and inefficiencies in the current infrastructure.