Central Bank Digital Currency? How money could be redesigned

Over the past year, an interdisciplinary research team funded by the Bill & Melinda Gates Foundation and including the MIT Digital Currency Initiative, Maiden Labs, University of Virginia, and 13 research teams in India, Indonesia, Nigeria and Mexico examined where existing payments technologies were failing to serve society’s most vulnerable members and whether a Central Bank Digital Currency (CBDC) might fill this gap.

Affordances refer to what a user can do with a technology and the kinds of activity that object or platform enables and constrains. We found that for CBDC to make a difference, it cannot merely replicate the affordances of the existing system. Instead, CBDC offers a chance to redesign those features in the public interest.

Our research, published on 12 January, identified five affordances that differ between intermediated digital funds and cash, which is perhaps the most inclusive existing payment medium that central bankers and CBDC designers should consider.

1. Who is able to custody the funds?

2. Who is able to access the currency, and what is necessary to send and receive funds?

3. How quickly do funds settle with finality, and what are the processes for reversing a transaction?

4. What kind of data trails do transactions leave behind, and who can access them?

5. How does transacting over distance – particularly over national borders – function?

As an example, let’s look at one differing affordance: custody. Cash can be used by anyone, but digital payments require the creation of a user account with an intermediary, the custodian of the funds. Both payment forms have advantages and drawbacks.

Intermediaries enable funds to be transmitted electronically, which is essential for participation in the economy in the digital age. They help keep users’ funds safe from theft and offer useful services. But this requires trusting an intermediary, not only to remain solvent but to steward transactions, continue to offer access, and to offer redress when problems arise. Intermediaries’ fees can be costly and unpredictable.

In contrast, holding onto cash can be cumbersome and sometimes even dangerous. But especially for those who have very little money or standing in the economy, it can afford much-needed control and certainty.

Lessons from decentralized cryptocurrencies like Bitcoin are instructive here.

First, these technologies have managed to separate custody (which is determined by who controls the cryptographic keys to move the funds) from the transaction execution and settlement layer (which is usually managed by a network of computers in a decentralized network maintaining a ledger). This, perhaps uniquely, enables self-custody in digital payments.

Second, in the cryptocurrency community, there is a popular saying: “Not your keys, not your coins.” This refers to the idea that unless a person controls the private key associated with their cryptocurrency, they don’t really own that cryptocurrency.

Many cryptocurrency exchanges and other intermediaries are custodial, but some services do enable people to transact and trade in cryptocurrency without taking custody of their clients’ assets. Because cryptocurrency exchanges and intermediaries have faced significant fraud, attacks and insolvency, many savvy users choose to keep their funds in their own wallets or use services that allow them to retain control of their own keys.

How might designers of CBDCs take inspiration from the innovations – and the lessons learned – in decentralized cryptocurrency while also taking advantage of the stability and other benefits of state-issued money?

An array of options exists, ranging from retaining the conventional intermediation role of custody to permitting end users to self-custody CBDC.

It’s important to remember self-custody comes with risks: the funds can be stolen or lost, and there is usually no form of redress once a transaction is complete. Managing cybersecurity is difficult, and many users might not want to take on the risk of full self-custody. We should not require them to do so, but we should consider when offering self-custody as an option to users increases overall dignity and welfare.

Beyond custody, each of the affordances of money we investigated similarly opens up a new landscape of questions, risks and opportunities.

The stakes for redesigning access to money are high. As such, many exciting areas remain for future research, including socio-technical and user research; systems design, security and privacy; and research on the economics of CBDC compared to existing solutions. In exploring these topics, we must always ask ourselves whether new financial technologies increase the self-determination and agency of the poor and vulnerable. In order to achieve a public interest benefit from money technologies, we must achieve inclusion as well as other dimensions of the public good.