Central Bank Digital Currencies Need Decentralization


    Igor Mikhalev is an expert principal at BCG helping clients develop business models with blockchain technologies and digital currencies. Kaj Burchardi is a Managing Director with BCG and leads the blockchain practice of BCG/Platinion globally.

    Digital currencies hold a long-term promise to change the way nations, corporations, and people transact value. Some of them – combining both cryptocurrency benefits (disintermediation, high speed, and low cost of transactions) as well as qualities of traditional currencies (e.g. price stability and being able to act as legal tender) – challenge traditional financial systems at the core. While first-generation digital currencies deployed by consortia of industry players may only deliver incremental changes such as the reduction in money movement prices and lowering the cost of capital for unbanked, adoption across nations through CDBC 2.0 holds the potential to unlock significant value available for first-movers to capture.

    In our recent work, we have analyzed key notable projects and developments around Digital Currencies, distilling them into key Digital Currency archetypes, see exhibit 1.  

    Exhibit 1: archetypes and design considerations of digital currencies (Credit: BCG)

    Throughout our analysis, we have developed and applied the Total Social Impact framework (see exhibit 2) to understand the societal value chain impact of the introduction of digital currencies as well as potential effects of adoption by nations, central banks, corporations, and individual users. Specific underlying drivers have been defined and evaluated for each TSI dimension.

    Exhibit 2: The Total Societal Impact framework for digital currencies BCG)

    CDBC 2.0 is the second step in the evolution of CBDCs: a new, most impactful (see exhibit 4) form of money issued digitally by one or many central banks using blockchain technology, interoperable and programmable by design.

    Currently, the responsibility for the monetary system lies under the jurisdiction of nation-states and international agreements. For a digital currency to be adopted in any state, it must first comply with the regulations of the state. Central banks, while curious about CBDCs, are wary of digital currencies that introduce decentralization of ownership or governance, and that makes traditional centralized governance a challenging task. 

    See also: Ajit Tripathi – 4 Reasons Central Banks Should Launch Retail Digital Currencies

    But CBDCs will fail if they don’t implement and benefit from arguably the most revolutionary aspect brought by Bitcoin and blockchain technologies: decentralization. Initial CDBC projects create incrementally better alternatives to the current financial system by enabling peer-to-peer transactions, but they are still keeping the governance centralized and circulation controlled.

    The major incentives for consumers to adopt a central bank-issued cryptocurrency will be based on decentralized governance and open circulation system. Public trust in government and banking institutions has dropped since the financial crisis of 2008. Therefore, there is room for a digital currency that has no central authority in its usual central bank sense which determines e.g. the borrowing rate or supply of money in circulation.

    Exhibit 3: Centralized vs. decentralized governance of CBDCs and its potential impact (BCG)

    Central banks wield a high level of power over national currencies. Average consumers have no influence over or knowledge of central bank activities or which parties are asserting influence over policy decisions.

    A CBDC 2.0 will be issued and decentrally governed (exhibit 3) either on a national or on a supranational level, across multiple jurisdictions. This implies a different set of legal, monetary, and fiscal policies, some of them automated, required to be codified and put in place across nations. 

    CBDC 2.0 will supplant the need for multiple other digital currencies intended for specific use cases such as mortgages, lending, trade finance, real estate, and so on. The CBDC 2.0 will have to be interoperable on a protocol level. Data exchange and functionality should be easily accessible and transferable from protocol to protocol.

    CBDC 2.0 will supplant the need for multiple other digital currencies intended for specific use cases such as mortgages, lending, trade finance, real estate, and so on.

    Decentrally governed CBDC 2.0 will bring multiple advantages for an average consumer, including fast and cheap cross-border transactions, pseudonymity, personal data protection, and international operability. It will arguably eliminate the risk of hyperinflation because issuance will be automated via an algorithmic “issuance system.” All the transactions will be recorded on an immutable (supra) national ledger open to everybody, with no risk of double spending and reduced chance of illicit transactions.

    Banks will have easier access to credit, meaning the money will move through channels faster. Cross-border transactions will require less documentation and time to settle. This will enable faster trade across the world and disempower monopolies. And traceability will allow nations to reduce criminal activities such as money laundering, tax evasion, and drug trafficking.

    Last but not least, the currency will be interoperable on a supranational level, meaning that emerging economies could suffer less from purchasing power inequality.

    Exhibit 4: CBDC 2.0 will have the most positive societal impact (BCG)

    During our workshop on CBDCs at Consensus 2020, we asked guests to list the benefits of decentralized CBDCs. They gave the following three. First, that CBDCs could improve democracy and distribution of power, and reduce political influence on decision-making. Two, they could reduce currency volatility, particularly in emerging economies. And three, they could cut the cost payments, notably cross-border.  

    The takeaway

    Central banks are traditionally centralized institutions, and not without a good reason. They have been created as independently governed bodies and entrusted significant power, to ensure long-term financial stability. ​ They enforced constraints when a king wanted to issue or alter coins to uphold the credibility of their currency. This approach worked for centuries, limiting a national leader’s ability to debase the currency and ultimately contributed to a common good through financial stability.

    As blockchain technologies mature, leaders should decide how to restructure existing financial institutions and policies to benefit from decentralization of governance and subsequently realize the discussed benefits introduced by CDBC 2.0. First-movers will be rewarded by an increase in competitiveness of their (supra)national currencies through improved democracy and distribution of power, reduced corruption and manipulation as well as more efficient and secure payments.

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