New paper examines central bank digital currency models

Bank of Canada experiment proves distributed ledger networks can be used to settle payments; paper examines the difference between retail and wholesale models

New details about the Bank of Canada’s (BoC) digital currency initiative – Project Jasper – emerged in a report published on April 4 by fintech firm R3.

In the report, CAD-coin versus Fedcoin, Rod Garratt, a professor of economics at the University of California, Santa Barbara, investigates two possible models for central bank digital currency (CBDC): a retail-focused public network similar Fedcoin, or a private, permissioned wholesale network akin to CAD-coin.

Project Jasper, a collaboration between R3 and six private Canadian banks, Payments Canada, and the central bank, was first announced in June 2016. The aim was to explore the possibility of clearing and settling large-value payments using distributed ledger technology.

However, very few details of the inner workings of the project were released to the general public, with only a few privy to the closed session called “Payments Panorama”.

In the new report, Garratt reveals phase one of the project involved a “simulation of a funds transfer”. It is hoped this simulation will be implemented in phase two, with the goal to conduct a set of payments between participants using distributed ledger technology (DLT).

“The simulation begins with participants pledging cash collateral into a special pooled account held by the BoC,” Garratt says.

The BoC then issues an equal amount of a digital asset, subsequently dubbed CAD-coin, onto the distributed ledger and sends each bank an amount of CAD-coin equal to the amount of cash originally pledged.

In this model, transactions are conducted on a private, permissioned network, with only a small group of “trusted users” able to validate and maintain the “integrity” of the ledger.

Garratt explains banks can send payments of CAD-coin to each other in real time to meet the payment obligations. Banks also have the option to send payments back to the Bank of Canada to “cash out” and “convert” CAD-coin back into Canadian dollars.

Unlike retail versions of digital currencies already in circulation, CAD-coin behaves like a deposit receipt and therefore begs the question: is it really a digital currency?

Garratt says it is: “It gives the holder a transferable claim on its value in central bank money. For all intents and purposes, this means CAD-coin is a form of central bank money.”

Retail versus wholesale

Fedcoin is the brainchild of economist JP Koning but has recently been adapted by David Andolfatto, an economist at the Federal Reserve Bank of St Louis.

Unlike CAD-coin, Fedcoin is a government-backed currency that uses similar protocols to the well-established digital currency bitcoin; only in this model, the currency has a fixed 1:1 exchange rate to the US dollar.

“Fedcoin is intended as a retail payment solution, while CAD-coin is intended as a wholesale payments solution: it does not trade on a public network, nor is it consumer-facing,” Garratt says.

While both digital currencies would be issued by their respective central banks, Fedcoin would be directly convertible to the US dollar. CAD-coin, on the other hand, would represent deposit receipts that are backed by central bank money.

Step backwards?

“The case for adopting DLT, which is still evolving as improvements in the technology develop, must be based on improved operational efficiencies, increased resilience and cost reductions,” Garratt says. He is not convinced either digital currency model meets these criteria.

He goes one step further with the CAD-coin model, stating “it is not an improvement in payments processing”. In fact “it is actually a step backwards”.

For Garratt, buying CAD-coin and using it, only to have to convert it back to Canadian dollars, is taking central banks in “the wrong direction”. It is “making things harder instead of easier”.

Nevertheless, the Bank of Canada’s proof of concept demonstrates central bank money can be transferred using DLT, which Garratt admits may appear “simple”, but is also “crucial”.

“It enables settlement,” he says, and “settlement is the final part of the holy trinity of finance.”


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