'Redesigning digital money: What can we learn from a decade of cryptocurrencies?' by Robleh Ali and Neha Narula of the Digital Currency Inititaive

Since the Bank of England first raised the concept of a central bank digital currency (CBDC) in its 2015 research agenda, the subject has gained considerable traction in the intervening five years. 

Several central banks are now working on CBDC research and in this paper Robleh Ali and Neha Narula from the DCI look at a decade of cryptocurrencies and what features are and aren’t beneficial when designing a CBDC. 

The paper 'Redesigning digital money’ considers three important features from cryptocurrency design - decentralization, programmability and privacy - and assesses their applicability to a CBDC.

Introduction

In a 2019 speech, Bank of England governor Mark Carney said that “Technology has the potential to disrupt the network externalities that prevent the incumbent global reserve currency from being displaced.” Certainly one of the most interesting places where technology is disrupting payments and finance is in cryptocurrencies. Cryptocurrencies have emerged from open source development communities in large part because electronic transaction systems are too expensive and they have not evolved fast enough to keep pace with the demand for retail online digital payments and more sophisticated types of financial transactions. The wide variety of experimentation in cryptocurrencies is causing technologists and central bankers to rethink the interface to money and explore a digital form which can be held by users and companies directly. This could lead to a financial system with a simplified institutional structure, capable of serving the public at a much lower cost. Though there has been much discussion about the policy design for central bank-issued digital currency (CBDC), there are important technical points missing from the conversation: CBDC should not be a direct copy of existing cryptocurrencies with exactly the same design and features but there are things we can learn from their emergence - the usefulness of programmability in money and the importance of preserving user privacy.

Cryptocurrency technology, in some instances, can provide an important feature: Anyone can participate and build applications with financial transactions to a standard, which creates a free-entry market that enables competition. These rules are set and maintained by users of the system, not by a coalition of companies or other large market participants. This is due in large part to the fact that many participate in observing, auditing, and validating the creation of money and the legitimacy of payments by observing a highly replicated audit trail of activities.

The cryptocurrency ecosystem should be viewed as a laboratory where developers are inventing different technologies, monetary policies, governance strategies, and reward systems which are competing. The space is still in its infancy, but make no mistake -- successful ideas from this area will eventually find their way into the more conservative world of fiat digital payments. Libra and other stablecoins are the latest prominent example of these ideas breaking through. There will be more.