Will CBDC Powered Offline Payment Systems Complement or Compete With Cryptocurrencies?

With the advancement of technologies such as Blockchain, efforts for the development of token-based payment systems are now being taken seriously by governments, enterprises, and even individuals, namely creating global digital currencies and central bank digital currencies [1].

A digital euro could be the reality. Photo by Mika Baumeister on Unsplash

In a previous article [2], I elaborate on some of the dangers of a global cryptocurrency managed by private enterprises, namely Libra; now, Libra has rebranded to “Diem,” a name given after an independent group organized by Facebook to manage efforts on the digitization of currencies.

Some of the reasons why regulators bounced back the Libra project included the possibility of disrupting the financial system, money laundering, and proving to be a direct competitor to the dollar.

However, Diem is not the only player in the market. Central bank digital currencies (CBDC) provide its users with a tokenized version of fiat currency, for example, a digital euro or a digital dollar.

Comparatively to traditional cryptocurrencies, a CBDC is centralized, and thus it is regulated by the issuing organization or country.

In a paper dated 14th December 2020, Visa Research introduced “Towards a Two-Tier Hierarchical Infrastructure: An Online Payment System for Central Bank Digital Currencies” [3].

In this technical paper, researchers propose an offline payment system for central bank digital currencies.

This system’s underlying idea is to allow peer-to-peer payments, without a third-party, even in an environment without an internet connection. One could then ask

“How can one be sure that the counterparty has enough funds for a payment if the payment network is not available”?

The solution is to use trusted and authorized hardware — enforcing that the funds are spent only once. This system could support CBDCs, offering a resilient payment network for consumers and businesses.

To access this platform, a user would need a specialized digital wallet, developed by trusted parties. Visa’s solution assures that the money’s issuer is liable, and the money maintains its value (no double-spending or counterfeiting is possible).

This scheme heavily relies on public-key cryptography. In other words, the holder of a wallet can always verify who issued the tokens that are being transacted to him.

Moreover, a CB issuing a CBDC can “outsource the complexity of managing several CBDC tokens to other financial institutions through a hierarchy of digital certificates originated from the central bank” [3].

This might come to an end in the following decades. Photo by Artem Beliaikin on Unsplash

However, some challenges still arise:

• A set of certified entities issues CBDCs and wallet providers. Who are they? Who decides who is qualified to do so?
• How is this infrastructure interoperable with existing systems, and, in particular, with existing cryptocurrencies?
• Will there be space to accommodate a diversity of solutions, or just the ones benefiting VISA?

I think it is reasonable to assume that interoperability will be a key factor in such a technology’s success, similar to what we have observed with the rise of the Internet [4].

If the trusted hardware is compromised, bad things will happen. In particular, a user could spend funds an unlimited number of times; if the hardware is lost, funds are lost.

So there is still a lot of work to be done. Let us expect fascinating developments for 2021 and 2022, where finally the reality of a digital euro powered by governments will likely be possible, as a complement to the available public cryptocurrencies.

[1] https://www.forbes.com/sites/pawelkuskowski/2020/06/07/central-bank-digital-currencies-cbdc-a-crisis-recovery-tool-for-governments/

[2] https://towardsdatascience.com/the-libra-blockchain-technical-overview-part-i-5e872b0369c, https://www.publico.pt/2020/03/22/p3/cronica/dinheiro-blockchain-1907261

[3] Towards a Two-Tier Hierarchical Infrastructure: An Oine Payment System for Central Bank Digital Currencies — https://arxiv.org/pdf/2012.08003.pdf

[4] A Survey on Blockchain Interoperability: Past, Present, and Future Trends — https://arxiv.org/pdf/2005.14282.pdf

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