Mar 09, 2021
By: Andrea Civelli
In this blog post we elaborate on one of the principles of designing a successful Central Bank Digital Currency (CBDC) introduced in our first post about CBDCs: the importance of a decentralized system.
The payment system would benefit from decentralization in numerous ways. We can identify at least five major areas where the advantages of a blockchain based decentralized CBDC for the payment system would be large.
However, despite the benefits to decentralization, CBDC implementations on decentralized systems encounter two challenges:
When it comes to finality, transacting in cash has immediate settlement finality, but is an expensive and centralized payment infrastructure. A digital currency must have immediate settlement finality if it has to compete with and improve on cash. Otherwise, the instrument would carry counterparty risk, undoing the benefits of introducing a CBDC. Early generation blockchains have been beset by the threat of forks, which force users to wait long periods of time to be fully sure no other competing branch of the blockchain prevails. The uncertainty associated with the risk of forking makes CBDC projects unfeasible. In order to be successful and ensure the transaction finality required, a decentralized CBDC must select the most advanced next-gen blockchain technology, which can prevent the system from forking, bringing the security and resilience of a truly decentralized system.
Scalability issues and insufficient throughput (number of transactions per second) have plagued most blockchains to date, particularly those based on a proof-of-work algorithm. To reliably handle the transaction volume required for a larger country’s entire economy, many early generation blockchains are not feasible for this. For example, in the case of a country with about 50 million CBDC users transacting a couple of times per day, the CBDC system would have to handle on average 1,500 transactions per second. This is a factor of one hundred more than the standard proof-of-work blockchains process today.
Scalability is key for a seamless user experience, which, in turn, is key for the adoption and acceptance of the new payment instrument. If users have to wait several seconds even for low-value transactions to clear, many essential use cases for cash will be inaccessible for a CBDC. For CBDCs to move from experimentation to real world implementation, advanced technology is required that can scale to meet the needs of global adoption.
The retail CBDC model we propose is inspired by the characteristics of both what we see required for the future of finance as well as the unique capabilities of the Algorand blockchain. For people, organizations, and governments to be successful in the future of finance and payments, the underpinnings of a CBDC must:
Algorand is uniquely positioned to empower strong CBDC implementations.
Decentralization is a function of the number of participants in the consensus protocol, hardware requirements, topography, and the number of people who own a stake in the consensus protocol itself. Algorand, unlike other platforms, has decided that to run critical infrastructure, enabling decentralization at every level is key to avoiding single points of failure. Algorand’s valuable experience designing systems that are both fully decentralized and highly scalable will allow Central Banks to deploy a decentralized CBDC system that guarantees stability and security, without compromising finality of transactions and performance of the network.
While most blockchains do not have immediate settlement finality—and some do not have settlement finality at all—Algorand’s Pure Proof-of-Stake consensus protocol implements this natively. Algorand blockchain is mathematically proven to never fork, and will also be secure against quantum computing technology.
Algorand is designed to be highly scalable as well, even on a globally decentralized level. It easily achieves several thousand transactions per second (TPS), with our block finalization time projected to shrink to 2.5 seconds and our TPS projected to grow up to 46,000 in 2021 (thanks to a truthful approach to block pipelining).
The Algorand CBDC model has been designed by a multidisciplinary team that includes cryptographers, economists, technology and policy experts, which embodies Algorand’s commitment to finding the most innovative and effective solutions for a frictionless economy.
As our experience here at Algorand has grown with national digital currencies projects (Algorand, for example, is the infrastructure behind the SOV - the Marshall Islands’ new digital currency), we have developed the original and thorough model of CBDC which we have discussed in a series of recent posts.