In his second article, Guy de Felcourt addresses a set of questions regarding digital currency, authentication and monetary transformation that have been at the centre of the last edition's debates as part of the main track on Blockchain and AI for Identity, Authentication & Digital Currencies.
It particularly refers to the conference track entitled "Digital currency between crypto, identity and monetary regulations - Addressing global challenges of Libra and CBDC!" which was presented by Prof. Dominique GUÉGAN and Mr. Louis ABRAHAM on the 26tth of November 2019.
Are digital currencies essentially cryptocurrencies with verified identities?
In recent years, we’ve all become familiar with the concept of transacting or paying for goods and services using a variety of convenient and trusted electronic methods – from the well-established debit/credit cards and electronic bank transfers, through to the more recent mobile wallet payments (via smartphone apps) and now SEPA instant credit transfer.
There’s also a growing move to embrace the idea of cryptocurrencies - decentralized digital currencies built on a distributed ledger infrastructure that’s often referred to as ‘blockchain’.
Digital currency – a short definition
Available in digital or electronic format only, digital currency (or digital money) is essentially a digital asset with the status of a legal and stable currency. Powered by blockchain technology, and enabling the safe transfer of ‘value’ between individuals or organizations, these currencies are integrated into the international monetary system and serve as a unit of account, a means of payment, and retain a reserve value for businesses and individuals.
These currencies (or assets) can be issued either by a central bank (a Central Bank Digital Currency) or by another regulated entity within the financial system.
Today, the current surge of interest in these currencies is being fueled by the growth of electronic and mobile payments in Africa and Asia, and the anticipated extinction of physical coins and banknotes (most notably in Scandinavian countries).
But it was Facebook's recent announcement of its new Libra cryptocurrency project that re-ignited intense debate around digital currencies – and who will control money in the future.
What’s at stake?
Central banks around the world are now evaluating the benefits and risks of establishing a digital currency. It’s a daunting challenge for these financial institutions and requires that a wide variety of monetary, economic, geopolitical, legislative, regulatory, and technical issues are addressed.
Let’s take a look at the implications associated with the issuance of a digital currency. Firstly, CBDCs (digital currencies issued by central banks) come in two distinct forms: wholesale currencies (WCDBC) and mass currencies (RCDBC). Wholesale digital currencies target functions related to interbank exchanges – which makes them easier to experiment with and introduce. While offering immediate efficiency benefits, these are also useful to test sophisticated features – especially with regard to programmable functions like the "smart contacts" of the blockchain.
Mass currencies, on the other hand, carry more risk and the main priority for implementing banks is assuring the stability of these currencies and their valuations. Of course, the signature of a central bank would, in itself, constitute the digital currency as legal tender. But a reserve threshold or guarantee of parity with existing physical currencies would be necessary to increase stability.
In much the same way as fiat currencies are pegged to an underlying asset (such as gold or forex reserves, which act as collateral), central banks will need to bridge the gap between fiat currencies and digital currencies. For this reason, they are grappling with the issuance of fiat-collateralized ‘stablecoins’ that will assure long term price stability for monetary exchanges – in much the same way as fiat currencies are pegged today.
ID verification remains a key issue
At TRUSTECH 2019, a presentation entitled Addressing the global challenge of Libra and CBDCs by Professor Dominique Guégan and Mr. Louis Abraham evaluated the fundamental challenges relating to digital currencies. Among these questions, two issues were hotly debated: identity verification and anonymity.
A digital currency has to reconcile two quite different objectives. On the one hand, it must respect data privacy regulations such as GDPR, while maintaining a degree of anonymity for the carrier handling the peer-to-peer connections that enable the transactions. On the other hand, transactions must also be traceable in order to comply with the prevention of money laundering (Anti Money Laundering – or AML checks) and terrorism (Combatting Financial Terrorism – or CFT) regulations.
From a technical implementation perspective, cryptocurrencies utilize a bearer-type token and an account-based version with party identification and authentication for a transaction. But is this distinction sufficient?
In the context of a real digital currency, even when using the mechanisms of cryptocurrencies, this must go through controlled nodes and intermediaries. To comply with economic and financial regulations and G20 stipulations, digital identity checks will be required to complete a transaction or create an account, even if the public transaction is carried out by the bearer.
If consumer digital currencies use the technical mechanisms of blockchain and cryptography, the management of permissions will present a significant governance challenge that will need to comply strictly with monetary regulations. In addition to AML-CFT and tax evasion prevention, identity verification will also be vital for helping to prevent potential bank run scenarios and the resulting instability of sovereign financial systems. There is no doubt that, although digital money is much more than crypto money with verified identities, it is clear this aspect is a key driver in financial risk management capabilities.
This is undoubtably a fascinating subject, and the potential deployment of digital currencies will require careful step-by-step evaluation of the potential benefits and challenges – political, regulatory, and technical.
At TRUSTECH 2020, attendees will be able to discover more about this fast-emerging topic, explore the issues in greater depth in a dedicated half day conference, and see how digital currencies can help restructure our future economy and society.
TRUSTECH 2019 Presentation: Digital currency between crypto, identity and monetary regulations -Addressing global challenges of Libra and CBDC!"
By Prof. Dominique GUÉGAN and Mr. Louis ABRAHAM
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- The other side of the Coin: Risks of the Libra Blockchain, by Dominique Guegan and Louis Abraham: https://arxiv.org/pdf/1910.07775.pdf
- Document of G7 «Investigating the impact of global stablecoins »: https://www.banque-france.fr/sites/default/files/media/2019/10/18/g7sc_report_on_global_stablecoins_-17_october_2019_final_0.pdf
- Uk Central Bank document: https://www.bankofengland.co.uk/-/media/boe/files/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design.pdf