As the blockchain industry matures and more financial use cases develop, central bank digital currencies (CBDCs) have been top-of-mind for central banks. CBDCs possess the potential to substantially improve the lives of citizens, whether by encouraging innovation in financial services, easing distribution of social benefit payments, bringing safety and security to the unbanked, or more. Thus, central banks have a real opportunity to radically improve equitable access to financial services through CBDCs.
However, central banks need to assess the risk of using technology in order to ensure the safety of their monetary systems. The way central banks accomplished this prior to the advent of blockchain technology was to maintain centralized control of the infrastructure these systems were built upon, including relevant databases and messaging systems. Yet, with blockchain, an asset can be kept safe and secure even if issued on common infrastructure.
Stellar is an open-source, decentralized blockchain network that was designed with asset issuance in mind. It offers the interoperability and flexibility of a permissionless ledger while possessing built-in capabilities to ensure security, certainty, and control – as with a centralized or permissioned ledger. That combination makes it particularly well-suited for issuance of CBDCs.
For this blog post, we’re going to go over what features of Stellar are the most relevant to asset issuance, and therefore to central banks considering CBDCs. This blog post contains excerpts/selections from our CBDC white paper. Read the paper in full here.
Stellar uses a ledger to track ownership, specifically listing accounts and the asset balances those accounts hold. To modify the ledger, account holders sign and submit transactions to network nodes, moving part of their account balance to someone else's account – essentially, a payment.
Payments on Stellar are not limited to assets hardwired into the ledger. In fact, any Stellar account can issue their own assets, accomplished with a simple transaction, and to enable other accounts to use those assets to make payments, accomplished with another transaction. Asset issuance is a fundamental built-in network feature of Stellar, with no need for smart contracts or complicated coding – it’s as simple as adding an entry to a ledger.
Although Stellar accounts are secured using public-key cryptography, with each account represented by a string of letters and numbers, the network itself does not prize or rely on anonymity or pseudonymity. Instead, organizations issuing assets representing real-world financial instruments link their accounts to verifiable information about themselves, their assets, and their Stellar integration in order to establish trust with potential asset holders and counterparties. When users hold an asset on Stellar, they know who issued it, what it represents, and the terms and conditions of its redemption.
Assets can be configured a number of ways on Stellar as to who can hold them, and regulated financial institutions that issue fiat-backed stablecoins often use standard Stellar compliance protocols to collect user information and perform appropriate Know Your Customer (KYC)/Customer Due Diligence (CDD) checks before moving value onto or off of the network. In many cases, that's enough to comply with local laws and regulations.
For central banks that want a greater degree of control over asset access, Stellar offers three settings that can be activated with simple account flags:
Issuers can activate any combination of these features, thus letting them fine-tune the degree of control they want over their asset.
Stellar is a public blockchain network, which means its ledger is copied and kept in sync on computers all over the world, run by independent individuals and organizations. Those computers, known as validators, run software that implements the Stellar Consensus Protocol (SCP) – the engine that drives the network – to pool, ratify, and apply transactions to update the ledger. Like all blockchain consensus protocols, the point of SCP is to make sure that validators always add the same set of transactions to the ledger history at each step.
However, unlike Proof-of-Work and Proof-of-Stake protocols, SCP relies on validators run by known organizations with verified identities instead of anonymous nodes. Each validator designates a subset of other validators to programmatically consult when evaluating a transaction set, and votes to accept it if and when that subset signs off. Once a validator accepts, its decision is final, and the transaction set it ratifies can't be overwritten – a process that takes around five seconds.
When an organization issues an asset on the network, they designate a specific validator to enforce transaction finality, and that validator serves as the source of truth for the state of the ledger. Often, issuers run (and designate) their own validator so that they have control over the subset of validators it consults when ratifying transaction sets, and running a validator is something any issuer of a CBDC would likely do.
So long as no one compromises an issuer’s validators (and the underlying digital signatures and cryptographic hashes remain secure), the issuer knows exactly which transactions have occurred and avoids the risk of losses from blockchain history reorganization.
By offering asset authorization capabilities and transaction finality, Stellar makes it possible for issuers to do something remarkable: they can take advantage of a tried-and-true public blockchain to issue and distribute assets without losing control over those assets or relying on unknown entities to validate transactions.
Today, Stellar hosts a variety of stablecoins, which are fiat-backed digital assets issued by regulated financial institutions, and the issuers of those assets, along with companies that build network interfaces, wallets, and other applications, leverage that feature to offer innovative solutions to real-world problems created by fractured payment systems. For instance, rather than facilitating cross-border payments through multiple correspondent banks, companies use Stellar to power direct remittances from Europe to Africa. They provide their customers a cheaper, faster alternative to the status quo, which is better for business and the world.
This feature becomes even more powerful if central banks issue CBDCs on Stellar. National currencies on a common ledger that automatically interoperate could facilitate secure, transparent, frictionless global commerce. Developers and entrepreneurs that build consumer- and business-facing products and services on the network could tailor their offerings to CBDCs, further offering financial access and connecting disparate markets. The thriving ecosystem of businesses that create compliance solutions, provide liquidity, offer network services, and handle money transfer could work together with central banks and regulators to ensure the common infrastructure both serves business needs and protects consumers.
Want to learn more about how to implement a CBDC on Stellar? Curious about what makes the Stellar Consensus Protocol so unique out of all blockchain consensus mechanisms? Access “Stellar for CBDCs” here.