Q&A: The digital dollar — how would it work, what would it do?

Over the past month, various world governments have stepped up efforts to create their own national digital currencies. The efforts are in response to the growing popularity of private sector decentralized digital currencies, such as Bitcoin, that exist without the backing of a central bank or commercial banks.

In recent weeks, US President Joe Biden has issued an executive order to investigate how to regulate  cryptocurrencies and speed up research into creating a digital dollar that would be backed by the Federal Reserve Bank and essentially “minted” by the US Treasury. Lawmakers then offered up a bill that would allow the US Treasury to create a digital dollar. And soon after that, the UK ramped up its own efforts to regulate cryptocurrencies and create a non-fungible token backed by the Bank of England.

Creating a government-backed digital dollar involves far more than just technology. It involves public policies, monetary philosophies, and international regulations that will affect cross-border transactions. It also involves securing that digital dollar so it cannot be counterfeited, and to ensure public transactions aren’t tracked by government entities.

Jonathan Dharmapalan, CEO of eCurrency, has been acting as a consultant to government bodies and central banks for more than a decade on the topic of central bank digital currency (CBDC) creation. According to Dharmapalan, eCurrency has advised more than 40 banks, including the Bank of England, the European Central Bank, the Reserve Bank of India, the Central Bank of the Philippines, the West African Economic Union BCEAO, the Bank of Uganda, the Bank of Tanzania, the Central Bank of Peru, and the Central Bank of Ecuador.

eCurrency created one of the world’s first retail CBDC solutions enabling central banks to issue secure digital-bearer instruments. Its Digital Symmetric Core Currency Cryptography (DSC3) technology and supporting tiered distribution solution enables transactions to be conducted through existing banking and Fintech ecosystems.

eCurrency

The digital currency can operate alongside fiat notes and coins as legal tender. The company combines hardware, software, and cryptographic security protocols to provide central banks the tools they need to preserve their charter as the sole issuer of sovereign currency in an increasingly digital economy.

Computerworld spoke with Dharmapalan on what steps governments must take to create digital fiat currencies, what the benefits are, and what risks are involved. The following are excerpts from that interview:

What is it your company does? “We focus on currency — not different forms of money. We think about currency as a general public good and as something that comes under some level of legal protection or legal doctrine that allows a sovereign [nation] to set a measuring standard for any financial transaction. It’s a little bit like defining what an inch is. Because someone defined what an inch is, I can turn around and tell you the size of my monitor’s screen; it’s a 13½-in. monitor.

“So, what is the currency of the United States? It’s a legal doctrine that says the currency of this country is the United States dollar. It’s legal tender. It’s the instrument of measurement for any financial transaction. And, because a standard is defined and receives legal protection, we are able to execute transactions more efficiently just because somebody said a dollar is that unit of measurement.

“Along with that comes certain rules and regulations. Congress says this is legal tender, the Treasury shall print it, and the Federal Reserve shall distribute it.”

So, who’s responsible for getting it into the hands of the public? “The Federal Reserve recognizes it as a liability…and puts it into circulation so that you and I get to use it with certain legal protections, such as privacy under certain conditions for executing transactions. It ensures certain security that if I buy a loaf of bread today, a week from now that loaf of bread will still be the same for a dollar. My credit worthiness, or my place of birth, or my status in society, or my address or driver’s license doesn’t ensure my ability to buy that loaf of bread. It’s the dollar that ensures that.

“Now, the question becomes, when that dollar becomes digital, how in the world will it work? How in the world is the Treasury going to mint this thing? You can’t stamp it onto a piece of paper, you can’t stamp it on a piece of metal and call four quarters a dollar.

“Once it mints it, how will the Federal Reserve take this thing that you can’t touch … and feel … and put it into circulation? And, then, how are the banks going to get it into the hands of the public to use it? All these problems start to bubble up when you consider creating a CBCD.”

How does your company deal with that? “What we did is to build a mechanism by which the Treasury can mint it, the Federal Reserve can issue it, and commercial banks can distribute it, and you and I can hopefully get it — not necessarily from commercial banks, but [from] any purveyor of payment systems. So, you should be able to get it through PayPal or Venmo. And, if we do it right, we should be able to hold this on our phones or in our pockets on a card.

“All this comes with strengths and weaknesses: does it ensure the instrument is secure in a way where it cannot be counterfeited? Can we secure the boundaries of how much of it is in circulation? Can you and I execute a transaction where I can buy bananas from you without the government snooping on it, discovering that I just bought bananas from you?

“These are the problems that need to be solved, and I think we’re well on the way to solving them. That’s what we do. We build the machinery necessary for this to exist.”

When you say, you build the machinery, what does that look like? Are we talking about data centers, software, peer-to-peer networks, blockchain ledgers? “So, should we build a big, centralized database and everybody has to go to the oracle to ensure the validity of this instrument? No.

“We should be able to build this thing so the minting can be assured at the central bank level. For the US, it happens with the Treasury, but for most countries there’s an entity called a central bank. Its validity and provenance can be assured in a highly decentralized fashion. …It’s a little bit like how we went from mainframes, to distributed servers, to our ability to have it all on our mobile phones. So, we looked at the possibility of creating a protocol that allows for centralized minting but highly decentralized transacting.

“You don’t have to go back to the oracle to validate every instrument. That’s why we call this a digital bearer instrument because it carries its own legitimacy – the fact that it came from the US Treasury and the Fed put it into circulation.

“Now, that comes with risks. If it’s a bearer instrument and you drop it in a lake, it’s in the lake. You don’t get to use it. So, it’s very much like a physical bearer instrument, which is what a dollar bill is. It’s recognized, it’s minted by the treasury, and the Fed will honor its validity, which means if you take it to the Fed and say I don’t want this one, they’ll give you another of the very same thing.”

Unlike a physical dollar bill it won’t wear out, right? “No, but its security will. Interestingly enough, a physical dollar’s security also wears out. As technology advances, we have to add more and more security onto a physical dollar, meaning when we didn’t have color printers, you could get away with a relatively simple dollar bill. But over time we had to create everything from secure fabric it’s on, to water marks becoming more complex to metal inks and strips and all the rest of the stuff we put into currency to keep it secure in such a way that the Central Bank stays a day ahead of other technologies.

“A similar thing will have to happen with a digital dollar. So, it has to be an instrument that can evolve. That’s an architectural design that has to be considered.”

How did your company get started? “…We started off with 30 or 35 central banks, and almost all of them agreed to talk to us, which is interesting. This was in 2011, 2012. This information began to create what I like to call our secret sauce or our requirement set. And we starting building to that requirement set. Fast forward five or six years later and people were going all kinds of different directions with this concept. But now it’s starting to converge again around what’s required to make this happen.”

What missteps are nations making in their attempts to create digital currencies? “I think the single biggest misstep is starting [the process] with the technology. I think the popular sentiment is asking what it will look like. Will it look like blockchain or it will look like Bitcoin, or it will be on a distributed ledger, or [is it] consensus-based — all that stuff. You’re starting off on the wrong end of the problem.

“The problem you have to solve first is whether there’s a legal doctrine that enables your central bank to issue digital currency in the first place. Current laws enable you to issue notes and coins, but those laws haven’t recognized the digital nature of it.

“From there, there are policy questions that must be recognized. Is this going to be a part of M0 or M1? In other words, is this a public currency that’s a direct liability of a central bank — not commercial banks, not stablecoins. So, are you going to recognize this as a liability on the Central Bank’s books?

“As a Central Bank liability, it only changes when the Central Bank issues more, or redeems some out of circulation.

“The second question is will the Central Bank get into the business of issuing this directly to the public, or are they going to use a two-tier mechanism, which is what they use today. Central Banks issue currency…and leave the distribution to commercial banks, and then merchants, and ATM machines and then whatever. They leave it to the private sector to get this thing out there.

“From there, there is a question of whether this will be a surveillance tool or a public good? If it’s a public good, then our privacy laws and our ability to, and our freedom to, use this digital currency and amass vast availability become important. Fortunately for us in the US, we have laws that should guarantee our privacy — laws that keep the government from snooping on our day-to-day activities.”

What real laws now protect the average citizen from government snooping? “Our Constitution ensures us certain rights to privacy and there are other laws that add to that. For the most part, I think we should insist that the information about individuals and their activity should be kept private, whether or not we have a digital currency.

“If nefarious activities take place we have a legal system to investigate that, but it still requires a legal process. It doesn’t require that everything is tracked. And the problem with everything being tracked is…that’s already happened and it involves the internet. It’s a problem with monopolistic entities violating our privacy for the benefit of profits. The internet has been hijacked by the private sector. We don’t need to repeat that hard-learned lesson when we create a digital currency.

“That doesn’t mean there shouldn’t be a legal system that addresses nefarious activity. The default, however, shouldn’t be we will track everybody so we can catch that one bad actor.”

What hurdles do governments face in creating CDBCs, whether cross-border regulatory issues, technological or otherwise? “Frankly, there are no technological hurdles. What I see as the biggest hurdle is political will. Do we or do we not want this, and do we or do we not want a public good provided by a sovereign or nation state?

“There is an argument that says leave this up to the private sector. Let the private sector do whatever. Another argument is leave it up to the private sector and then regulate the crap out of it. I think both of those are problematic because the private sector’s primary purpose is making a profit. So, it’ll naturally gravitate to whatever is the most profitable scheme.

“Currency is a public good. It keeps us out of a world where I have to trade a pound of flesh for the service you provided me. I get to settle it in something other than my daughter’s hand in marriage or my favorite goat.”

From a technology standpoint, what’s involved in creating a national digital currency? “Security. You are really protecting a national asset, so technology wise you’re going to have to create a non-counterfeitable item. You’re going to have to rely on the highest level of security and that’s never going to stop. …You’re going to have to really step it up. And, even after we’ve stepped up, it won’t be good enough in a year… or, I don’t know, in day. It’s a constant battle, and the responsibility for staying ahead of that game is the various nations’ treasuries.”

What nations are ahead of the game for creating digital currency, and which countries with leading economies do you see as lagging? “I think the furthest along are China and little Jamaica. Everybody else is half-baked. And, China doesn’t have the same value system or legal system as we do. So, they built something that works for their legal and value system, but they are way ahead of making a practical digital currency. They’ve answered some of the important legal questions, such as do we have the legal doctrine in place to set the authority over it, does it belong to the central bank, and does the central bank mint it and leave distribution to the private sector? These are the hardest questions they’ve answered.”

What are the risks to the nations falling behind? “I wouldn’t say countries are falling behind, but I do think if countries go through this decision criteria that really starts with the legal doctrine, they’ll catch up quickly because the technology is here already.

“I don’t necessarily subscribe to the belief that the first country that comes out of the gate is going to capture it all and it’ll be the dominant sovereign currency. There’s a lot to be said for people forging the way, but this is a slow process. It’s not going to happen overnight. But I would certainly say the United States should get going with the principles important for us because we will set the standard; we always do. We’ll catch up and surpass others, we just need to choose to get going.”

What are the regulatory impediments? “We need to decide what we really want. I’ll just talk about the US, but I think it applies to every other country, too. In the US, Congress has to act. Congress is the one who says the US Treasury must ensure the US government is secure. Then Congress says this is now a liability of the Federal Reserve. Now, we can change that and make up new laws, but I don’t see a reason to do that. Once Congress acts, the Fed will get on board, the Treasury will get on board, and all the commercial banks will get onboard. And all the people will get on board.”

What would the CDBC look like? Will it be like a debit card, or a USB drive, or a digital wallet you access on your phone or computer? “I think it’s all of the above. If you’re going to create something as powerful as some of us imagine, it should be able to reside on your phone, on a card, and on some digital wallet provided to you by payment service providers. And it should be able to go from John’s phone to Amy’s phone through PayPal. It has to be interoperable. It should be able to reside on something we haven’t even imagined yet — a USB device or something else. As long as it can be stored and secured in digital form, it can reside anywhere and everywhere.

“But if you really want this digital dollar to be powerful, we also should be able to lose it. Without the possibility of forgetting, your privacy goes away. It’s a philosophical question. If you really want to create something powerful, then you should be able to drop it into a lake and no one should be able to find it again. So the ability to lose it makes it something you and I can execute a transaction on without someone being able to snoop on you with it.”