blockchain’s role in the financial landscape

According to De Nederlandsche Bank (DNB), the use of cash in the Netherlands has been declining for years, but only took a dip due to corona. The number of cash payments fell from about 60% to 32% in 7 years, and the share of cash payments is expected to fall to 25% in 2025. It is clear that the meaning of cash is changing, which is one of the driving forces – next to interbank payments – for the digital euro. The digital euro can complement all the payment methods we already have and can contribute to financial stability. Moreover, it can offer an efficient, secure, privacy-friendly payment system that is accessible to everyone. In this article, we will take a closer look at the digital euro, its design possibilities and explain the role of blockchain technology.

Currently, central banks, such as the European Central Bank (ECB), only issue money as reserves for commercial banks. These reserves are not available to the public and citizens hold deposits from commercial banks, which is less transparent and raises questions about control of the money supply. The ECB is considering a new form of electronic money that will be available to everyone, including citizens, in Europe. The move stems from the declining use of cash, even for very small payments, and the maturation of relevant technologies. One of these technologies is blockchain, which offers the most secure and efficient platform to introduce a digital euro.

Blockchain design opportunities digital euro

The ECB recently published another progress report outlining design and distribution options for the digital euro. In 2023, the ECB will further assess a number of options and present the overall design of a digital euro to the Governing Council in the second half of the year. The ECB is experimenting with different approaches and technologies for the digital euro, such as Private Server, Cloud Distributed Server and blockchain.

The two design options for the digital euro on the blockchain are the private blockchain and the public blockchain. The private blockchain is a closed network where only authorized parties can access and use the network. This provides certain advantages, such as the ability to centralize transaction validation and maintain control over the network. However, this is not necessarily privacy-friendly, and data can be changed without leaving a trace, which can lead to data being out of sync.

The public blockchain, on the other hand, is an open network. It provides the benefits of transparency and the ability to easily verify transactions without compromising privacy. It is secure from attacks and data is immutable and cannot be changed, making it tamper-proof.

In general, both options for the digital euro on the blockchain have both advantages and disadvantages. However, one thing is certain: the digital euro is expected to function on the blockchain as a token that can be easily issued and exchanged in banking systems. Cryptocurrency will not affect this development.

How the digital euro can be used correctly on the blockchain

The digital euro in retail and interbank (wholesale) payments are two different situations, each requiring their own design choices. Below we discuss how the digital euro can be properly used on the retail blockchain in terms of identity, privacy, security and financial inclusion.

Currently, small cash payments are completely anonymous. No one knows who you pay to and how much. So no identity information is required. However, this changes if the threshold for ‘Anti Money Laundering’ (AML) and ‘Know your customer’ (KYC) rules are reached where identity information is required. Larger amounts also require extra verification steps on top of the already known identity information. With the digital euro, one universal identity protocol will be needed to link the electronic money to a person. For example, if the identity is verified by a trusted company that performs KYC, it can be linked to a specific ID number (master key). This can then be used to derive subkeys that can be used for purchases. In this way, privacy is preserved, while at the same time it can be demonstrated that the purchase has been completed. With this approach, enforcement remains possible while making large-scale data scraping difficult.

It is possible to guarantee privacy Unused transaction output (UTXO) model can be used. Instead of an account on the blockchain showing the balance, this model only shows individual transactions. A new cryptographic address is generated for each transaction, making it impossible for outsiders to trace transactions. The state of the account is only visible to the owner outside the blockchain. However, authorities can track and trace money flows with the necessary legal basis.

The digital euro also promotes financial inclusion. The digital euro does not require a bank account or even an internet connection. Cash can be instantly digitized so that it is compatible with any smartphone, smart card or older mobile phone. This will give everyone access to (especially digital) products and services without a bank account, and there will be dynamic pricing based on the purchasing power of the euro. In this way, a much larger part of the population can participate in the global digital economy.

This is what society looks like with a well-executed digital euro

With the arrival of the digital euro on the public blockchain, the central bank can not only maintain but also strengthen its monetary policy. The digital euro not only supports direct, offline, peer-to-peer payments, but also enables data integrity and traceability. This means that the digital euro can be selectively maintained without collecting more data than necessary. Privacy is guaranteed as no unnecessary data is leaked with each transaction and a new cryptographic address is used. This makes it impossible to link transactions together as an outsider.

In addition, the digital euro enables real-time payment of taxes and VAT. This means no time is wasted filling out forms or waiting for tax refunds. The digital euro is therefore not only an easy way to pay, but can also lead to cost and time savings for both citizens and the public sector.

In short, we are not far from a global shift in the payment and banking sector. The uncertainty and skepticism surrounding the digital euro and Central Bank Digital Currency (CBDC) is closely related to the design options rather than the concept itself. Just as we use the public internet today as a basis for setting up secure and private services, the public blockchain can also serve as a basis for setting up a secure sub-environment. As a result, we maintain global integrity, which is the best solution for financial inclusion, privacy, scalability, security and financial stability.

This article was written by Niels van den Bergh, CEO of mintBlue.

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