Today the Hong Kong Monetary Authority (HKMA), the Bank of Israel (BoI) and the BIS Innovation Hub, published a joint central bank digital currency (CBDC) report on Project Sela. Like most CBDC projects, it involves a public-private partnership. However, a key focus was to expand the range of intermediaries who enable consumers to access the retail CBDC. In other words, they don’t just want to use banks and major payment providers.
“Competition and innovation require a flourishing and open ecosystem with many different types of service providers,” said Mr Andrew Abir, Deputy Governor of the BOI. “This was our initial goal in Project Sela as a proof-of-concept, and the project proved the feasibility of the model we had in mind.”
Previously, Hong Kong’s Project Aurum had the central bank operate a wholesale ledger for the eHKD, and retail banks dealt with all customer facing issues. In contrast, Project Sela has the central bank operate the retail ledger.
This is similar to the approach of Israel’s digital shekel. And that design choice critically influenced much of Project Sella. To broaden the range of service providers who can offer retail CBDC (rCBDC) services requires lowering the barrier to entry and reducing the regulatory burden.
A new kind of CBDC intermediary
To achieve this, the service providers – Access Enablers (AE) – never have control over any CBDC balances. That contrasts with most conventional payment providers. Nor do the AEs need to have liquidity to support the CBDC services.
Their functions include enabling onboarding and access to the CBDC, know your customer and other compliance obligations, and routing the payment. The primary role of banks and other “funding institutions” is to enable the conversion of cash and deposits to CBDC.
Here’s the rationale: “Technological developments in the open banking and DeFi space have demonstrated the ability to disentangle financial services through open access to financial data and end users controlling their own funds,” the report says.
Project Sela envisions the unbanked using ATMs to convert cash to CBDC. However, we observe that in many countries, the design of most ATMs is to give out cash rather than take it in.
Our observation is the addition of Access Enablers could be bad news for banks. CBDC threatens to impact bank deposits. But one of the potential upsides is that some CBDC designs position banks as wallet providers and custodians. That gives them an opportunity to play a significant role in a future world where most consumer assets are tokenized. The Project Sela route does not provide this opportunity.
Privacy becomes even more important for CBDC
If the central bank is operating the retail ledger, then it’s important they can’t see personal information. Hence, the AE’s obfuscate the personal identifiers using a hashing mechanism. Privacy was not the focus of the report, hence it didn’t discuss the issues in detail. However, we’d observe that if the central bank has to interrogate any accounts for anti money laundering, it will always know the identity of that account going forward. Hence, this model may be more challenging from a privacy perspective.
Cybersecurity becomes a priority
By opening up to more intermediaries, the central bank also raises the bar for cybersecurity. The project limited the scope of the exploration, focusing on the security of the rCBDC ledger.
For programmability, the central banks don’t want to take the risk of allowing a program to run on the main rCBDC ledger. Hence, any programmability would be provided by the Access Enablers.
Project Sela also explored safeguarding private keys. The central bank and financial institutions used hardware security modules (HSMs). And it used cloud hosted secure enclaves for the the Access Enablers.
The paper concluded with list of further areas to explore. A key one is the incentives for the Access Enablers.
FIS and M10 were the technology providers for the CBDC side of the project. Clifford Chance provided legal advice and Check Point advised on cybersecurity.
