Transparency, Interoperability and Systemic Risk Considerations for CBDCs

In the wake of the announcements of Facebook’s Libra and the Chinese government’s intention to have a Central Bank Digital Currency (CBDC), the topic of CBDCs as a new component of a country’s legal tender has become popular with governments and commentators. The basic idea is to have fiat money represented in digital form. While most, if not all fiat currencies currently have a digital form (central banks create and track their currencies on computers), the CBDCs under discussion would bring about multi-functional digital money that is able to move in the digital world (from computer to computer and other devices) rather than just sit static on a database. It would also be programmable such that its movements could be automated. Many theorize about how such a fiat digital currency would revolutionize payment systems and other digital financial and commercial activities through efficiency, convenience, and versatility.

the #CBDCs under discussion would bring about multi-functional digital money that is able to move in the digital world Click to Tweet

How this new digital money would work from a policy, economic, and architectural standpoint also has spawned much discussion. Practical questions abound, such as how a transition to digital money might work, to what extent would fiat currency be only digital in nature, what technology would underly any such CBDC (e.g., blockchain or other distributed ledger versus a more centralized database), who would hold accounts at the central bank (e.g., only the largest banking institutions on a spectrum to every person). Some have argued that a CBDC would smooth the distribution of government aid in this time of COVID-19. For a sense of many of the key points that have emerged in the discussion of CBDCs, this article includes a selection of links to resources at the end.

The purpose of this article is not to catalog nor opine on the many considerations that various consultation papers, studies, and articles do a good job of identifying and discussing if not actually solving. Examples of important issues that have come under consideration include personal privacy,¹ the technical architecture of a CBDC system,² and the potential macro impacts on the financial system, as well as monetary and fiscal policy.³

Rather, this article focuses on three particular considerations that have received comparatively little attention and attempts to provide brief but useful thoughts on each.

The first is transparency, though not as the opposite of individual privacy rights but around the architecture and structure of the entire CBDC system from both a technical and organizational perspective. Two questions summarize this issue: how is the technology architected and programmed? Who plays what roles in the implementation?

The second little-noticed area concerns interoperability. A CBDC may be designed to have broad uses but the ways it can be used on or with other systems is critical. This includes whether it can be traded or used as payment on digital asset exchanges and digital marketplaces for goods and services and whether it can be withdrawn and used like cash. Without the ability for a digital fiat currency to be used extensively in commerce, the central bank is stuck in the present, not preparing for the future.

Without the ability for a digital fiat currency to be used extensively in commerce, the central bank is stuck in the present, not preparing for the future Click to Tweet

Third, more thought should be given to the systemic risk considerations of a digital fiat currency. I argue that CBDCs will, in fact, decrease systemic risk for many of the reasons that strong fiat currencies create a level of financial stability but also because it would bring a new diversity to the financial system. Of course, it is incumbent on central banks to manage the currency well in order for systemic risk to remain in check.

This article discusses each of these three considerations in turn.

CBDCs could prove the most important financial innovation since the end of the Bretton Woods system. Personally, I am a believer that governments should begin to adopt CBDCs and think that private, fiat-linked digital “stablecoins” are the laboratories pointing the way. Those experiments are ripe for encouragement and study to help chart the course for the successful future of CBDCs.


Transparency in CBDC

Transparency can be a nuanced term because it is often applied selectively. People and organizations make decisions about how much transparency they will permit: what to disclose what to keep secret and from whom. In a radically transparent scenario, everything is disclosed or at least visible on demand by everyone. Such an architecture does not respect privacy, which many CBDC commentators rightly describe as a fundamental human right. At the other end of the spectrum is complete privacy, where no information is available to anyone other than the person involved.

This article is not focused on questions of personal privacy around transaction, identity or other information but rather on the transparency of the system itself and advocates for disclosure of the functions, features and primary activities around any CBDC, including the rights and obligations of participants. This transparency of the overall design and architecture would create the trust needed for broad adoption of a CBDC. There are two primary areas where transparency should be mandatory in order to establish integrity: the code on which the CBDC functions, and the responsibilities and liabilities of key actors.

With respect to the latter, a CBDC system should disclose the different participants and their roles in the CBDC implementation, from the central bank and the direct account holders to the custodians of accounts, payment processors, wallet providers and other permissible intermediaries. The CBDC system should be clear about the different activities and capabilities of each participant in the system.

Where does the digital money come from and who creates it? Is the system account-based (balances are reflected only in user accounts) or token-based (digital items are held directly by users)? How are balances updated and those updates verified?

What permissions does each participant have and do they differ in ways that make sense given the role? Can they recover my account if I lose access, fix errors, or make other changes? What types of accountability are built into the system and who is responsible for them? What liability is associated with each participant and their activities and how is liability established such that they are accountable? What compensation do they earn for their activities and how is it set? How will the programmability of the currency, if any, work?

These are important questions for the design and architecture of the CBDC platform and need to be known to all in order to create an appropriate level of integrity and verification in the system. The Bitcoin blockchain establishes trust through reliance on open-source computer code and the role of miners each checking the others’ work before an update can occur. Those features maximize transparency to create trust, but they are not the only way to create a Byzantine fault-tolerant platform (as a proxy for trust). Intermediaries can be trusted too but only if their roles, responsibilities, compensation and liability are well-understood. The choices of the CBDC designer with respect to actors on the platform will need to create Byzantine fault tolerance or other trust for all stakeholders.

The above concerns participant transparency but there are also important transparency issues associated directly with the programming of the software. It must be an interactive, iterative process that relies on crowdsourced skills and competencies. Open source code allows all stakeholders an equal ability to access, read and assess the computer code, look for bugs and larger flaws, and otherwise test that the code functions as disclosed and is not subject to exploits that can result in hacks, stealing or even bringing the system down. A CBDC will need an equivalent means to let stakeholders trust the code and thereby trust the currency.

There will be objections to this level of transparency, some of them strongly stated around national security and safety. These complaints will not withstand scrutiny. Stakeholders are tired of secrecy about money and the complex systems that create, distribute, and process it. People need clarity around the workings of important financial processes in their lives so they can participate effectively, plan effectively, and be responsible users. The vast preponderance of those stakeholders will be good people. Systems should be designed with transparency to encourage the good because that marginalizes the bad and results in a platform more likely to realize its positive attributes and become ubiquitous.

Moreover, much of financial services regulation focuses on disclosure and transparency by regulated entities and their activities, systems, processes and other minutiae. These disclosure obligations stem from the ideal of making it more difficult for bad actors to thrive. There is no good reason to exempt a CBDC from these principles.

We see the same trends beyond financial services. In the COVID-19 crisis, more transparency and information was used to “flatten the curve”, protect populations and their return from self- quarantine and rework production and supply chains to get needed medical and other materials to the places that needed them most.

Lastly, transparency creates resiliency, not only from the standpoint of systems that weather attacks but also systems that evolve and upgrade to meet threats and challenges or just make practical changes that benefit users. Transparency will help drive innovation both with respect to the CBDC platform and flexible usage of the CBDC.

Countries that adopt CBDCs will want excellence as they replace existing systems. Transparency will help ensure excellence; indeed, it is a key feature of excellence.

Countries that adopt #CBDCs will want excellence as they replace existing systems. Transparency will help to ensure excellence. Indeed, it is a key feature of excellence Click to Tweet

Interoperability in CBDC

For a CBDC, interoperability is about its ability to be multi-functional and multi-platform, to play well with others. Thinking about physical cash illuminates the concept.

Someone carrying US dollars in cash walking around New York City can buy a lot of things. That’s a level of interoperability. But that same person carrying US dollars in Paris has much less ability to buy. And that same person trying to use physical cash on the internet has lost all ability to spend it. Physical cash has fairly good interoperability in the physical world if you’re in the right country but its interoperability declines quickly outside its primary context.

Digital money, on the other hand, can have excellent interoperability. Credit cards show the way. The same New Yorker carrying a credit card can spend money in New York City, in Paris (because the credit card company and banks convert to the appropriate fiat currency) and online because the payment rails move the digital money to the right place (at least most of the time).

A CDBC could break down these barriers even further. This idea is part of the original conception of Bitcoin: you can spend it anywhere simply by using your private key to sign a transfer from your account to the recipient’s account. There is no technological reason that prohibits a CBDC from fulfilling this promise. In fact, it is one of the primary benefits of digital fiat money. 5

Most #CBDC proposals are not considering interoperability because they are trying to merely duplicate the existing system. Such limited vision will stifle the efficiencies and innovation that an interoperable CBDC can deliver Click to Tweet

Most CBDC proposals are not considering interoperability because they are trying to merely duplicate the existing system. Such limited vision will stifle the efficiencies and innovation that an interoperable CBDC can deliver. Put another way, a CBDC designed to function on or in conjunction with any platform will become a reserve currency and dominate, or at least have a significant role in, commerce for the next several generations. Everyone will want it because it works most everywhere, creating a simple store of value and facilitating fast, efficient and immediate payments. And adding programmability to interoperable digital money will further expand the possibilities. Fiat-linked stablecoins, discussed below, strive to fill the current lack of interoperable digital money, so the demand is clear.

The type of transparency discussed above serves the cause of a truly interoperable CBDC because it allows all participants and stakeholders to trust the digital money and trust that it will function in all or nearly all contexts. CBDC has the benefit of being backed by the full faith and credit of the government. Combining that backing with transparency and interoperability will result in even higher levels of trust in the CBDC and leads into our next point.

Systemic Risk in CBDC

Systemic risk is the idea that financial system collapse might occur as a result of tight linkages between and among certain factors, products and/or activities when one or more triggering events happens. The concept rose to prominence after the 2008 financial crisis and there is extensive literature on the topic, particularly from global financial regulators. The resources at the end of this article link to some items for reference.

There are two primary unknowns associated with systemic risk:

(1) what will trigger it and

(2) why will the triggering event cause financial system collapse rather than just remaining isolated to a single entity, sector, or country.

Because of these unknowns, the regulatory response to systemic risk has been sweeping requirements designed to strengthen all institutions, spread risk broadly amongst financial markets participants and conduct scenario analysis of different possible internal and exogenous “shock” events to analyze the flow and spread of possible repercussions across institutions, segments of the financial markets and the global financial system as a whole.

A CBDC is just a new format for the fiat currency, so in that sense it should not introduce any new systemic risk. It may change some of the plumbing of the financial system in ways that reduce operational and credit risk but it is not a new instrument, it does not change the denomination of anything and it can be used exactly the same as existing money (because it really is the same as existing money!).

A #CBDC is just a new format for the fiat currency, so in that sense it should not introduce any new systemic risk Click to Tweet

But there are other forces at play, in particular fiat-linked stablecoins and the rise of digital ecosystems, both of which drive the continued drawing together of global activity, communications, information-sharing, commerce and markets. These tight linkages, together with existing financial instruments and their markets, make it important for CBDC creators to consider how CBDCs can help lower systemic risk by adding trust and diversity into the system.

For our purposes, stablecoins are digital currencies designed to have a stable value against a fiat currency.6 They are privately created and operated, sometimes on a decentralized basis, and seek to provide a technological bridge between blockchain assets and fiat currencies. They make fiat currencies blockchain-friendly so that transactions in fiat can occur on blockchains. Assessments of their possible risks, systemic and otherwise, have been written, a selection of which are linked to below.

Digital ecosystems, which I sometimes refer to as “platforms as cities”, are simply self-organizing communities in the digital world. They are sometimes centrally operated, like many social media platforms or multi-player online games, but also can be decentralized, like public blockchains. These ecosystems can be commercial in nature but also can have many other purposes, from simple communications to academic pursuits to gaming to political organizing to unlawful activity. The key is that they attract people from around the globe and allow them to interact under a common architecture and set of rules.

Stablecoins and digital ecosystems are significant contributors to, and accelerators of, global closeness that will soon allow anyone, anywhere, to communicate and trade with anyone else anywhere else, so long as they both have access to a computer and the internet. CBDCs will play an important role in the financial system as it grows to accommodate and serve digital ecosystems and global closeness. They can contribute to financial stability within the digital realm and its ecosystems but only if they respect the values of transparency and interoperability discussed above.

The recipe might seem deceptively simple: govern responsibly so your currency is stable and make sure the CBDC can function across platforms such that it coexists with all digital assets, both traditional and newer. But it will also require the trust that comes with transparency and the interoperability that allows for diversity of options, including private money (like multi-purpose cryptocurrencies and fiat-linked stablecoins).

The second part, multiple types of money, might be easier to conceptualize and integrate because we already live in a world of award points, in-game gold, and prepaid cards, to name a few current offerings. Transparency, however, should not be too difficult either, as we have seen the rise of data collection and availability coincide with disclosure-based regulation.

CBDCs offer at least two means of reducing systemic risk. First, fiat currencies already underpin nearly all of the financial system, notwithstanding the introduction of cryptocurrencies and decentralized finance. Second, fiat currencies benefit from government backing, creating greater stability, particularly for developed economy currencies.

Governments, central banks, and global institutions tout the benefits of fiat currencies. With the right transparency and interoperability, the CBDC versions of fiat currencies might bring those benefits to the digital world.

The near future of CBDCs among the G-20 will involve much debate and many proposals. Stakeholders and commentators should judge the proposals across a range of factors but should be consistent in advocating strongly in favor of proposals that skew towards transparency and interoperability that thoughtfully address systemic risk because the three concepts are tightly coupled. Reimagining commerce and finance around a CBDC is fun with the endless possibilities it allows. The consequences of the wrong final design and implementation, however, will create new problems and exacerbate existing conditions. We should do better than that.

Governments, central banks, and global institutions tout the benefits of fiat currencies. With the right transparency and interoperability, the #CBDC versions of fiat currencies might bring those benefits to the digital world Click to Tweet


Lee A. Schneider is General Counsel at, one of the world’s largest blockchain companies and creator of the EOSIO blockchain protocol.  In that role, Schneider is responsible for various aspects of the legal function as well as the company’s government affairs initiatives. He joined after leading the blockchain, Fintech, and broker-dealer practices at two major international firms.  Lee has been recognized as one of the leading voices in blockchain-related regulation and compliance and has played a role in structuring several of the largest and most successful blockchain-related projects. Schneider co-hosts the Appetite for Disruption podcast with Troy Paredes and is the contributing editor for the Chambers and Partners Fintech Practice Guide. He is the contributing editor of the Chambers and Partners 2019 Fintech Practice Guide.


Selected Resources-CBDCs:

CoinTelegraph survey article on CDBCs Oct. 2018
Zerohedge article “CBDC: The Overarching Goal Behind the Digitisation of Money” Apr. 2020 BIS paper updating of survey on CBDCs
French central bank consultation paper on CBDC
UK central bank discussion paper on CBDC
Bank of Korea Working Paper on CBDCs and financial stability Feb. 2019
Bank of Japan Working Paper on CBDCs and the digital and data revolution Feb. 2019
European Central Bank Working Paper on Tiered CBDC and the financial system Jan. 2020
Bank for International Settlements Mar. 2018 report on CBDC
Bank for International Settlements Quarterly Review on payments Mar. 2020
European Parliament study on cryptoassets Apr. 2020
Press release announcing central bank working group on CBDCs, including European Central Bank, Bank of Japan, Bank of Canada
Dutch Central Bank report on CBDC Apr. 2020
World Economic Forum toolkit on creation and introduction into circulation of CBDCs
Fed Governor Brainard Oct. 2019 speech, Feb. 2020 speech on CBDCs
Digital Dollar Project website
Kenneth Rogoff article on China’s proposed CBDC
Bloomberg Law article identifying potential issues with proposed legislation on digital dollar Apr. 2020 by Patrick Murck & Linda Jeng of Transparent Financial Systems Inc.
Academic paper on architecture of digital currencies to ensure privacy May 2019 by G. Goodell & T. Aste, Univ. College London
Selected Resources-Systemic Risk:
Bank for International Settlements article “Systemic Risk: How to Deal With It”
Working Paper “Basel III and Systemic Risk Regulation: What Way Forward?”
University of Pennsylvania Wharton School summary “The Causes of Systemic Risk – and Ways to Prevent Them” Jun. 2016
Selected Resources-Stablecoins:
FINRA alert “3 Things to Know About Stablecoins” Apr. 2020
Financial Stability Board paper on global stablecoins Apr. 2020
IOSCO paper on global stablecoins Mar. 2020
European Parliament monetary dialogue paper “Public or Private? The Future of Money” Dec. 2019
G7 Working Group paper on global stablecoins Oct. 2019 Selected Resources-Miscellaneous:
Wikipedia entry on Bretton Woods system
Wikipedia entry on Byzantine fault
Article on Byzantine fault-tolerant algorithms Wikipedia entry on open source software movement
Wikipedia entry on open source software movement

1 If everyone has an account at the central bank that bears their identity, then the central bank knows everything about every transaction you make, unless physical cash simultaneously exists. While that may be excellent for the detection of money laundering, terrorist financing, and other unlawful activities, it subverts personal privacy. The situation is exacerbated if the central bank permits others to view your information, even for legitimate purposes such as credit reporting, to support a loan application or other forms of due diligence in business and personal arrangements.
2 The importance of technical architecture cannot be overstated, as the articles and reports recognize. The choices that are made about technological architecture and structure can dictate the outcomes for many of the other issues, including privacy. If the CBDC is designed with a strong zero-knowledge proof technology, for example, you may solve the privacy issue without much ado. If the central bank builds in a back door to the zero knowledge proof system, you have both solved privacy and undermined your solution. Designing the system from the outset to credibly protect agreed-upon rights and values would use code to ensure integrity.
3 These are perhaps the most wide-ranging questions and by their nature involve educated speculation. The results for the financial system might be very different depending on whether the central bank allows direct retail accounts compared with a “primary dealer” like structure for choosing which banks are direct participants in the CBDC. Moreover, the question of whether the CBDC is the only representation of the fiat currency or is implemented in conjunction with other options can play a decisive part in the impacts not just for the local economy but the broader world economy. A CBDC system with automated inflation might effect monetary policy programmatically. There is much more to think about here and the articles and reports highlight many considerations.
4 There may of course still be foreign exchange issues with a CBDC. The point is that an interoperable CBDC might play such a natural role in commerce that it becomes widely accepted outside the home country, something that is impossible for a CBDC that is not adaptable outside its platform of origin.
5 This definition is intentionally narrow. Stablecoins could be designed to achieve stability against any asset, as I have expressed elsewhere. See remarks at US Commodity Futures Trading Commission, Technology Advisory Committee meeting, Oct. 3, 2019 video [starting at 18:04]

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