Analysis of 3 smart contract architectures: Bank of England March Digital Fiat Report
The Bank of England released a 57-page report in March 2020, studying how to introduce CBDC into existing markets [1], both as a store of value and for daily transactions, and analyzed its possible impact on maintaining monetary and financial stability Major challenges posed. This report entitled "Central Bank Digital Currency March 2020: Opportunities, Challenges and Design" is a report after more than 5 years of research by the Bank of England. Many financial institutions, including the International Monetary Fund, began to worry a few years ago that fiat currencies issued by central banks in various countries are losing their market bases, albeit slowly. This view reappeared in foreign media when the Bank of England issued this report in 2020. [2]
The Bank of England (BoE) is seriously considering the pros and cons of issuing a central bank digital currency (CBDC) denominated in pounds. The Bank of England recognizes that the digital pound could disrupt the current banking system. However, digital currencies can take advantage of the latest fintech to make it easier and faster for consumers to transact.
"We are in the midst of a payment revolution. Banknotes are the easiest form of currency available to the Bank of England and they are used less frequently. At the same time, Fintech companies have begun to offer new currency formats and new Payment methods to change the market. These developments have created significant new opportunities, brought new risks, and raised some profound questions for the Bank of England. "Note that they use the word" revolution ".
The Bank of England currently maintains control of the fiat currency (sterling) and has not entered the new digital fiat market. Facebook's announcement of a special announcement to stabilize Libra has forced some countries to seriously consider implementing digital fiat currencies.
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The issuance of digital fiat currencies will be a major innovation for the Bank of England, as such currency transactions often provide more secure transactions, easier remittances, and a way to receive funds. However, this will bring changes in current monetary policy and the risks of volatility associated with certain cryptocurrencies. [3]
If large deposit balances are transferred from commercial banks to CBDC, it may affect the balance sheets of commercial banks and the Bank of England, the amount of credit provided by banks to the overall economy, and how banks implement monetary policy. [4]
Due to the length of this report, we mainly discuss one point here. This is a rare time for the Bank of England to openly discuss the mechanism of smart contracts in digital fiat currencies. If there were discussions before, most of them were brief. This time, three different architectures were proposed to implement smart contracts. I believe these mechanisms have intellectual property rights, so that the Bank of England did not provide details. However, the Bank of England still provides enough information to analyze the differences between the three structures. Other important points are listed in section II. Section III discusses the smart contract perspective of the US Commodity Futures Trading Commission (CFTC). The three structures developed because the Bank of England's smart contract design clearly accepted the views of the US Commodity Futures Trading Commission. The fourth section mainly discusses the three smart contract architectures proposed by the Bank of England, and proposes a new hybrid architecture on these three architectures, and compares the similarities and differences, advantages and disadvantages, and feasibility of the three major architectures. Section 5 summarizes the analysis and mentions 4 directions in the 10 research directions of the blockchain.
This report is a long and popular article, so the same point of view will be repeated and discussed for the reader to read and understand the full text. Here is the important information in the report:
- Retail Digital Fiat : Retail digital fiat is discussed throughout the report. This was originally the Bank of England's original goal, but was abandoned in 2018. It was also the year that the Bank of England attached importance to "wholesale" digital fiat currencies. With the birth of Facebook's Libra, the Bank of England was forced to return to the research of retail digital fiat.
- Wholesale digital fiat currency : However, the Bank of England did not abandon the "wholesale" digital fiat currency, and said it would issue a wholesale digital fiat currency report like this report. In fact, the United Kingdom has already made efforts in this regard. In cooperation with the Bank of Canada and the Bank of Singapore, a joint report was issued in 2018, and the actual project has been handed over to a private company to complete. Universal synthetic CBDC. [5] [6] [7]
- Payment technology changes financial markets : The Bank of England still insists that payment technology changes financial markets. The information released on August 23, 2019 even shocked the Federal Reserve, which mentioned that this change could make the US dollar lose its status as the world's reserve currency. After the study in the United States, the theory was formally taken into consideration in November 2019. The Fed began to study the theory seriously and discussed it extensively during his speech in February 2020. Economists and people in the financial community have always been conservative in this regard, thinking that blockchain or digital fiat currency will not affect finance, will not change the market, and the impact on fiat currency is very limited. The last point is the Fed's public view in June 2019, when Facebook released the Libra white paper. [9] But in October 2019, the Fed invited a professor at Princeton University to give a lecture on the new theory of "digital currency areas", and then publicly discussed the new theory in February 2020. The discussion pointed out that Princeton University theory was the most complete. The European Central Bank discussed Princeton University theory in September 2019.
- Comprehensive evaluation : The Bank of England's report gave important information. The design of the digital fiat currency system needs to be comprehensive. It must not be a single line of thinking. In general, this report is long because it lists many problems.
Let us first discuss the views of the US Commodity Futures Trading Commission. It is worth noting that the Bank of England's views on smart contracts coincide with the US Commodity Futures Exchange. The US Commodity Futures Trading Commission released the "A primer on Smart Contracts" at the end of 2018, introducing the technology of smart contracts. Previously, they also published a blockchain guide. In this smart contract guide, the U.S. Commodity Futures Trading Commission has issued two major points of view that two important applications of smart contracts are:
- Financial transaction algorithms : They believe that smart contracts can be used for derivatives trading because they can be easily digitized and encoded, for example:
- Commodity forward contract
- Futures contract
- Futures contract options;
- Swap.
They believe that smart contracts can simplify transactions (such as options, futures, and swaps), improve the efficiency of pre-trade to post-trade (such as price discovery, execution, clearing, and settlement), and reduce double confirmations, reducing trade, capital, and margin risks, Automatically fulfill the contract.
This information is crucial because the US Commodity Futures Trading Commission is a US regulator that oversees US derivatives (such as futures) transactions.
U.S. Commodity Futures Trading Commission Smart Contract Guide
- Regulatory technology: The US Commodity Futures Trading Commission believes that smart contracts are suitable for implementing regulatory regulations and can be implemented automatically. They believe that smart contracts can strengthen internal written policies and procedures, as well as improve user compliance with legal obligations and regulatory requirements, and help improve regulatory reporting.
- Increase market vitality and efficiency;
- Verify the identity of customers and counterparties;
- Promote trade execution and contract performance;
- Ensure the accuracy of books and records;
- Complete instant regulatory reports.
These confirm the author's point mentioned in the 2018 Chinese Dream of Blockchain article 4, that is, the view that blockchain-based regulatory technology guarantees people's safety.
The Bank of England report proposes three smart contract applications, all of which are based on regulation and are consistent with the views of the US Commodity Futures Trading Commission:
- Option 1: The smart contract system and the core ledger system are combined;
- Solution 2: The smart contract system and the core ledger system are separated, and the two systems are in parallel;
- Solution 3: The smart contract system and the core ledger system are separated and placed on the interface connecting the third-party payment system. [8]
This is in Chapter 6 of the report. The main content of Chapter 6 is shown below:
Outline of Chapter 6 of the Bank of England report, this article discusses only one page
The first solution is the design of traditional smart contracts, such as Ethereum; the Bank of England analyzed this in the report:
"Providing full programmable currency functionality on the core ledger brings significant trade-offs. However, due to the complex calculations that smart contracts may bring, it will affect the performance of the core ledger. Whether these transactions are related to smart contracts, Transactions may slow down as a result. However, this approach may be needed to realize the full benefits associated with programmable currencies. "
Smart contracts are in the core ledger, which is a traditional design
Under this architecture, the Bank of England has full control over the ledger and contract systems, including the development and operation of these systems. Since these system operations are performed within the central bank, the central bank has full regulatory power. This is exactly the opposite of the traditional digital token system (such as the Bitcoin system), which is completely controlled and supervised by the central bank, while digital tokens evade supervision, but all use the same blockchain and smart contract technology.
The question here is whether the ledger and transaction information are handled together in the core system. If put together, this system is difficult to scale [10].
4.2. Parallel processing of blockchain system and contract system
The second solution can make the smart contract platform and ledger system parallel, increasing speed. The report says:
"Another alternative is for the Bank of England to develop an additional" module "separate from the core ledger to manage and process smart contracts. This module will be responsible for processing the smart contract code and then instructing the core ledger when payment is required. This approach It can mitigate the negative impact on the performance of the core ledger system, while the Bank of England still assumes the function of a public creditor. This module will require appropriate permissions to transfer users' funds, as well as the process by which users control and approve this function. This approach will need to revolve around Think about everything, including the user authentication process. "
Smart contracts and core ledger processing in parallel
Compared with the traditionally designed smart contract architecture, the architecture here is more reasonable in designing that the ledger service and contract service are processed separately. Under this structure, the Bank of England still has complete control over the core ledger system and contract system, including development and operations. Because these operations are carried out entirely within the central bank, the central bank still has full regulatory power. The Bank of England did not provide technical details here. We add 2 options here:
- All trading operations are handled by the contract system. In this way, the core ledger system is to provide database service management accounts;
- Part of the transaction operations are handled by the contract system, but some remain in the core ledger system. In many application scenarios, smart contracts perform only some functions, and a transaction may be completed by multiple smart contracts, such as a verification of identity, a bookkeeping, a completion record, and a tax return.
If the first solution is adopted, the core ledger provides ledger services, and the contract system provides transaction services, so that the ledger system can be expanded and fast, which is the starting point of the panda model. The core ledger system here is the ABC account chain in the panda model. If there are many smart contracts, how to build the contract system here is still a research topic, because most smart contracts just complete an operation in a transaction. In computer theory, this is the concept of microservice.
If the second solution is adopted, how to design the core system is a research topic, while the contract system may be easier to design. If the core system does not process the ledger and transaction data separately, it is difficult to expand. If it is not designed well, the performance may be worse than the first solution, because the contract system and the core ledger system both have contracts, and the two combinations still have interactions. If these interactions are well designed, performance can be improved a lot, but if they are not designed well, system performance will be worse.
The third option is closer to the application side, and the report says:
"The third option is the minimum and low-functioning smart contract that the Bank of England will provide, because external payment providers can provide better and more complete smart contracts. The minimum functionality may include locking funds to a valid escrow service with a password. In this approach, the Bank of England will also play a role in developing smart contract functional standards. These standards will ensure interoperability between providers and set minimum security standards, but will not determine how to provide service."
Smart contracts run at interfaces with outside merchants
Under this architecture, external smart contracts are provided by suppliers. There are still many tasks that the Bank of England needs to prepare:
- Develop your own ledger system and contract system;
- Propose regulatory policies;
- Verify that external smart contracts comply with regulatory policies.
All interactions with the core ledger here are still developed and operated by the central bank itself. For example, the central bank's core system and smart contracts are used to ensure the security of the central bank system.
Therefore, the smart contract of the central bank needs to provide 2 major functions: 1) complete transactions; 2) engage in supervision. The external contract system provides: 1) completing some transactions; 2) providing other services other than the central bank, such as discounts, insurance, or connection services.
The plan here is basically that the central bank provides fund investment management mechanism and services. This means that no matter how the external system is designed, it is ultimately supervised by the central bank system.
The above three mechanisms will not be the only choice. For example, these three mechanisms may be used at the same time, or any two mechanisms may be used simultaneously. Because there will be more than 2 sets of contract groups that may run at the same time, when the system is designed, you need to ensure that there is no conflict when running.
If the three mechanisms are used together, some contracts are in the core ledger, some contracts are on a parallel system, and there is another contract system in the interface. For example, the contract for the completion function of the transaction is deployed in the core system. The independently executable contract can be processed in parallel outside the core ledger, and the contract for real-time monitoring or verification information is on the interface. Since the data contacted by the three sets of contracts are different, the design will not conflict.
Smart contract model for troika
The Bank of England spent only three paragraphs discussing these three options, but we took a lot of time to explain them, and these three options have different characteristics in many aspects. Since the Bank of England did not provide details, we need to provide details, so the details we provide may not be the same as they imagine, but because the problems encountered in system design are scientific problems, the scientific problems and solutions facing the UK and China are both Are similar.
The three smart contract platforms proposed by the Bank of England are rare designs. Don't think that the Bank of England has nothing to do. Feel free to come up with these new plans and write them in the report. In the last report of the Bank of England's RTGS (Real-Time Gross Settlement) experiment, the experiments in the report were unsuccessful (several teams did not complete the system connection, which is equivalent to the expiry of the experimental deadline). However, in this "failure" report, a new design idea of "one currency, one chain, one current account" that was later released in 2019 was actually proposed. [11] Therefore, we believe that the Bank of England must have considered these three options, and have different views internally.
In the past, some units spent a lot of time designing systems to avoid government supervision. Here the Bank of England spends a lot of time designing blockchain and smart contract systems to regulate financial transactions.
This report the Bank of England still insists that the various solutions they are discussing can be completed using the blockchain system, but can also be completed using traditional centralized systems. But if these schemes are really implemented using traditional centralized systems, these schemes seem strange.
5. Summary
This article only discusses about one page of the Bank of England report (57 pages in English). You can see that the report is rich in content. In the questionnaire, Britain has actually reflected their choice of major points. For example, the Bank of England does not ask whether to use blockchain and smart contracts, but asks which smart contract platform design is most suitable for the central bank's configuration.
This article also touched on 4 directions in the 10 research directions of the blockchain we mentioned:
- Software and hardware design: The Bank of England proposes three smart contract structures, and we add one;
- Regulatory technology: here the UK has always focused on regulatory technology, including regulatory policies;
- Trading technology: here the UK offers a variety of trading platform design solutions;
- Smart contract: Here the UK proposes three major contract operation platforms, the main two functions are to complete transactions and supervision;
The solution proposed here also needs to be solved urgently. For example, the design of smart contract platforms will affect the settlement and settlement of transactions, the regulatory mechanism, the speed of transactions, and the service design of external suppliers.
Due to the importance of smart contracts, we are completing a smart contract monograph, which is expected to be published in July 2020. It will also mention many other new smart contract technologies.
references
[1] .https: //www.bankofengland.co.uk/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design-discussion-paper.
[2]. Cai Weide, Jiang Xiaofang, "The Bank of England declares war on third-party payments and digital tokens-in the manner of a British gentleman", 2019.06.27.
[3] .https: //www.coindesk.com/understanding-dao-hack-journalists.
[4] .Bank of England (2018), 'The Bank of England's future balance sheet and framework for controlling interest rates: a discussion paper'.
[5] .https: //www.bankofengland.co.uk/working-paper/2018/broadening-narrow-money-monetary-policy-with-a-central-bank-digital-currency.
[6]. Cai Weide, Jiang Xiaofang, "Rebuilding the Global Financial System Based on Wholesale CBDC Digital Currency", 2019.10.01.
[7]. Cai Weide, "Development of Foreign Digital Fiat Currency", 2019.10.23.
[8]. Https://www.ecb.europa.eu/pub/pdf/other/stella_project_report_march_2018.pdf.
[9]. Cai Weide, "3 Principles of Digital Fiat Currency: Important Information Brought by Facebook Libra", 2019.08.24.
[10]. Cai Weide, Jiang Xiaofang, Liu Can, "The fourth biggest pit of the blockchain (middle)-Is the blockchain sharding technology a scalable solution?", 2018.8.2.
[11]. Cai Weide, Wang Juan, "Digital Fiat Currency: New Global Currency under Asymmetric Regulation", 2019.11.12.
[12]. Cai Weide. Panda-CBDC Central Bank Digital Currency Model. 2016.11.05.
Xiang Weijing
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