Bakong: How Cambodia’s blockchain-based central bank digital currency works
How it works, the problems it solves and how and why Cambodia's upcoming CBDC uses blockchain.
Cambodia's central bank, the National Bank of Cambodia (NBC), will launch a blockchain-based central bank digital currency (CBDC) within a few months, NBC director-general Chea Serey has reported to The Phnom Penh Post.
The initiative is called Bakong and it's been specifically designed to facilitate financial inclusion across Cambodia. Initially, it will be for domestic payments only, but eventually it's intended to be used for cross-border payments too.
For the end-user, Bakong will take the form of a mobile payments app, created by the central bank, which lets people send money peer to peer to Bakong-connected phone numbers and make payments by scanning QR codes. Using Bakong requires a bank account, and Bakong payments are made from the user's bank account. Initially, Bakong accounts are not expected to pay interest.
But how exactly does it work and why does it use blockchain?
What the Bakong blockchain looks like
The Bakong blockchain is an implementation of Hyperledger Iroha, which is a permissioned blockchain framework, with a strong emphasis on modular, safe and easy-to-write smart contracts for managing digital assets.
The consensus algorithm powering Hyperledger Iroha is called Yet Another Consensus (YAC), although, for obvious reasons, this is usually just left as YAC whenever it needs to sound professional.
But the consensus algorithm probably isn't overly important in this case, because the NBC will be the network's sole validator. The other non-validating nodes on the network will be commercial banks (and potentially other financial institutions).
The banks involved in the transactions can see details including customer names and transaction details, but the central bank only sees anonymised serial numbers. The digital currency itself is held in Bakong Settlement Accounts.
Participating banks can allocate funds to these Bakong Settlement Accounts by exchanging their existing reserves – held at the central bank – for Bakong money. Commercial banks can then distribute this Bakong money to their customers, which includes both individuals and businesses.
It can (really quite roughly) be visualised like so:
There are several advantages to using this particular arrangement, compared to other arrangements:
- Compliance. It doesn't open up any new money laundering risks, and commercial banks are still responsible for all the compliance legwork in this system.
- Ease of adoption. This system can be introduced with minimal disruption. Central bank and commercial bank responsibilities remain similar.
- Low risk. The central bank balance sheet remains the same size and it can limit Bakong Settlement Account balances and cap Bakong money transfer sizes at a level it's comfortable with.
- Good data. The central bank doesn't have undue access to commercial bank customer or payment information, but this data is still available to commercial banks and accessible when needed.
Additionally, some of Hyperledger Iroha's features perfectly match some of the things the NBC hopes to achieve with Bakong.
The problems it solves
According to the World Bank, more than 40% of the population sends or receives domestic remittances each year, but less than 5% of the population sends remittances through bank accounts. The bulk of those remittances are done with over-the-counter payment service providers, such as with cash payments at Western Union branches. Another large chunk of Cambodia's domestic remittances each year are just cash deliveries.
Only 22% of Cambodian adults have a bank accounts, but the country also has more mobile phones than people.
The problem, as the NBC described it, is that Cambodia has a very fragmented and cash-heavy payments system. It's dominated by cash usage and networks of payment service providers, which operate largely separate from the country's commercial banks.
This exceptionally heavy cash use makes it harder for financial services to bridge that gap.
The main way Bakong solves this problem is by creating an entirely new network to encompass all players, from the central banks to the commercial banks to third party financial services. It's been designed to be easily accessible to all of these parties, letting them seamlessly transfer value between each other.
Individuals can equally tap into the Bakong network and start enjoying similar levels of financial services directly through their banks, or via the mobile money and over-the-counter payment service providers, who can themselves tap into Bakong via commercial banks.
This accessibility is one of the reasons it's using blockchain, NBC says. And going forwards, Hyperledger Iroha is specifically designed to make it quick and easy for these participants to start building financial services into the network.
The advantages of Bakong
So far, the network itself probably sounds similar to any other payment app.
But one other key difference between Bakong and other bank apps like WeChat Wallets, Apple Pays and Alipays, is that Bakong payments directly settle in digital currency, while all those other payment methods still rely on banks moving money around behind the scenes. With Bakong payments, you're actually moving currency as an "object", rather than simply moving a "claim".
Object vs Claim payments
The International Monetary Fund characterises this distinction as the difference between "Claim" type payments and "Object" type payments.
When you make a bank transfer to someone else, what you're actually transferring to the other person is a "claim" to a certain amount of money held in a bank account. The recipient doesn't get the actual money, they just become entitled to a certain amount of the money in your bank account. It's up to your bank and the recipient's bank to move the actual money between each other at a later date.
Stablecoins are also "claim" payments in this way, because they represent a claim to a certain pool of actual money being held elsewhere.
Bakong payments, however, are actually more akin to something like Bitcoin because both Bitcoin and Bakong are "object" payments. Instead of simply transferring a claim, you're actually transferring an "object" (the digital currency) that holds value in its own right. Also like Bitcoin, the Bakong currency lives on a blockchain.
The key benefits of Bakong, the reason the NBC created it and the way it uses blockchain technology are primarily built around the advantages of "object" payments rather than "claim" payments.
The benefits of object vs claim payments
"Claim" type money represents a claim on an underlying pool of assets. It's basically a digital IOU.
So when you make an instant domestic bank transfer of $20 from your bank (Bank A) to the recipient's bank (Bank B), what actually happens is Bank A sends an IOU for $20 to Bank B. Having received that IOU, Bank B gives $20 of its own money to the recipient.
The banks will then periodically settle up all those IOUs with each other through a central clearinghouse. Theses clearinghouses are typically entirely separate companies with hundreds of their own employees, and their own expenses and revenue streams that they get from charging banks. International transfers are based on a broadly similar system of IOUs.
This is the enormous, expensive, complex system that underlies most payments networks. And it's all done to create the illusion of instant payments.
These costs are part of the expense of consumer money transfers and financial services. And because all business involves payments, and almost all payments have to go through this system, its costs are also gently baked into almost everything else you'll ever spend money on, from groceries to entertainment.
However, by swapping out "claim" type currency for a digital "object" type currency, you have a way of making instant payments without all those complicated and expensive things going on in the background. It also lowers the barriers for entry to new financial services companies and prevents banks from using their clearinghouse access to monopolise a country's financial services industry.
Using digital currency to move from "claim" money to "object" money is just all-around much cheaper, faster and more efficient.
There's no question of whether digital currency can be better. The real challenge is finding a way of doing it safely and without introducing new problems.
This may be where Bakong's design really stands out as an example of practical blockchain-based CBDC.
Disclosure: The author holds BNB, BTC at the time of writing.
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