Since the Bitcoin whitepaper, it has become obvious that the current debt-based fiat system is obsolete. However, Bitcoin itself remains controversial, even as it continues to gain adoption as a method of transferring value, globally and at scale. Since Bitcoin emerged from obscurity to the global discourse, the debate has raged between those who advocate for Bitcoin itself, and those who advocate for “blockchain, but not Bitcoin.”

This latter position is popular among those who would like to implement a CBDC in their respective countries.

What is a CBDC?

A CBDC (Central Bank Digital Currency) uses some of the technologies that Bitcoin pioneered, especially decentralized ledger technology (DLT). But where Bitcoin is pseudo-anonymous, permissionless, and fully decentralized, CBDCs are permissioned, not at all anonymous, and only decentralized to an extent that government actors may retain control over them. The Peoples’ Republic of China has implemented a CBDC with some success, and it has been proven to work. There are many reasons to implement it, but there are also many concerns.

The Good

The positives are manifold. For one thing, a CBDC represents a much more frictionless way to transfer sovereign fiats than is currently possible under traditional banking practices, in that, while bank transfers currently take days, CBDC transfers take seconds, or fractions of a second.

Secondly, a CBDC allows governments to inject fiscal stimulus in a highly targeted way, lending much more validity to MMT assumptions than currently apply under the debt based system. This is because DLTs, and, by extension, CBDCs, are programmable money, and can be made to do very specific and discrete things in response to digital oracles.

Thirdly, what is for some a bug, is for others a feature; namely, it allows for significantly more direct control over inflation, deflation, and economic activity. The supply of money can be expanded or contracted instantly. Certain purchases or behaviors can be incentivized, while others can be disincentivized.

Fourthly, CBDCs are not necessarily debt based. For that reason, there need not be any sovereign debt. If there are concerns about the inflation of the currency, the government can simply proportionally reduce the supply of the CBDC across all accounts to offset it. Now, some CBDC schemes have involved simply granting M1 accounts to all users, in which case, it would conceivably still be debt based; but now on an individual level, rather than an institutional level, but this needn’t necessarily be the case.

Finally, calculating taxes owed becomes a fully instant and automated process, and taxes can even be collected automatically; tax evasion could be basically eliminated in a lot of ways.

The Bad

The legitimate concerns are just as numerous. While CBDCs offer an opportunity for governments to respond to economic concerns in much more dynamic and targeted ways, they also do nothing to constrain government spending. Additionally, they provide tools for extreme warrantless surveillance and economic censorship. CBDCs represent a tool of absolute power over the economy, all the way down to individual savings and spending choices. Finally, CBDCs expose individual savings to the very real risk of hyper-inflation. CBDCs are not necessarily debt based, and if they are, they are designed in such a way that rates can go extremely negative by forcing a negative savings rate. This means that there is nothing to stop the government from inflating it infinitely, as opposed to now, where they are somewhat (though not totally) constrained by the zero bound interest rate.

Under the current system, governments are at least theoretically constrained by sovereign bond interest rates. Although, in reality, governments can get around this through the monetization of debt, there are other consequences it must face if it does this. With a CBDC, governments can simply confiscate from accounts at will to offset inflation from government spending, causing the currency to retain its value. In short, a CBDC puts a citizen completely at the mercy of his/her government. This is a terrifying tool in the hands of a corrupted government, and almost all governments become corrupt over time.

The Ugly

In spite of the problems related to CBDCs, their adoption may be inevitable. The current system is extremely Byzantine, slow, and inefficient. As more and more countries adopt CBDCs, retaining legacy systems will introduce relative drag, making commerce with those countries more complicated and less attractive. Additionally, the internal inefficiencies will make domestic production more relatively expensive. 

The Need for a New Approach to the CBDC

Since the global adoption of CBDCs is highly likely, there is a need for a version of a CBDC that addresses the many legitimate issues that detractors have about them. What follows is a proposal for such a CBDC.

Some Assumptions:

1. This paper was written for a socialist audience. The first assumption is that the government has partially or fully nationalized systemically necessary industries; particularly industries related to the production of raw hard commodities (e.g., the mining industry).
2. Financial institutions in their current forms do not need to be accommodated. If they do need to be accommodated, then there are work-arounds for that which I will address later.
3. The government is able to develop networked ledger devices that are not readily hackable.

I will describe the proposed CBDC, and then I will explain how it addresses each of the legitimate concerns mentioned before.

The Proposal

I propose a CBDC based on a permissioned version of the sharded proof of stake technology being developed by the Ethereum foundation. The dollar will be reimagined as the native token of this blockchain, rather than its current status as a debt note. Banks in their current form will be phased out, as will the Federal Reserve. The Treasury department will be significantly restructured in a way that fulfills the original intent of the US Constitution (not that this proposal is specifically for the USA).

Instead of a legacy central bank and associated commercial and investment banks that have M1 accounts with that central bank, there would be institutions which managed permissioned nodes. These nodes would be similar in most respects to Ethereum nodes, except that they would have to be permissioned by the SEC (or similar administrative body), the nodes would function as delegated proof of stake (DPOS) nodes for individual account holders, and the administrators would have to meet certain criteria. 

CBDC Node Criteria

These criteria are as follows:

1. Each institution would be able to administer a maximum of 10 nodes.
2. Each of these nodes would have to stake between an equivalent in today’s (10/07/2023) USD value of a minimum of $1 billion and a maximum of $3 billion. Any value over $3 billion in a single node would be automatically and instantly taxed at 100%, and that tax would be delivered to a blockchain address of the Treasury department. If any of that institution’s nodes exceeds $2.75 billion, they cannot accept any additional account holders.
3. The owners of these institutions would have to disclose any relationship they have to anyone else who has an ownership stake or is employed by any of the other institutions. If they are found to collude with them or fail to disclose them, that will be punishable by incarceration with hard labor for a period commensurate with some multiple of the financial gain acquired through the relationship.
4. Each individual account holder would have a single address that is independent of any particular node administrator or lending institution. The public key of that address will be an equivalent of today’s social security number.
5. The transaction fees collected by the nodes administered by these financial institutions will be taxed at a 50% rate.
6. These institutions will be able to attract capital from individual savers by offering an interest rate that represents a portion of the fees collected. E.g., if the current interest rate on staked dollars is 10%, then after Treasury taxes, it is 5%, and the node could then offer individuals 1-4% to delegate their funds to stake with them; the more money in the node, the more likely it is that that node will be selected by the algorithm to publish the next block and collect the fees. When fees are distributed, they are distributed to all account holders with that institution; not just just the ones delegating to that particular node. In the unlikely event that the holdings of one of the nodes is approaching $3 billion, they can transfer some of it to another node, or they can distribute a dividend to their account holders. If such a dividend is distributed, then, afterwards, all DPOS stakes must be ended, and the bank must advertise itself as open to the general market, excluding any addresses that received the distribution. This is to prevent the potential for ongoing financial fraud. If it is found that an institution is intentionally inflating its nodes to distribute dividends, then its license will be revoked, the funds of anyone involved will be taxed instantly at 100%, and those involved will serve a prison term with hard labor. Any time a distribution occurs it must be reported.
7. Lending institutions must be entirely separate from staking institutions. Lending institutions will be similar to what banks are today, but they will be considered securities subject to something similar to current securities regulations. Individuals may invest with them, but if they do, they will have to accept that they are exposing their funds to financial risk. The intent is for staking institutions to offer an equivalent of today’s savings accounts, while individual wallets will replace checking accounts, and lending institutions will be a rough equivalent to today’s managed brokerage accounts. Instead of paying an interest rate, lending institutions will offer dividends based on the performance of the companies it purchases and the interest rates on business loans. Since governments will own the systemically important industries, the intent is for lending institutions to be community-based, such that when people lend money to these lending institutions, they are investing in their own local and regional economies.

Why I Selected These Criteria

The intent of these criteria is to eliminate financial corruption, collusion, and fraud, and to ensure that no financial institution ever becomes “too big to fail.” The net worth of these institutions is capped at $30 billion. This means that, if one of them were to fail, this would not be an existential crisis of the kind experienced in the USA in 2008. If there are not enough nodes for the system to maintain a high degree of resiliency, the government can encourage the formation of nodes by lowering the capital requirements, or can provide financial incentives to form them, such as seed money in exchange for shared interest, lowered taxes on block rewards, etc.

If the regional lending institutions were to fail, this would also not be a systemic risk, because the largest industries would be funded through the Treasury directly and government owned. There are many reasons that regional economies suffer, but this is often because of a national reorganization of the industrial base. In such a case, a failure of a regional bank, while traumatic to investors, is not a systemic problem. Investing in a regional lending institution should be viewed as a risk. The population should be educated to understand the difference between staking institutions as vehicles for savings, versus regional lenders as a private security that is higher on the risk scale.

If the government wants to encourage savings, it may introduce block rewards in addition to the normal transaction fees. If the government wants to stimulate spending, the treasury can inflate the currency directly through blanketed fiscal stimulus. It can create new dollars and distribute them across individual wallets.

Integration with Other Cryptocurrency Networks

Bitcoin, Ethereum, and other crypto nodes, should be regulated within the country in a way similar to Dollar node administrators. If a mining or staking institution exceeds $30 billion in combined annual net revenue and value of crypto assets held, anything beyond that will result in a tax bill to that institution at a rate of 100% at point of sale. However, that institution may, instead, use that revenue to form Dollar nodes, so effectively, mining and staking institutions can expand their cap to $60 billion by diversifying into both the Dollar system and other cryptocurrencies. The desired effect of this is to encourage domestic investment and innovation in the blockchain space while ensuring that the power of institutions that do so does not grow beyond what can be checked and corrected by the peoples’ government, while also leveraging that innovation into reinvestment in the national currency.

Note that, if a single entity attempts to circumvent the $30 billion rule by spreading their holdings across several nodes, if found guilty, those involved would face confiscation and prison sentences with hard labor.

Also note that, the intent is not to create a wealth tax. Crypto taxes are levied at point of sale, and are at 0% until the market value of crypto assets held exceeds $30 billion. At that point, crypto sold is taxed at 100% until the value of assets held falls below $30 billion. However, any cryptocurrency that is transferred out of that node will be treated like a sale and will trigger a taxable event.

How to Address Devaluation Concerns

This power to directly stimulate will raise legitimate concerns of devaluation. For this reason, the people need to have the power to express their concerns by having access to other forms of value storage.

The CBDC DEX

Bitcoin, Ethereum, and other major, systemically significant cryptocurrencies will be wrapped as Dollar Request for Comments (DRC – similar to ERC) tokens on the Dollar blockchain available for direct purchase and storage within the Dollar CBDC application. In addition, the government will tokenize commodities and make them available in the form of DRC tokens within the Dollar CBDC app, which will have a DEX (Decentralized Exchange) feature. 

A decentralized exchange is an on-chain exchange in which token swaps take place from one address to another directly on the blockchain with no third party intermediary. In order to introduce assets onto a DEX that are not digital assets that are native to that blockchain ecosystem, they have to be “wrapped,” meaning, the actual digital asset has to be locked up in a smart contract, and that smart contract must issue tokens programmed for the blockchain in question against that asset. Once those tokens are issued, they are effectively equivalents of the asset, because they can be used to unlock the asset from the smart contract, and back onto their native chains to the address designated by the token holder.

So if I have BTC, and I want to be able to trade it on an ETH DEX (e.g., Uniswap), then I would provide my ETH address to a wrapping smart contract, send my BTC to the address provided by the contract, and then that contract would issue wrapped BTC tokens to my ETH address. From there, whoever I sent the wrapped BTC tokens to could then send those tokens to that smart contract to unlock the BTC and have it send to their BTC wallet. All of this would be done without a third party intermediary, merely by interacting with a cross-chain smart contract. Therefore, in terms of their market value, wrapped tokens are “as good as” the assets they represent, which makes them tradeable assets on a DEX.

Creating On-Chain Raw Commodity Tokens

Government mining and exploration concerns will be run by an independently elected government body not directly answerable to the rest of the government. If there is wide scale malinvestment of the mining and exploration department, then the leadership may be impeached through direct or indirect public vote (depending on the specific political structure in question). The performance of the mining sector will be audited and publicly reported yearly in order to facilitate public knowledge of the state of the industry. 

Development, Ownership, and Revenue

The Treasury will provide low interest loans to mining companies based on the approval of the mining and exploration department. Mining companies will be structured much in the same way that regional lending institutions are. They will be owned in part by the government, and, in part, by the general public. They will issue dividends based on profits from revenue to shareholders. The government will have the first right to purchase commodities mined on an over the counter basis based on the current market value. Anything in excess of this may be sold on the open market.

The government will purchase these commodities at sufficient scale to satisfy its own industrial and military needs, as well as the needs of the retail investors. If those commodities are not being produced in sufficient quantities, it will buy them on the international market or, preferably, expand its domestic production of these commodities.

Tokenization

The government will use technology similar to that developed by VeChain – or VeChain itself – to mark and track its commodity reserves. In that way, when a citizen purchases, say, an ounce of silver or a barrel of oil in the DEX on their app, they are purchasing a particular ounce or barrel that has been accounted for as a distinct NFT (Non-Fungible Token) on the blockchain. For a fee, they can then have certain of these commodities (especially monetary commodities, such as silver and gold) delivered to them personally.

The DEX as the Public Voice

In this way, the citizen has the power to keep his government fiscally responsible. If they no longer believe in the viability of the dollar, they can transition out of it into other wrapped digital assets, or identified raw physical commodities in the form of NFTs. This directly provides vital price signals to government economists about the perception of the Dollar’s value and the level of trust that the citizens have in them.

Although the government will require its mining companies to provide enough commodities to meet retail demand, in order to ensure that the citizenry are not de facto shut out of the commodities markets through supply failures, private sales of monetary commodities will be fully legal within the country.

Inflation is not an Existential Problem for the Proposed CBDC Model

This, then, fully addresses concerns about runaway inflation. The Dollar will be required for all taxes, will be legal tender within the country (meaning that all merchants will be required to accept dollars for all goods and services), will be the native token of an Ethereum-style blockchain, and individual savings will be encouraged through DPOS. All of this provides support for the Dollar as a store of value. If there is any residual doubt about the stability of the dollar, it will be fully exchangeable for traditional cryptocurrency or individually tracked and not rehypothecated raw physical commodities.

How to Address Privacy Concerns

There then remains the detractors’ legitimate privacy concerns. Historically, CBDCs have been envisioned as “cashless” instruments, meaning that the introduction of the CBDC is meant to accompany a reduction in the use of cash or an elimination of it altogether. Since, in some sense, a CBDC is a form of digital cash, the idea of many is that the CBDC eliminates the need for physical cash. This is true except for the fact that CBDCs do not allow for the same level of privacy and anonymity that physical cash provides.

For this reason, what I am proposing is a “cashable” CBDC. What follows is a description of how that works.

CBDC to Cash ATMs

The government will provide ATMs (Automated Teller Machines) in secured public places. These ATMs will be, conceptually, similar to Bitcoin ATMs in some respects, but will be quite different in terms of the accounting and back-end physical process. The ATMs will not hold physical cash. Instead, they will contain paper money printers, paper money destroyers, Dollar CBDC nodes, and physical cash verification nodes (PCVNs).

When a citizen interacts with these ATMs, they will have the ability to turn CBDC Dollars into physical cash that is completely separate from the CBDC system. To do so, they will activate their ATM by presenting their public key to a camera attached to the HMI. When they do so, that will activate an oracle that will track the activities of that wallet. Then, the ATM HMI will present a burn address (an address that “burns” tokens by receiving them into a non-send address, which takes them out of digital circulation) to the user. The user will send CBDC Dollars to that burn address. Once the oracle detects this, it will activate the PCVN.

The PCVN – a Novel Concept for Producing and Verifying Physical Cash

The PCVN is similar to a crypto node except that while it creates, tracks, and deletes serial numbers and shares this data with other nodes on the network, it does not send or receive. When CBDC Dollars are burned, the PCVN creates an equal number of physical dollars by generating and storing unique serial numbers and printing them onto traditional dollar bills with a combination of microscopic and visible watermarks that serve the function of verifying the legitimacy of the document. It will then deliver these dollars to the user in the exact way that modern ATMs do.

While there may remain privacy concerns, since these bills are serialized and can be matched to a non-anonymous blockchain address, once these bills circulate in the economy, there is no way to associate it with that address, and total economic privacy is restored. In other words, e.g., if you have $1,000 in your CBDC account, and you have the ATM print out a $100 bill, that $100 bill can be tracked to your account. But if you go out and spend $40 on groceries and receive $60 in change, there is no way to associate that $60 in bills with your account, and your privacy has been restored.

How the PCVN Prevents Counterfeiting

Merchants will be able to purchase devices connected to the PCVN network that are read only and can detect the microscopic watermarks and verify the validity of the bill’s serial number. This will provide robust commercial resistance to counterfeiting. In order to facilitate validity in cash transactions without such devices, the visible watermarks will serve as a backup to this system. These devices will be able to verify both that the serial number is valid, and that the paper it is printed on is legitimate. This will make counterfeiting almost impossible while fully preserving economic anonymity.

Transitioning from Cash Back into a CBDC

In order to transition physical cash back onto the blockchain, the process is simply reversed. The user presents their public address to the HMI, activating the oracle, and then inserts the cash into the ATM. The PCVN scans the watermark and the serial number, deletes that cash from the ledger, voids the bill by heat stamping “VOID” all across the surface of the bill and then shredding it. The oracle then instructs a smart contract to produce Dollars in that amount onto the user’s individual CBDC wallet.

PCVN Security Concerns

It is paramount that the physical and digital security of these ATMs be absolute at all times in order to ensure the validity of the PCVN network and physical cash circulating in the economy. Since I am not a digital securities expert, I leave that to others to work out.

Conclusion

The system described above is a fully cashable CBDC. The value of the currency stands on its own merits, based on its fundamental value to the citizenry of its sovereign territory. To ensure that it does, the citizenry can correct policy excesses by putting their economic trust elsewhere, forcing the government to reign spending back in. If the citizens prefer the anonymity of cash, they can seamlessly transition in and out of cash using CBDC Dollar ATMs.

This is how we preserve privacy and sovereign currency as a store of value as we move into an economic future dominated by blockchain and DLT.

Implementing This in the USA

While the above has been a thorough description of the general parameters of a cashable CBDC, remains the issue of applying it to the American context specifically.

The primary question is whether or not the entity implementing this is in a position to nationalize the banking system or not. If they are, then the Fed can be abolished, dollar creation can be tasked back to the Department of the Treasury, and the legacy commercial banks can be nationalized and transformed into securitized regional development banks.

However, if, as we implement this, we are not in a position to nationalize the banking system, then the existing banking system can be integrated into this system, although that is far from ideal.

How to Integrate the Legacy Banking System (if Absolutely Necessary)

In order to integrate the legacy banks into this system, they would still have to be significantly restructured. Their ledgers would have to be restructured as nodes on the CBDC network. Account holders would have to be transitioned to stakers. Banks worth more than $30 billion would have to be broken up. Banks that engaged in both commercial and investment banking would have to be broken up along those lines.

The Implications of Retaining the Federal Reserve

Furthermore, if the Federal Reserve persisted, the dollar would remain a debt based instrument, exposing it to the potential for deeply negative interest rates. In such a case, the Federal Reserve would have to have very clearly defined permissions on the USD blockchain in order to secure the credibility of the system.

For example, the Fed would need the ability to lend money to permissioned nodes. But in order to restrain the Fed from abusively negative interest rates, they would have to be barred from regulating or participating in the USD on-chain DEX, so as to not call into question whether they are manipulating the market in a bid to pressure citizens back into the dollar.

Making the Cashable CBDC Compatible with a Central Banking System

What’s more, it isn’t entirely clear how a DPOS and a central banking system would be made to be compatible. The obvious way to do this would be to have the Treasury set the rate of staking issuance, while the Fed would have a separate power to issue dollars as block debts. However, in such a situation, if the Executive were at odds with the Fed, the monetary outcomes would be unpredictable.

How to Integrate the Legacy Banking System – it’s Better if You Don’t

So, it is possible to grandfather in the existing banking system into the system I’ve described, but it’s much better if you don’t.

If the administration implementing this has come into power through revolution, they should abolish the Federal Reserve, and the legacy banking system. However if they come to power through the electoral process, then they may not be able to do that, in which case, there may be complications. This is one way to navigate those complications.

How to Ensure that Innovations to the System are Functional and not Destabilizing

Another important implementation consideration is the possibility of the system encountering unpredictable problems which can cause economic instability.

This is an issue that is shared by private cryptocurrency projects. These projects usually have a “testnet” in which the technology is tested in a separate environment from the established chain so that it can be thoroughly tried and tested for bugs, exploits, and any unpredictable problems.

Florida: America’s Testnet

In order to implement this system and keep it up to date, America would need a robust testnet for the system.

What this would look like is to create an American Hong Kong in one of our most economically dynamic and free regions. The region that makes the most sense for this is the State of Florida, which is already leading the way in cryptocurrency adoption and innovation in the USA in many ways, and has a tradition of economic freedom, entrepreneurship, trade and experimentation.

CBDC Testnet Parameters

Specifically, it would work in the following way:

1. This state would be the only one to implement the system, initially.
2. This system would have to run without significant failures for a continuous year before the system would be implemented nation-wide.
3. Updates to the system would go through the same process as the initial implementation.
4. The only exception to this process is if a flaw is discovered in the USD “mainnet,” and a patch or fix has to applied. In this case, the fix will be applied in an expedited manner.
5. This state would have its own distinct currency. It would seek to peg to the USD, but it would be its own currency (the FSD; the Florida State Dollar) which would have to be exchanged for USD to trade with the other states; normally on a one to one basis.
6. This is necessary because, should a problem occur in the testnet, the rest of the country would need to be able to quarantine it to the maximum extent possible. This scenario is not likely, but not outside the realm of possibility.
7. This exchange process would need to be materially supported in order to ensure that the necessity for the exchange wouldn’t become an economic barrier.
8. Until the system is initially adopted nationally, the exchange would be facilitated by the legacy banking system which would be expected to instantly exchange FSD for USD, and the Fed in cooperation with the Florida Treasury would provide any necessary liquidity to facilitate that at 0% interest.
9. After the system is initially adopted nationally, the exchange would take place instantly within the Dollar CBDC digital application.
10. Special economic rights and privileges would need to be provided for the State of Florida in order to ensure that the state is not abandoned due to economic risk aversion.

Acknowledgements:

The following people were good enough to read over this paper and contribute useful feedback.