U of T researchers help lay groundwork for Bank of Canada-backed “digital loonie”

How much longer will Canadians want – or be able – to use physical cash? Could a digital currency such as Facebook’s Diem Coin or Bitcoin make the Canadian dollar obsolete?

The Bank of Canada recently announced it was designing a contingency plan for a Central Bank Digital Currency (CBDC), which sparked speculation about a “digital loonie.”

While the central bank has no plans to issue a digital currency, it is nevertheless conducting research on digital money. Last year, it tapped the expertise of universities by launching a competition that asks experts to propose a system architecture and business plan for a Canadian digital currency.

One of the three proposals selected by the Bank was created by a team of University of Toronto and York University researchers. They estimate it will take another two or three years to properly implement a central bank digital currency, adding that other countries already have a head start.

“You cannot click a button and have a CBDC tomorrow morning,” says team-member Andreas Veneris, a professor in the Edward S. Rogers Sr. department of electrical and computer engineering (ECE) in the Faculty of Applied Science & Engineering and in the department of computer science in the Faculty of Arts & Science.

“This is a long technological, economic, legislative and cultural shift behind digital currencies.”

In addition to Veneris, other members of the U of T-York team are: Andreas Park, an associate professor of finance at U of T Mississauga and the Rotman School of Management; Fan Long, an assistant professor in the department of computer science and the department of electrical and computer engineering; and Poonam Puri, a professor at York University’s Osgoode Hall Law School.

The multidisciplinary team is using its diverse expertise to tackle the problem from multiple perspectives, including technology, economy, legal and global geopolitics. Veneris, for example, is an expert in system design, formal verification, techno-legal questions and crypto-economics. Long, meantime, is a distributed systems and programming languages pioneer, while Park, in his own words, explores how the “plumbing” of financial markets shapes economic outcomes. Puri is an expert in securities law and regulation.

Deepa Kundur, chair of the department of electrical and computer engineering, says collaboration is the key to solving tough problem in critical sectors.

“A complex area like monetary infrastructure has such a wide-ranging impact that a comprehensive analysis demands thought leaders from different fields,” she says. “The proposal is a good example of why ECE has prioritized cross-disciplinary efforts.”

The team members say that the financial sector is lagging behind when it comes to digitization, noting that connected devices have already infiltrated most aspects of daily life, from cars and homes to manufacturing and health care.

Yet, Park says that “payment, the backbone of all commerce, still operates on a legacy infrastructure that lacks the flexibility to adapt to this digitization of the economy.”

For example, he points out that you can buy things on Amazon and receive them the same day – but the seller only sees the payment on their account days later. Such inefficiencies in the payment system add up, with consulting firm Ernst & Young estimating that slow payments cost Canadian businesses $2.9 to $6.5 billion dollars a year.

New players are already emerging to exploit these shortcomings. In 2019, a Facebook-led consortium announced its intention to create a new financial payments infrastructure and with a cryptocurrency known as Diem Coin (formerly Libra Coin), which is scheduled to launch in 2021.

“Facebook has 2.7 billion monthly users,” says Veneris. “Once Diem goes live, it will offer a wide range of functionality for retail payments and make it easier to conduct business. It’ll be as though Facebook became, overnight, the biggest central bank of them all.”

In addition to concerns about how Diem Coin would handle privacy issues, Park says that small economies like Canada could experience currency displacement:

“People may stop using the native loonie, first for convenience and later out of necessity,” he says.

Preventing displacement and protecting privacy were key questions that guided the team’s thinking.

In addition to data security, the team’s proposal considers a number of critical issues facing the launch of a new CBDL: linking legacy and new infrastructure; incorporating privacy into its design to protect consumers and businesses; and providing incentives for the private sector to innovate and excel in a global digital economy while protecting Canada’s social values.

The team suggests a two-stage launch. In the first stage, the Bank of Canada would set up a working infrastructure to give people the ability to make e-payments with a new digital loonie. (A secondary payment CBDL cash-card system would cover Canadians who lack internet access.)

Transactions between parties would involve no credit and be immediate, limited in size to a typical purchase at a grocery store or other retail outlet.

“You would go to a shop and scan a QR code and that’s everything you need to make a payment,” says Long. “It’s a viable, convenient payment mechanism that will be much cheaper for merchants to use than the current system.”

In the second stage, the system expands to an open but controlled network: a “permissioned” blockchain. Here, private sector entities take the lead and build on the central bank’s initial innovation. Customers could keep their transactions private while being able to monetize their personal data to get extra services from the private sector.

Veneris emphasizes that this blockchain is not like Bitcoin, and that a CBDC is not a volatile asset prone to speculation like many cryptocurrencies are today.

“Think of it as an intelligent, open-source social operating system for programmable e-money,” Park says. “A company like Tim Hortons can plug into it to develop an enhanced reward program, or a firm can customize a service for smaller merchants. Entrepreneurs will ensure the payment mechanism keeps pace with incoming tech: Internet-of-Things micropayments, for example.”

And in an emergency, the system is set up to revert back to the central bank’s full control.

While setting up a digital currency is a massive undertaking, Veneris, Park and Long say that where the Bank of Canada leads, others – both locally and globally – will follow.

“The bank has spent the better part of the last decade preparing for this moment,” says Park. “It has a head start over most other central banks in the world.”

Adds Veneris, ”This is Canada’s opportunity to be a global leader.”