EUROchain Proof of Concept Explained

In mid-December, the European Central Bank (ECB) published a report outlining its proof of concept for using distributed ledger technologies in for their EUROchain project

The main idea of the solution presented by the ECB is the potential use case for a central bank digital currency that blends anonymity with AML and CFT regulations (Anti-Money Laundering and Combating the Financing of Terrorism, respectively). By using distributed ledger technologies, or DLT, the EUROchain proof of concept takes a forward approach in the digital currency landscape.

The project’s announcement came months after multiple news stories worldwide about central banks considering a digital currency. Yet it was clear that at this time, the ECB has no concrete plans for implementing such an endeavor.

The project was developed by the European System of Central Banks (ESCB) along with strategy consultants Accenture, and R3’s Corda enterprise blockchain

Side note: Interestingly, R3 once partnered with Ripple back in 2016. R3’s blockchain project was to promote Ripple to all the banks in its consortium. By 2017, the two had filed lawsuits against each other over a dispute involving options to buy XRP.   

Features of EUROchain

The ESCB, together with the teams at Accenture and R3, came up with a number of unique features for a potential central bank digital currency (CBDC). These features include:

  • A digital solution for AML and CFT compliance that keeps a user’s identity and transaction history hidden from the central bank or 3rd parties (unless so chosen by the user).  
  • Limits for anonymous transactions to be enforceable through automation.
  • Anonymity Vouchers, which allow users to transfer a certain amount of funds in CBDC over a certain timeframe.

Definition: What is a proof of concept?

A proof of concept involves a project that gathers evidence from research and experimentation to suggest the feasibility of a design concept or business proposal.

Through the study of EUROchain’s proof of concept, the ECB explored privacy issues in relation to compliance of AML and CFT procedures. They also provided support for potential cost savings that could be realized by using distributed ledger technologies.

What is a Distributed Ledger?

EUROchain Proof of Concept

The proposed proof of concept for EUROchain would feature a reliance on certain “intermediaries”. Each having a node, these intermediaries could access central bank ledgers and reserve balances in order to provide digital currency options to central bank users.

In essence, such an interbank payment system could allow for certain levels of privacy, as with low-value transactions. At the same time, the transactions with larger values would be subject to AML/CFT compliance checks. 

The EUROchain project identifies two main use cases:

  1. Securities settlement (i.e. stock trade settlements)
  2. Payment solutions for member central banks to provide to their users 

These use cases can be broken down into four principles:

  1. The central bank digital currency (CBDC) is cash-like in multiple ways. For instance, the emphasis on privacy for smaller transactions.
  2. There’s a system of intermediaries with two tiers. The central bank would rely on intermediaries that could access the central bank ledger and reserve balances at the central bank, enabling the use of CBDC between users. The intermediaries process transactions for their institutional clients who receive custodial services from the central bank.
  3. Only the central bank itself can issue units of CBDC or take them out of circulation.
  4. An identified AML Authority will process AML/CFT compliance checks for large transactions. Additionally, this Authority monitors transactions to make sure restricted users (i.e. due to sanctions or investigations) cannot send or receive CBDC.

ECB’s proof of concept – Tech summary

  • EUROchain’s proof of concept was developed using Corda’s DLT platform, which enables transactional information between two users to be stored locally while remaining consistent with the larger data set, which is private from other users. 
  • Four entities are involved in this proof of concept, each operating a node running CorDapp5
    • Two intermediaries
    • One central bank
    • One AML Authority
  • CorDapp5 is a web app that enables interactions between users, offering a range of application programming interfaces (APIs) related to communication interactions between two users.
  • Each unit of CBDC exists on the ledger by Corda states. Each ‘state’ has specific data on the value, past ownership, and cryptographic validation. Essentially, this represents proof that since the initial issuance of any CBDC unit, all transfers relating to that unit have complied with central bank rules. Corda states are similar to how Unspent Transaction Outputs (UTXOs) work, where each use of a unit triggers a new version of itself on the ledger. Only state versions that are unspent and have followed the rules are allowable for future transactions.
  • Ultimately, it’s the responsibility of each payee’s intermediary to ensure the validity of each state when received by clients.
  • A Non-Validating Notary is a special node that enables intermediaries to test for a state’s validity. It always maintains a ledger of valid UTXOs in real-time. However, the Notary does not have access to transactional or user data. 
  • Rules for maintaining governance over the transfer of states are minimal. So these rules only govern the prevention of double-spending while automating AML restrictions. 
  • There’s also some flexibility as all entities can apply other rules of their own through the use of a token software development kit (SDK). This feature would add a ‘programmable money’ aspect to the CBDC.
  • Chain Snipping helps reduce the amount of visible data to those parties not privy to a transaction. It takes a snippet of the redemptive values of all CBDC units held by the accounts of a user. This then triggers the relevant amount of CBDC per user to settle.  The ‘resettlement’ lessens the data that is viewable by other participants. However, the central bank does receive the full data set following all redeemed units.

EUROchain – Background & Summary

As former IMF Director and current President of the European Central Bank, Christine Lagarde has been vocal about the coming cryptocurrency revolution and the role of central banks. Together with 18 European central banks, payment and IT specialists, and financial infrastructure experts, the ECB under her leadership has been moving forward in the development and potential implementation of CBDCs.

“Central bank digital currency is coming alive.”

Christine Lagarde

Unlike projects such as Binance’s Venus and Facebook’s Libra, EUROchain’s proof of concept is not a stablecoin directed at consumers. Instead, it focuses on bank to bank integration of DLT and enterprise blockchains. In other words, it is designed for improving global payment settlements between central banks and member banks

The ECB news regarding the EUROchain project opened up exploration into new technologies that may affect European citizens later on. Should the need arise. But the ECB also maintains that its own findings from the proof of concept should not deter other private market initiatives. In fact, payment solutions that improve cost efficiency and speed are welcome.

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