Boston Fed, MIT Digital Dollar Test Casts Doubt on Blockchain as Processing Platform

A digital dollar experiment by the Boston Fed and MIT was able to produce a functioning and fault-tolerant central bank digital currency (CBDC) design that could handle 1.7 million transactions per second, with 99% completed within one second. And it isn’t built on a blockchain.

The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology’s Digital Currency Initiative launched Project Hamilton 18 months ago, with the goal of providing technical design research and testing.

The digital currency testing required the ability for users to “interact with a centrally administered transaction processor, using digital wallets with individual, cryptographic signatures that authorize the movement of funds,” according to a Thursday (Feb. 3) press release from MIT.

Both organizations made clear that their goal was evaluating the fundamentals of transaction processing rather than proposing an actual digital dollar architecture or even supporting the development of a CBDC in the first place, which would require far more policy decisions.

Depending on policy goals and central bank objectives, the digital dollar could be “a general-purpose CBDC that can be made available to the public for retail, e-commerce, and person to person payments” or a back-end system used to settle large transactions between financial institutions, a Project Hamilton executive said. So far, the public debate has focused on the former.

As for objectives, the discussion has centered around expanding financial inclusion, making payments more efficient, encouraging and supporting innovation in financial services, maintaining financial stability, and protecting users’ privacy.

Neha Narula, director of MIT’s Digital Currency Initiative (DCI) at the MIT Media Lab, said there are three use cases she is very excited about. “One is improving financial inclusion and giving people access to digital payments, cheaply and efficiently. The second is improving cross border transactions — so people could do things like remittances, with more certainty and friction. And I think the third area is creating a platform for innovation.”

“There were no intermediaries, fees, or identities outside of public keys,” a Project Hamilton white paper noted. “However, our design supports adding these roles and other features in the future.”

When it came to intermediaries, the key was designing a code base that was flexible enough to handle different design but also evolve over time, said Boston Fed Executive Vice President and Interim COO Jim Cunha.

Cunha said it “is critical to understand how emerging technologies could support a CBDC and what challenges remain. This collaboration between MIT and our technologists has created a scalable CBDC research model that allows us to learn more about these technologies and the choices that should be considered when designing a CBDC.”

Blockchain Bottleneck

One surprise the researchers found is that the blockchain technology underlying cryptocurrencies was an inferior platform, creating bottlenecks as it requires a complete record of transactions in the order in which they were processed.

The blockchain-based digital ledger “had pretty significant bottlenecks,” said Narula. It produced 170,000 TPS — still well above the goal of 100,000 TPS — and while the majority of transactions were processed in less than 0.7 seconds, it didn’t reach the non-blockchain version’s 99% completion threshold until two seconds.

While it used cryptography and other elements of blockchain technology, the more successful system “processes transactions in parallel on multiple computers and does not rely on a single ordering server to prevent double spends,” the project’s executive summary said. “This results in superior scalability but does not materialize an ordered history for all transactions” — which is the backbone of blockchain technology.

The system appeared to be able to “scale linearly with the addition of more servers,” the summary added.

That said, Cunha pointed out that it wasn’t a black and white choice between blockchain and not blockchain. Both systems used a substantial number of elements from that technology.

The security developed for the two systems were essentially similar, Cunha said, emphasizing that it focused on two areas: Double spending and resiliency. Nor was one better than the other.

The project’s design requirements included a central transaction processor run by a trusted operator — likely the U.S. Federal Reserve Bank — which is very similar to a permissioned or “enterprise” blockchain.

It also had to use digital wallets that store cryptographic keys, the project’s executive summary said. “The Funds are addressed to public keys and wallets create cryptographic signatures to authorize payments.”

Which sounds very blockchain-like. It even added that the centrally controlled transaction processor stores cryptographic hashes — explained in the link below — that represent unspent central bank funds.

See: PYMNTS Crypto Basics Series: What’s a Blockchain and How Does It Work?

However, the Hamilton Project researchers found that separating the transaction processor into modular components improved scalability and flexibility, the executive summary said. “For example, we can scale and replicate transaction validation independently from preventing double spending and committing transactions.”

That design also was able to support a number of different privacy options it said.

Privacy and Transparency

The researchers said they were aware that consumer privacy will be an essential design element in any working U.S. digital currency, and ultimately a digital dollar’s privacy features would be determined by policymakers.

As a result, Narula said, the team “created architectures where the central bank didn’t necessarily need to see or store [much] user information.”

She added, “What I’m really excited about in the next phase of work is exploring cryptographic designs for privacy. We have a lot of techniques in computer science that can help us verify the integrity of information while not necessarily revealing exactly what that information says.”

Which leads to another interesting discovery: Despite the cryptocurrency industry’s focus on privacy and pseudonymous transactions — bitcoin is not really anonymous — the blockchain option offered less user privacy options.

Both systems are open-source, with their code available to the public — a standard best practice in cryptography as it offers the opportunity for many experts to search out flaws and offers reassurance that the code really does what its designers say it does.

“It’s clearly an important way to build, implement, and potentially launch, in large part because monetary systems benefit from transparency and verifiability, and open-source offers those two things,” Narula said. “In addition to supporting collaboration, monetary systems benefit from transparency and verifiability, which open-source offers.”

Next Steps

“There are many research questions left to answer that we haven’t gotten to yet, such as the roles of intermediaries, how to promote access securely, and how to design for those who might not have smartphones or consistent internet access,” the researchers said.

Phase one did include the requirement for the digital dollar to work without interruption even if two large regions of the U.S. lose power and connectivity.

But they left for the second phase features including high-security issuance, systemwide auditability, programmability, balancing privacy with compliance, the role of intermediaries like banks and other financial institutions, and the ability to withstand to denial-of-service attacks.