In many countries, establishing a central banking authority is accompanied by certain guidelines or restrictions on that authority that are meant to keep its role in the financial ecosystem clearly defined. This has been embodied as rules that restrict the central bank from issuing accounts for individuals. Indeed, the typical role of a central bank is to offer accounts only to larger financial institutions through which they push central bank-issued currency into the broader banking system. This typically draws the line between wholesale and retail banking, and the rules are designed to keep the central bank OUT of retail banking.
The key is the “term account.” A term account is a holding place offered by a bank or a financial service provider to facilitate transactions using the services available to that bank. You deposit funds into an account to be held by the bank, and then you can instruct that bank to perform actions on your deposit.
However, we don’t use accounts in the digital currency world - we use wallets. Wallets in the digital currency world belong to the individual with the keys to those wallets. They are not linked to or owned by a banking entity.
Custodial vs non-custodial wallets
In the crypto world, there are typically two types of wallets.
- Non-custodial Wallets are randomly generated key pairs that become active on a cryptocurrency blockchain when you initiate a transaction to transfer value into the wallet. These cryptographic key pairs are usually kept and only known to the creator. These wallets do not require any identity or registration.
- Custodial Wallets are key pairs generated by a business or crypto services organization, usually after completing a registration process and satisfying any “Know Your Customer” (KYC) requirements that are enforced in the organization’s jurisdiction of operation. In some cases, the wallet custodian also provides services for the protection and recovery of the wallet’s keys as a value-add to your registration.
The ability to support non-custodial wallets in cryptocurrencies is what fuels the often overstated myths of transactional anonymity within crypto. A 2012 project proved that it was possible to de-anonymize over 84% of active non-custodial wallets on Bitcoin and Ethereum within a matter of 2 weeks.
For Central Bank Digital Currency systems, all wallets are custodial wallets. The wallet belongs to the individual or business that it is issued to. Central Banks will license accredited wallet issuing custodians that can issue wallets to anyone who registers and completes the KYC conditions. Only wallets digitally signed by an accredited wallet issuing custodian can transact using a CBDC.
Wallet custodians will play a key role in the consumer protection side of CBDCs. When recovering access to a wallet due to lost/broken devices or corrupted data, wallet custodians will have the tools to recover access to or to re-issue a wallet and funds referenced on the ledger. So, the wallet is like your physical wallet. It is yours, and it contains your digital currency. With a CBDC, there are no accounts and no ‘deposits,’ just wallets and a ledger. Thus the central bank is not issuing accounts, and the concept of ‘banking’ becomes entirely different from what we know today. More on that in a future post.
