CBDCs, where did the idea come from, why are banks obsessed with them, and why you shouldn’t be into it.
Virtual money approved, issued, and regulated by the government? It’s not cryptocurrency (but of course), and its name is CBDC, or Central Bank Digital Currency.
CBDCs are digital versions of fiat currencies that are issued and backed by a country’s central bank. They are a new form of digital money that could be used as a legal tender and would be backed by the ‘full faith’ and credit of the issuing central bank.
Obviously different from cryptocurrencies like Bitcoin and Ethereum, which are decentralized and operate independently of central authorities. CBDCs are designed to be centrally controlled and regulated by the issuing central bank and the government it is subordinate to.
CBDCs are seen as a way to provide a digital alternative to physical cash, which is becoming increasingly less common in many countries. They could also potentially improve the efficiency and security of payment systems and provide better financial inclusion for people who are unbanked or underbanked.
Several central banks around the world are currently exploring the possibility of issuing CBDCs, including the People’s Bank of China, the European Central Bank, and the U.S. Federal Reserve.
There are still many technical, economic, and regulatory questions that need to be addressed before CBDCs can become a reality, but should you even want it to become one?
CBDCs: Where did they come from, where do they go?
The idea of Central Bank Digital Currencies has its roots in the emergence of cryptocurrencies like Bitcoin, which first appeared in 2009. While cryptocurrencies offer the potential for decentralized, peer-to-peer digital transactions, they are not backed by a central authority and in that sense lack stability.
As the potential of crypto became more undisputable, central banks recognized a need to explore the possibility of creating their own digital currencies, which would be backed by the authority and credit of the issuing central bank. The first to seriously explore the idea of a CBDC was the Bank of Canada in 2013, which conducted a study on the feasibility of a digital currency.
In subsequent years, other central banks around the world began to explore the idea of CBDCs, including the People’s Bank of China, which has been testing a digital version of the yuan since 2014. In 2016, the Swedish central bank began investigating the possibility of issuing an e-krona, while the European Central Bank (ECB) started researching the potential of a digital euro in 2018.
The interest in CBDCs has grown in recent years, and many central banks advertised the benefits of a digital currency as offering increased financial inclusion, improved efficiency and security of payment systems, and the ability to provide an alternative to physical cash.
Several countries are currently in the process of researching, developing, or piloting CBDCs, while some have already adopted them or are planning to do so:
- China: China has been one of the most active countries in developing and testing a CBDC, known as the Digital Currency Electronic Payment (DCEP). The DCEP has been piloted in various cities and is expected to be rolled out nationwide in the near future.
- The Bahamas: In 2020, the Central Bank of The Bahamas launched the Sand Dollar, a digital version of the Bahamian dollar, as the country’s official CBDC.
- Sweden: The Swedish central bank, Riksbank, has been exploring the possibility of launching an e-krona since 2017 and is currently in the testing phase.
- The Eastern Caribbean Currency Union (ECCU): The ECCU, which consists of eight Caribbean nations, launched the pilot of a CBDC called DCash in 2021.
- The United States: The U.S. Federal Reserve is conducting research into the feasibility of a CBDC and is expected to release a report on its findings later this year.
- The European Union: The European Central Bank (ECB) is currently researching the possibility of a digital euro and is expected to make a decision on whether to move forward with a CBDC.
- Japan: The Bank of Japan has been conducting research on a CBDC and plans to begin testing its own digital currency in spring 2023.
The development of CBDCs is still in its early stages, and it remains to be seen how they will be implemented and what their impact will be on the global financial system.
A digital currency by any other name would smell as centralized
Cryptocurrencies and Central Bank Digital Currencies are both digital currencies, but there are significant differences between them.
- Both are digital currencies that operate using digital technology and can be used for transactions.
- Both can potentially offer faster and cheaper transactions compared to traditional banking systems.
- Both can be held and transferred without the need for a physical medium like cash.
- Cryptocurrencies are decentralized and operate outside of the traditional financial system, while CBDCs are centralized and issued by central banks.
- Cryptocurrencies are not backed by any government or central authority, while CBDCs are backed by the issuing central bank.
- Cryptocurrencies are subject to market forces and can experience significant price volatility, while CBDCs are designed to be stable and predictable in value.
- Cryptocurrencies provide a high degree of anonymity and privacy, while CBDCs are subject to regulatory oversight and could potentially provide less privacy for users.
- Cryptocurrencies operate on a global scale and can be used across borders, while CBDCs are typically issued by a specific country and operate within its borders.
Cryptocurrencies and CBDCs have very different design goals, use cases, and regulatory frameworks. Cryptocurrencies prioritize decentralization, anonymity, and independence from central authorities, while CBDCs prioritize centralization, stability, and regulatory oversight.
Why governments and banks are all-in for CBDCs
Governments and central banks have different goals and priorities than the creators and users of decentralized finance (DeFi) currencies. Cryptocurrencies like Bitcoin and Ethereum operate independently of central authorities and are designed to be decentralized, CBDCs are designed to be centralized and issued by central banks.
One of the main reasons governments and central banks are interested in CBDCs is to maintain control over the monetary system and ensure financial stability. By issuing a CBDC, central banks have a direct and immediate influence on monetary policy, including controlling the money supply, setting interest rates, and implementing macroeconomic policies. This level of control is not possible with decentralized currencies like Bitcoin, which operate outside of the traditional financial system.
Lyn Alden, founder of Lyn Alden Investment Strategy, summarized the usefulness of a pure central bank digital currency from the government perspective:
- Send international payments without the SWIFT system
- Try to give banking access to the non-banked or under-banked populations
- Track and surveil any transaction, including with Big Data/AI technologies
- Blacklist or block certain transactions that violate their rules
- Add expiration dates or jurisdiction limitations to currency
- Take away money from citizen wallets for various violations
- Give money to citizen wallets for stimulus or rewards
- Impose deeply negative interest rates on citizen account balances
- Program money to have different rules for different groups
- Reduce the control and fee pressure that commercial banks have over the system
Governments and central banks promote the idea of CBDCs as a device to improve the efficiency and security of payment systems. A digital currency that is issued and regulated by a central bank could potentially offer faster and cheaper transactions, as well as greater security and privacy for users. This narrative also perpetuates the ability of CBDCs to provide greater financial inclusion for people who are unbanked or underbanked, as they could provide a low-cost and accessible alternative to traditional banking services.
While DeFi currencies have gained popularity in recent years, their decentralization and lack of regulation are not compatible with the goals of governments and central banks. As such, CBDCs are seen as a potential solution that could offer the benefits of digital currency while still being subject to regulatory oversight and control by central authorities.
Be careful out there, it’s a centralized world: Why CBDCs are not “for the people”
The implementation of Central Bank Digital Currencies poses risks to the privacy and financial freedom of individuals.
These risks include:
- Surveillance and tracking: CBDCs provide central authorities with greater visibility into people’s financial transactions, allowing them to monitor and track individuals’ spending habits, income, and financial activities.
- Abuse and censorship: The centralized nature of CBDCs means that central authorities have the power to selectively approve or deny transactions, potentially leading to censorship and discrimination. There is also a risk that CBDCs could be used for political purposes, with authorities using them to restrict or control certain activities.
- Security risks: CBDCs are vulnerable to cyberattacks and hacking, potentially leading to the loss of funds and personal information.
- Financial exclusion: CBDCs exclude people who do not want to or have access to the necessary technology or who do not have a stable internet connection, which creates a new form of digital divide and financial exclusion.
- Impact on traditional banks: CBDCs could potentially disintermediate traditional banks and financial institutions, which could lead to job losses and other economic disruptions.
As such, CBDCs are closer to the Chinese Communist Party’s (CCP) infamous social credit system than they are to cryptocurrency. After all, both CBDCs and the social credit system both involve the collection and analysis of extensive data about individuals. CBDCs could provide central banks with detailed information about individuals’ financial transactions, which could be used to monitor and analyze economic activity. Similarly, the social credit system collects data about individuals’ behavior in various areas of life, which is used to assign them a social credit score.
Both systems can enable more effective government control and monitoring of individuals. In the case of CBDCs, central banks could use the technology to track and limit certain types of financial transactions. The social credit system, meanwhile, could be used to monitor and regulate individuals’ behavior in various areas of life, including political activity and online behavior.
Nigeria: Cash restriction and the failure of the eNaira
Nigeria is set to hold presidential elections on February 25, 2023. With under three weeks until the poll, the country is in a state of crises. Major shortages of cash and fuel in a society where the informal economy is vital have now provoked riots. This is the result of a series of market manipulations, further exacerbated by the government’s unwillingness to make any changes so as not to jeopardize the upcoming elections.
Because of artificial engineering and cash scarcity, the government is pushing for the transition to digital payments, but only around 0.5% of the Nigerian population has adopted the eNaira.
Nigeria was the second country to introduce a CBDC, following the Bahamas in 2022. Around 40% of the population are unbanked, a matter the Central Bank of Nigeria (CBN) aimed to tackle by introducing a CBDC, the eNaira. To further the process, CBN ordered banks to close any accounts that had crypto transactions. Now, authorities have replaced the old naira notes with new ones, with the purpose of reducing the volume of money outside the banking system. People returning old notes to the bank cannot get new ones, as the CBN has not printed enough. With cash shortages, authorities are urging Nigerians to turn to digital payments, but it’s not a solution to any but the authorities themselves.
Gross abuse of power can easily be exercised by authorities even en route to implementation of CBDCs, as was the case in Nigeria. General unreliability of the government directly results in suspicion of citizens, who much prefer decentralized finance. Even following the ban, use of crypto in Nigeria soared. And while the “stable” central bank-backed naira has fallen 60%, Nigerians turned to Bitcoin and Tether.
CBDC: The things it is not
While financial inclusion and security are the most frequent platters upon which banks serve the idea of a CBDC, ultimately they are anything but inclusive and secure.
Compromised privacy due to the monitoring and tracking of all individuals’ transactions can not be the price of having and using any currency. And there is no limit to the level of control that the government could exert over people if money is to be provided by the government directly.
In a 2009 blog post, Satoshi Nakamoto, creator of Bitcoin, summarized the dysfunctional essence of centralized finance.
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”
When a government offers a ‘compromise’ cryptocurrency which lacks its essential component — decentralization — there can be no charitable or liberating motive.