CBDCs
Chain 1: What are CBDCs, and how are they different to crypto?
CBDC stands for Central Bank Digital Currency. It’s issued and controlled by the central bank making it a different version of fiat currency. Unlike a cryptocurrency which is based on a decentralized blockchain, a CBDC is based on a distributed database which is managed by the central bank. The central bank controls all the nodes in the system, allowing it to alter supply at its will. In addition, a distributed database is closed-source, meaning nobody except for the central bank can see what’s happening behind the scenes.
There are two types of planned CBDCs – Retail and Wholesale. Retail CBDC is designed for everyday consumers. They can use it to pay for everyday goods and services like they used to do with cash.
Wholesale CBDC is used by financial institutions for interbank cross-border transfers and holding digital currency reserves. It removes any intermediaries, thus improving efficiency and speed and making countries less dependent upon the global financial system.
Another key difference with cryptocurrency is that CBDC is influenced by monetary policy and inflation. The government and the central bank can thus manipulate its supply and value. In Bitcoin’s case, a limited supply of coins can be mined, meaning its value appreciates over time due to the price mechanism.
Furthermore, a cryptocurrency and a CBDC differ in the way of custody. Originally cryptocurrency is stored in one’s personal digital wallet. No personal information is required to create a wallet making cryptocurrency transactions pseudonymous. The owner has full custody of his crypto coins unless he transfers them to a custodial wallet such as a crypto exchange. However, all CBDC holdings are held at the central bank giving it control over everybody’s money.
Chain 2: Why are governments introducing CBDCs?
The first country to introduce a CBDC was the Bahamas with its Sand Dollar in October 2020. Multiple countries have followed suit, such as China, with its digital Yuan. The Bank of England and the Federal Reserve are also developing digital versions of their currencies.
The most common reason stated for CBDC creation was decreased physical cash use, especially after covid-19. For example, since 2017 cash use has been declining by 15% each year. Another reason is to make transferring money more accessible. Currently, people from less well-off backgrounds don’t have a bank account because they cannot meet the minimum deposit requirements and can’t afford to pay the fees. Now people will be able to create CBDC accounts for free.
However, above all, central banks feel threatened by the increased use of cryptocurrencies. Bitcoin and almost all other cryptocurrencies aim to provide an alternative to the current financial system. People are starting to lose faith in the ‘hardness’ of fiat currencies due to high inflation resulting from the constant expansion of the money supply by the central banks throughout the previous decade. Cryptocurrencies provide an appealing alternative. Their decentralized nature stops anybody from inflating the supply and devaluing the coins. Central Banks aren’t prepared to give up control, so they are developing CBDCs to challenge cryptocurrencies as the dominant digital asset. They are marketing CBDCs as a more stable digital currency since it’s backed by the government to appeal to more conservative investors.
Chain 3: What are the potential concerns of CBDCs?
A CBDC gives even more control to the central banks. They can control how many coins you can hold, what you can buy and where. They can enforce their moral standards by blocking purchases of questionable goods such as alcohol or cigarettes. This completely destroys any financial privacy and foreshadows a totalitarian society. In addition, central banks can set negative interest rates on CBDC accounts to enhance their monetary policy. This means that your money will begin to disappear, forcing you to spend it. CBDCs allow governments not only to increase the money supply as before but also to shrink it (previously impossible).
All CBDC accounts are held at central banks, making anonymity impossible. Citizens must reveal their identity through the Know Your Customer (KYC) mechanism. This allows central banks to assign social credit scores to their accounts. The Social Credit system has already been tested in several Chinese cities. Although most Western democracies have criticized these systems, the central banks of these nations are nonetheless pushing ahead with similar dystopian measures.
Finally, a CBDC is vulnerable to a cyber-attack. Its distributed database is centrally controlled, creating a single failure point. Should the central banks' system be hacked, all the country's citizens will be exposed. Such an attack would be less likely to succeed for a cryptocurrency since it would have to gain control of 51% of the nodes to corrupt the system. The processing power required to achieve this would be too big for any hacker.
Chain 4: What does the future hold?
Although multiple countries are considering CBDCs, there is still a long way to go before global adoption. Existing attempts, such as the previously mentioned “Sand Dollar”, have failed to gain traction. According to surveys, only 4-12% of people are willing to adopt a CBDC. CBDCs face a lot of opposition because most people aren’t prepared to give up their financial privacy. In addition, as cryptocurrencies gain mass adoption, their value will stabilize, significantly reducing their volatility. Thus, the main advantage of CBDCs will disappear. It is likely that governments will try to fight crypto with rules and regulation. Authoritarian regimes will be able to force CBDCs onto their population and ignore any opposition.
On the bright side, most people will choose to work on blockchain projects rather than CBDCs. The salaries offered by the private sector companies are far higher than what the central banks will be able to offer. In addition, the negative media coverage will further discourage people from working on such dystopian projects.
References
https://cointelegraph.com/learn/wholesale-cbdc-vs-retail-cbdc-key-differences
https://www.ft.com/content/44015dbd-e28a-4be9-b690-ff309b80b890
