Central Bank Digital Currency (CBDC) is the digital form of government-issued currency that is not pegged to any physical commodity. Working like a stablecoin, but differing from cryptocurrency, in a way that it is not decentralized, CBDC is issued and operated by the state. Currently, 114 countries, representing more than 95% of global GDP, are exploring CBDC, more than 50 countries are in the advanced phase of testing and 11 countries have fully launched a digital currency. The media coverage of the phenomenon has been increasing rapidly and in some parts of the world it has already become commonly used. However, there are also many drawbacks, a lot of skepticism from the population and contradicting information between the published reports and the press conferences.
In order to understand where all these fears and arguments come from, it is crucial to analyze the benefits and the challenges that such an outbreaking financial innovation implies. The main drivers of introducing CBDCs are the continuous decrease of cash usage in the past two decades, calling for a new digital financial system and the simultaneous increasing interest in cryptocurrency. There are three main types of CBDCs currently developing: retail, wholesale and hybrid. While a retail CBDC is accessible for the general public, used for retail transactions and peer-to-peer payments, has a significant direct impact on the supply and demand of money and on traditional finance and an increased level of privacy concerns, the wholesale CBDC is mainly addressed to financial institutions, used for interbank settlements and wholesale transactions, has less impact on money supply and demand and on traditional finance and lower privacy concerns.
Digital transactions have gained popularity, and cash payments are declining year by year, but they still make up a majoritarian percentage of payments. Currently, 1.7 billion adults around the world do not have access to the financial system and more than 6% of Americans do not have a bank account. Issuing a digital currency could be a solution to this problem and to many others, as one of its main advantages is its lower costs and increased accessibility. CBDC does not require individuals to even hold a bank account and may therefore offer a safe and liquid government-backed means of payment to the large public. According to McKinsey, over $400 billion can be saved annually in the transition towards a more digital financial system. However, at the moment, there is still the need for major investments in R&D, implementation and advertising.
A second advantage is better security: the cryptographic protocols, including digital signatures and encryption could considerably reduce the risk of hacking, backed by tamper-resistant ledgers (such as blockchain) with immutable records of transactions, impossible to delete, therefore preventing fraudulent transactions and ensuring transparency. Another plus when it comes to security is smart contracts, meaning that there will be self-executing programs that automatically enforce the terms of a contract, so that payments are only made when certain conditions are met.
Higher efficiency is an uncontestable benefit, as transactions are faster (almost instant), cheaper (lower transaction fees for both individuals and businesses), more accessible (because of the lower cost compared to traditional banking), better integrated (with other digital systems), all this both for domestic and international payments. Moreover, they can facilitate central banks’ implementation of monetary policy. CBDC means an enormous control and monitorization of the money supply, and they can be used for specific targeted sectors of the economy, with no need to rely on commercial banks. This could enhance financial stability, reducing the need for deposit insurance and mitigating a run risk.
However, despite all the aforementioned benefits, there are some serious drawbacks that have recently spread much fear among the population. The technical complexity of such a system requires a lot of time, risk management, and cybersecurity measures to become a safe alternative to traditional banking. Then, after its implementation, there is the risk of disrupting the existing financial system (also known as banking-sector disintermediation), which must be carefully managed in advance. Also, it may reduce the need for financial intermediaries (although a replacement of commercial banks is highly unlikely, as it would not benefit any of the parties).
The most concerns among individuals, however, are related to privacy and control for retail CBDCs: once you have them, the central authority can easily decide how much you can save and spend, where you can do that and what you can buy with them, as a feature that they possess is that they are programmable. Some extreme scenarios include having a daily limit or being forced to spend them by a certain deadline, engineering the behavior of individuals in order to achieve the governments’ goals. For instance, something that is already tested is the carbon allowance, a measure that is supposed to put a carbon limit on each individual. With the help of a CBDC, the government could easily calculate your carbon usage and prevent you from generating more, by blocking certain payments for products or even automatically fining you. More smoothly, they might be offered as a form of basic income, which increases the concerns of individuals’ freedom being severely limited. The most terrifying prediction refers to the fact that they could use this to take away our freedom of speech, following the model of China, where people’s social credit scores are linked to their bank accounts and citizens are ranked and punished with no internet access or train and flight bans if the Communist party considers then untrustworthy (INSIDER). China is also the major economy with the most advanced CBDC system development. It has been running tests since April 2020 for its digital yuan and consumers have been spending over two billion yuan in over four million transactions.
Some of these ideas might sound unreasonable, especially in the EU or other democratic states. However, the truth may be somewhere in the middle, as there are many events proving that the concerns are founded. Africa is a very interesting example, as in December, the Nigerian Government set limits to cash withdrawals in the country to $45 per day, in the attempt to force the population adopt its “eNaira”. However, it was demanded by only 0.05% of Nigerians in the first year, while the cash limit only increased the opposition against the CBDC. Recently, the Government took a step back and announced that they concluded that cash should be kept in circulation at least until December. UK’s “Britcoin”, recently announced by Rishi Sunak, caused confusion among people, as the report was not in line with the public announcements. The finance minister reassured people that it will not replace cash or stablecoins, but the published report contains more hidden details such as the possibility of freezing holding in times of crisis to prevent bank runs. ECB decided to let the commercial banking sector handle everything related to the issuance of its CBDC, promising to the public that it will not be programmable.
All in all, solving the challenges of traditional payment systems, but introducing new risks associated with the centralized system, CBDCs are highly complex, widely misunderstood and very powerful. Everything depends on their purpose, regulation, and the degree of opposition from citizens. As long as they do not replace bank deposits and represent just a complement or alternative digital financial system that is not introduced by force, fairly used by authorities and willingly accepted by individuals, it has the potential to bring numerous benefits and make many lives easier. However, if the opposite happens, it may be the biggest threat to our financial freedom.