Erik Weijers, a year ago

Central Bank Digital Currencies: should we worry?

When Facebook proposed to launch its own stablecoin Libra in 2019, alarm bells went off in Western governments. If a behemoth like Facebook starts issuing its own money, we will lose our monopoly. So we have our work cut out for ourselves. Enter Central Bank Digital Currencies (CBDCs). What is the current situation and what will be the impact of this new form of money? And what does this development mean for crypto?

You can think of a CBDC as a way for governments to seize power over the financial system. In the traditional system, the creation of money is largely outsourced to commercial institutions called banks. A first sign that this system was becoming obsolete came in 2014. That's when the company Tether used blockchain technology to issue a stablecoin: USD Tether (USDT). Suddenly, banks and governments had a competitor. Since then, the stablecoin market has grown to just under two hundred billion dollars.

Since the launch of stablecoins, banks have been gnashing their teeth at the fact that people can do much more with stablecoins than with the traditional banking system. For example, with stablecoins you can transfer money to your aunt in Australia within minutes and without a limit, on the weekend. Without needing anyone's permission (fiat) to do so. Try that in the traditional banking system. As a bonus, it's great to park your 'stables' on a crypto interest account and catch a nice interest rate on them.

The possibilities

In short: the Central Banks had to get to work, as they realized all too well. What if we had the power and the technology to issue our money ourselves, directly to citizens? So without the mediation of banks, in an app? Wow, what unprecedented possibilities!

Central Bank Money, in short, is a new technological manifestation of fiat money (dollars and euros). It is digital cash. But precisely because it is digital, there are major differences from cash in terms of privacy and control. Before we get into the more ominous possible consequences, let's take a moment to look at the potential benefits of this technology.

  • Countries may eventually get rid of SWIFT, the cumbersome system that allows payments between countries.
  • People who do not have access to a bank account, for example in less developed countries, can access the world of online payments.
  • The government can easily and directly hand money to people - think of the stimulus checks in covid time.

In short, provided the government uses the extra power over money issuance well, the people of a country can benefit. But we should also talk about the downsides.

The less pleasant aspects

The word says it all: this is centrally controlled money. As money issuance becomes centralized and disconnected from commercial institutions, a number of inconvenient obstacles may disappear. And perhaps financial services will also become cheaper. But there are also reasons to worry.

  • CBDCs lead to loss of privacy because transactions can be easily monitored by the government.
  • If you want to spend money on things the government doesn't like, transactions can basically be blocked.
  • A ban on cash combined with CBDCs makes a hefty negative interest rate possible.
  • Money can be earmarked and only allowed for certain expenses ('Payment at gas station denied. Your CO2 footprint has reached its max this month').
  • Money can be given an expiration date: spend it before a certain date or else…
  • Money can be taken away at the push of a button if a citizen does not comply with certain rules.

Depending on how free-thinking a government is, these measures may or may not be implemented. But either way, the possibility will be there. It is suddenly extremely tempting - because extremely easy - for a Central Bank to block someone’s account if that person participates, say, in a certain demonstration.

How far along are various countries?

According to Atlantic Council, at this writing (March 2022) 87 countries are researching the introduction of their own digital currency. In the spring of 2020, there were 35. Furthest along are Brazil, China, Ukraine, Thailand and Sweden.

China: the digital Renminbi
China was the first major country to issue a digital currency: the digital RMB. A pilot began in 2020 in a few cities. In April 2021, the test area was expanded to include Shanghai. By the end of 2021, there were over 260 million users participating in this testing phase.

The digital euro
The European Central Bank is lagging. It will be at least until the summer of 2023 before the ECB announces the results of their tests of the digital euro. Then a decision will follow and if that decision will turn out positive, it will take some time before necessary legislation will be implemented.

America: Fedcoin
Of all the major countries thinking about a digital currency, the United States is the furthest behind. In January 2022, the Federal Reserve issued a report in which it announced that it was gathering input and conducting research on the costs and benefits of the so-called "Fedcoin”.

The power play with banks and crypto

Although many crypto advocates are spooked by the arrival of CBDCs, they are primarily a danger to our current banks. In the event of another banking crisis, the banks could just be the ones to suffer. Instead of providing banks with money, a Central Bank could let the banks go bankrupt this time. The account holders will then be told by the Central Bank: download our app and you will get your old balance back as a CBDC. Many people will then be forced to sign at the dots.

Perhaps there will not be a banking crisis in the near future. But even if the transition is gradual and 'peaceful', the role of banks as money creators will be reduced. Of course, banks will not allow themselves to be pushed aside. They will at least want to attract the part of the corporate stablecoin market. They may also still assist in the issuance of CBDCs. At least that is the intention of the European Central Bank. It is conceivable that EU citizens will soon have an ECB account that they can manage at their ordinary bank. Banks have the manpower and server farms ready for that.

Why don't crypto owners need to worry? Because the contrast between what Bitcoin in particular does and what Central Banks do could not be greater. It is true that banks borrow technology from crypto – but that does not mean that the fundamental properties can be copied. With Bitcoin, those are: a predictable issuance schedule and thus a maximum number of Bitcoins ever to be mined. Whereas a CBDC, like our current fiat money, can be reprinted to infinity. Second, of course, is the fact that Bitcoin and other crypto do not ask for permission: you do not need anyone's permission to transfer money. It is an inclusive system rather than (potentially) repressive. Precisely because crypto exists, we have a life raft if we get the idea that governments are going too far in financial repression. The irony is that crypto thus becomes, in a sense, the financial watchdog of the powers that be.

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