Recently, Central bank digital currencies (CBDCs) have been a topic of increased interest from governments and other organizations. Proponents of CBDCs claim they are a way to give more people access to convenient, safe money, and to make payments more efficient.
However, much of the allure of CBDCs from the position of governments and other regulatory bodies is that they resemble Bitcoin in superficial ways while in fact offering nearly none of Bitcoin’s benefits.
The International Monetary Fund (IMF) has been asked by 40 countries for guidance on CBDCs, and is planning a handbook outlining its approach to CBDC development.
Despite failed CBDC rollouts like Nigeria’s eNaira, there is still sustained interest in them from governments. So far, nine countries have developed their own CBDCs, while more than a hundred countries have expressed interest in developing them, including the Biden administration, which has been notably Bitcoin-averse.
Let’s take a look at exactly how CBDCs function, why governments are interested in exploring them, and how they run counter to the interests of Bitcoin users, Bitcoin miners, and all those who stand to benefit from decentralized, open-source cryptocurrencies.
What are CBDCs?
A CBDC is just what its name describes: digital money housed at a nation’s central bank. For example, a Federal Reserve CBDC would be digital money issued by the FED directly to consumers, bypassing local commercial banks.
While the growing interest in CBDCs is new, digital currency systems have actually existed for years, even prior to the invention of Bitcoin in digital payments systems. The reason why CBDCs are all the rage now is because of the evident benefits of incorporating blockchain technology into payments schemes.
Blockchain-based digital currencies are more robust against attacks (with blockchain data synchronously stored in multiple servers). Additionally, blockchain-based digital currencies can autonomously clear account debits and credits to remove human error from ledger data entries.
Deputy Managing Director of the IMF, Bo Li, says the IMF’s CBDC handbook addresses technical issues on good CBDC design, with tailored assistance for each country based on its regulatory standards and technological capacity constraints.
What are the downsides of CBDCs?
If properly designed and implemented, a CBDC could strengthen the usability, resilience and efficiency of payment systems and increase financial inclusion, Bo Li has said.
However, this is hard to believe, considering that CBDCs tend to include:
- Fractional reserve banking, which is not a good benchmark for resilient banking, with credit bubbles and bank runs.
- Quantitative Easing (QE), which blows up credit bubbles even more, and creates financial exclusion with rocketing asset prices.
- Quantitative Tightening (QT) when the easing has been too easy. This shrinks bond values and exacerbates financial instability.
About fractional reserve banking
Fractional reserve banking—operated by central banks through local commercial banks—is often decried because it allows printing of money out of thin air, by loaning the same money over and over to different customers.
With fractional reserve banking, if everybody went to the bank to ask for their money back at the same time, it would not be there. When the markets go awry, a bank run of this sort has been known to occur, which can cause eventual collapse, as happened with Silicon Valley bank (SVB) and many others.
Why is the IMF advocating for CBDCs?
With a CBDC, the state hypothetically gives citizens better money, but this is money that the state maintains full control over.
This is nothing short of hijacking the market, hence subsuming consumption and production decisions to the controllers of the CBDC.
CBDCs also offer governments financial stability
A CBDC saves central banks from the liquidity problems associated with fractional reserve banking because all the money created and given out to people actually remains in the CBDC ledger. It is not somewhere in someone’s private stash, like cash can be.
However, financial instabilities leading to bank runs still abound. While no local commercial bank will collapse, simple, old-fashioned inflation of the money supply can lead to spikes in the CPI, which is the new nemesis for a CBDC.
This can be managed by having very effective credit scoring and credit policy management technology coded into a CBDC that also tracks spending and earning with AI-powered systems.
Because a CBDC is digital, smart contracts can be layered all over it unlike with paper currency. This is why CBDCs are seen as the panacea for financial instabilities by 40 governments and counting.
Hiding behind the business angle
Looking at it optimistically, an American CBDC could be viewed as digitization of the dollar. This idea follows in the footsteps of digitization of records as done by many government agencies to foster efficiency and effective operations. An example is the digitization of records for the New York City’s Metropolitan Transportation Authority (MTA).
However, this is state control of the market. CBDC roll-outs are rationalized with ideas like finding a way to quickly stop inflation in its tracks when the need arises, but they really foster zero reserve banking and targeted credit expansion.
The ability to print money, give loans to individuals, track credit scores and reward/punish dissenters all rolled into one package sounds like the ultimate efficiency hack. However, it crosses the line, going way beyond regulation into state control of the market.
Will CBDC implementation succeed?
Some CBDCs have already been released, largely to disappointing fanfare. After the Nigerian CBDC was created, the token money was freely given out. The Nigerian government spent huge sums of money promoting the CBDC, but it remained a flop.
In China, a social credit scoring system infused with AI tracks and assesses the behaviour of individuals using facial ID technology, and seems to be doing a good job at punishing and rewarding citizens based on their credit scores. It also helps curb commercial bank losses, benefiting the People’s Bank of China (PBOC).
The PBOC was however not satisfied and resolved to launch the e-CNY CBDC—aka the digital Yuan—with a first test done in 2020. Alas, adoption rates have been just as miserable and many of the 123 million individual wallets are practically empty and not in active use. “Project Hamilton” from the Federal Reserve Bank of Boston in the USA is fairing slightly better, but is not what anyone would call a runaway success.
Promoting a healthy Bitcoin ecosystem instead
Unlike CBDCs, Bitcoin is a decentralized currency that empowers users, allowing them to protect their privacy and financial independence. The widespread growth and adoption of Bitcoin in recent years is testament to its ability to revolutionize global finance. Attempts by groups like the IMF to combat the rise of Bitcoin can also be seen as indicative of how powerful Bitcoin is and will continue to be, in 2023 and beyond.
The continued growth and adoption of Bitcoin is reliant on a few key factors. One of these factors is Bitcoin’s ability to avoid the influence of undue regulatory pressure. A second factor is access to reliable and affordable sources of energy to power Bitcoin’s proof-of-work mechanism. A third key factor is for Bitcoin miners to have access to the hardware they need to profitably produce new bitcoin and keep the network secure.
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