What is a CBDC?

Central bank digital currencies (or CBDCs) use an electronic record or digital token to represent the virtual form of the fiat money of a specific nation or region (e.g. Europe). CBDCs are centralized, and they are issued and regulated by the competent monetary authority of the country or region.

It is now clear that CBDCs are the future, and the technology behind them will radically change the way money is used, as well as the existing financial model as a whole.

Around the world, the largest economies, working with their central banks, have announced that they are already working on CBDCs.

The US Federal Reserve, the Bank of Canada and the European Central Bank are trying to follow in the footsteps of the People’s Bank of China, which is already testing CBDCs with a sample of 50,000 citizens. In October, the Bahamas issued its own central bank digital currency, the “Sand Dollar.”

CBDCs promise faster settlement, greater security, ease of use, immediate implementation of monetary policy, and lower transaction costs than cash. It is expected that in the future these advantages will be stressed again and again by experts and politicians to make this technology more accessible to the average citizen. 

Although these advantages are real, it is important to also consider the implications of this technology and how it could hurt the economy and citizens. There are different types of CBDCs with different levels of risk, and it is important to understand the trade-offs of these systems.

Here are four scenarios for how CBDCs could undermine financial stability and wipe out privacy:

A centralized financial system

Governments will always be prone to errors. Just think about what has happened over the last ten years with the launch of health.gov, or the federal and state-level breaches that leaked 300 million pieces of sensitive data. With CBDCs, the entire financial system could collapse because of data leaks from the central transaction system, which would in no way be protected the way Bitcoin is. It took Bitcoin more than a decade to secure the integrity of its blockchain. Governments will never reach that level of expertise and will be forced to rely on more fragile ways of protecting the central transaction system.

CBDCs = a dystopian nightmare

Governments tend to collect as much data as they can about their citizens, using security as a pretext. Think for a moment about the example of Greece and the controversy over remote learning and the handover of 1.5 million students’ personal data to CISCO. While we are in no way implying any wrongdoing, imagine the consequences of a potential leak.

If this seems far-fetched, consider a scenario in which a government has introduced a social scoring system under the pretext of turning citizens into model citizens. Imagine that social scoring system combined with CBDCs, where every purchasing decision you make affects your final social credit score. You make a donation to WikiLeaks, for example, and your application for a government job gets rejected! 

No, we are not describing an episode of Black Mirror: these examples are already happening in China! Even just spending time with the wrong people can affect your social credit score, which in turn affects your ability to shop, work or even travel. Combine that with the ability to monitor online purchases, and you have the perfect recipe for Big Brother on crypto-steroids.

The end of the “black” economy

Globally, more than 60% of jobs are in the “black” (informal) economy. This is due to the lack of free-market institutions such as the rule of law, property rights and sound money in many developing countries. But even in developed countries such as the US, the informal economy is huge. The International Labour Organization (ILO) estimates there are at least 30 million jobs that rely on the informal market, for example when you pay your neighbor to fix your fence or pay a young person to clean up your yard, and so on.

A great many everyday activities fall into the informal economy, and they are genuinely efficient: they make our lives easier, save us money and help us avoid red tape. Naturally, governments don’t like this, because they lose money by not taxing them. A government transaction-monitoring system (ledger) that tracks every transaction would make the informal economy impossible. As a result, a huge share of the 30 million jobs mentioned above would disappear. CBDCs pave the way for a cashless society, which is exactly what governments want. 

Central banks and fiscal policy

The pandemic has brought the work of central banks almost in line with fiscal policy. Governments are stimulating the economy like never before. Of course, the resulting deficits are huge. Because of low interest rates, bond yields are at historic lows, as is demand for bonds. Normally, governments would not take on so much debt. However, they are not worried, given the Fed’s (Federal Reserve System) huge demand, as it buys essentially all the new debt being created. In effect, what the Fed is doing is indirectly monetizing public debt.

The truth is that CBDCs could do away with fiscal policy entirely. Central banks could create cash and hand it out to small and medium-sized businesses. Those with more savings could receive higher interest rates than those without. Tax incentives and a tiered approach to interest rates become possible when governments have access to citizens’ financial data. Governments would argue that this access can only be beneficial. However, it could bring the risk of manipulation and financial mismanagement, and it would lead to faster monetization of public debt, which would come at a huge cost to all of us, as we would ultimately end up with less and less purchasing power in our hands.