CBDC: Solution or Problem?

Wire transfers: a short history

The first wire transfer-related service open to the public was launched by Western Union in 1872 and relied on the telegraph network, so much so that some people still call it telegraphic transfer

After 5 years of service, more than $2.5 million a year was already flowing through this network, which is equivalent to more than $12 billion nowadays.

A consolidated way of making payments, based on IBAN and BIC addresses, has been established for decades now. Globally, the SWIFT system is predominantly used, which has also played a role in the “monetary disconnect” of so-called “rogue” states such as russia and Iran.

However, russia, disconnected since the start of the war of aggression against Ukraine, had taken precautions in good time, as it implemented since 2018 the SPSF system, which to call it expensive and cumbersome is a compliment, while China is also prepared for the worst with its CIPS, used in more than 100 states.

Regardless of the various players in the field, slowness and complexity are nonetheless inherent characteristics of these kinds of systems, which in any case have to deal with several layers of a system that has never been remade from scratch.

More than 100 countries are implementing, testing or learning about Central Bank Digital Currency.

We have all dealt with the slowness (and uncertainty) of a bank transfer, with phone calls, TRNs sent by email, scans of payments made with photoshop but never executed…

However, just as Internal combustion engines are finally about to be supplanted by electric ones after more than 200 years of unchallenged dominance, the time has come for wire transfers to give way as well.

Given the requests and the positive feedback related to one of my earlier, more “political” articles, I decided it was worth the effort to expand this topic.

So, why CBDC?

Essentially for 3 reasons:

• the adoption of a common platform based on smart contracts will certainly lead to a reduction in costs
• the reduction of intermediaries and the ability to transact directly between end users

the backing of a central bank will be risk free for the users, unless the state fails: a not so rare event…

The dark side of CBDC

This kind of transactions will record a great deal of information regarding our habits, vices, and medications we use.

We have already witnessed scandals in the past regarding embezzlement and offshore funds of some influential politicians, but they were usually mischief caused directly by their lack of caution or by hackers or banking personnel themselves. Instead, the CBDC system would expose all of us to potential scrutiny that could be done automatically directly by states or supranational bodies for political purposes.

Not to mention the overt goal that is rarely considered: the disruption of the current order constituted by cryptocurrencies, which is seen (rightly or wrongly) as a threat to the current world monetary status.

China

We have seen before how China is pioneering an authoritarian use of hi-tech, just look at the use of facial recognition to profile and classify its population by ethnicity or to humiliate people who wear pajamas in public.

It was only a matter of time before Xi Jinping turned his attention to the world of blockchain.

China has always been among the most enthusiastic states about cryptos, at least until September 2021, when, after a series of stop-and-goes, cryptocurrencies were permanently banned using ecological concerns as a scapegoat.

Few had any doubts about the real nature of this ban: I am, of course, referring to Digital Yuan, which is in advanced testing thanks to an 8-year gestation.

The matter has several bittersweet sides:

• this “cryptocurrency” is not based on blockchain
• in order to encourage its adoption, the Chinese government is giving away small amounts of coins in the guise of a lottery
• cryptos are continuing to be mined inside government buildings.

U.S.

As for CBDC, the United States of America remains at the research stage. The official position of the treasury is that the government wants to be sure to apply a model that meets the standards of democracy, freedom, and privacy. Nobody is considering the fact that Bitcoin already includes all of these qualities, apart from usability, which should be the thing to be most considered for mass adoption.

As of 2021, the Federal Reserve has begun to express interest about the possible adoption by the U.S. of a central bank digital currency. This service “will be complementary to the use of bank deposit cash and, although it will incorporate some of Bitcoin’s architecture, will not be decentralized and mining will not be possible.”

As much as mining is now an obsolete practice, there should be some debate, however, as to whether printing currency willy-nilly would be a more ethical and sustainable practice.

The real reasons behind this lagging interest in cryptos in the U.S. are probably to be found in the age of the last two presidents: 150 years in two if we consider the year of their inauguration, and even the Chair of the Board of Governors of the Federal Reserve System is a 70-year-old gentleman.

Unfortunately, we are faced with a gerontocracy that has few rivals in the world, able perhaps to provide a minimum of stability, but certainly not to innovate.

Eurozone

The digital euro is scheduled to go online in about 2025, and although the European central bank project is further ahead than the federal reserve project, concerns remain about adopting a centralized model, but at least the wrong decision has not already been made. The deadline for enquiring is September 2023, when the appointed team will move from design to development.

The use cases currently under study are three:

• transactions between friends
• payments in physical or digital stores
• payments to and from the government

Various reassurances have been given to the banking sector, as it seems that the Digital Euro will not be designated to become a financial instrument, and that banks will still be retained as an intermediary. Also various statements regarding privacy, may still be more credible than those of countries such as russia and China, partly because of previous battles such as that over GDPR.

Across nations

The adoption of digital currencies among various countries, could greatly improve international transactions, and several tests involving Switzerland, Singapore, Hong Kong, Thailand, China and the United Arab Emirates have already been conducted.

A common thread linking these experiments confirms the initial premise that it is much easier to interface CBDCs with each other than with traditional central banks, as well as providing the benefit of faster and cheaper payments with operational transparency.

The biggest challenges will be mainly related to the harmonization of different access policies and legal frameworks.

It may be possible to simply replicate in blockchain the already estabilished SWIFT mechanisms, or create something completely different.

This fully digital interchange between different nations could on the one hand contribute to financial resilience, while on the other hand it could exacerbate liquidity issues, given the extreme speed with which it could move from one currency to another.

Developing countries

A key application of a cross-border CBDC could be to make remittance-related payments cheaper and more transparent, which currently have costs in excess of 7 percent, despite the pounding Western Union advertising that has been raging for weeks.

Let’s analyze what might be the other pros and cons of adopting a digital currency in developing countries.

PROS

• Improve efficiency of domestic payments: payment services in developing countries are often in the hands of a few people, it follows that the introduction of CBDC could increase competition and reduce the costs typical of these monopolies
• Enhance financial inclusion: low-cost access to financial services would certainly be beneficial in countries where 30 percent of the population does not use banking services, despite largely owning a cell phone
• Tackling tax avoidance: this goal is not officially declared, but it is obvious that in states with the highest rates of tax evasion, some governor would gladly throw an eye on transactions, to punish the most blatant cases.

CONS

• IT security: the lack of attention to details related to the cyber security and resilience of CBDC infrastructure could lead to unimaginable banking catastrophes
• Disintermeditation: banks in these countries have traditionally been more fragile and exposed to financial storms, and taking some of the business away from them could be a major blow to many of them
• Low user adoption: people in these countries generally have less spare time to evaluate new technological opportunities and are traditionally more inclined to use cash

CBDC and beyond

Why don’t we make the leap for credit cards already?

Japan Credit Bureau, a Tokyo-based credit card company has set a goal of adapting its current infrastructure to the CBDC payments system, moving in 3 directions:

• QR codes
• dedicated credit cards
• touch payments

And it looks like they will be able to be operational by the spring of 2023, thus anticipating Digital Yen, which could be operational by 2027.

Despite his no longer tender age, 65-year-old Japanese Prime Minister Fumio Kishida, in addition to being an active promoter of CBDC is also an enthusiastic crypto and supports social integration projects related to the metaverse and NFTs.

How’s the outlook?

So this is where we are today: apart from China, the adoption of digital currencies is only on paper: the outlook is not positive and only the future will provide answers to a number of questions, which in any case it is good to raise now:

• Will it be designed in such a way as to guarantee anonymity for users?
• Will it really be based on distributed technology?
• Will it be widely adopted by consumers?
• Will it still require the costly intermediation of banks?
• Are we not simply looking at a digital reissue of the current monetary order, with a sprinkling of blockchain?

Let us all ponder these points together, not least because they will form the basis of a future in-depth study.