Central Bank Digital Currencies: What you need to know
Slowly but surely, the news is starting to emerge that Central Banks are going to adopt digital currencies or CBDCs. This turn of events has several implications on modern monetary theory (MMT), international politics and behavioral economics, potentially upending the economic rule-book entirely.
What are CBDCs?
Unlike bitcoin, central bank digital currencies are fiat currencies that will be issued and controlled by various central banks around the world, namely the US Federal Reserve (FED) and the European Central Bank (ECB), which have warmed up to the idea.
CBDCs broadly refer to a digital representation of central bank fiat money, including digital account balances that are held in commercial banks or in Central Banks. The difference here, is tokenization, which creates a unique digital representation of value that is more portable and functions in the digital realm in a similar (but different) way that physical cash exists in real life.
On the fluffly side of things, tokenized fiat currency promises greater flexibility for central bankers to manipulate currency and facilitate cross-border payments using some form of ledger technology, which will most certainly not be decentralised.
To transfer money today, you need to go through the banking system. Digital currencies (CBDCs) mean that Central Banks will operate directly to you. i.e., you will have an account with a digital wallet with the central bank.
The benefits & trade-offs
While the technical details and monetary coding for central bank stablecoins have not been openly discussed or implemented yet, the IMF’s annual meeting hinted at the direction such currencies will take.
During the meeting, Augustin Carstens, who manages the Bank of International Settlements (BIS), said quite ominously: “with CBDCs, the central bank will have absolute control on the terms and regulations of the currency and also we will have the technology to enforce that.”
In short, this means that central bankers will be able to implement various automated processes such as automatic tax collection, instant adjustments of inflation rates (possibly based on demographics), blacklisting of certain addresses and many more tools which will effectively give central banks a big role in fiscal policy while making processes much more efficient.
Of course, the prospect of nationalizing banking and fiscal policy sounds like a dystopian nightmare, in part because it removes the relative anonymity that comes with physical cash transactions, but also due to the absolute centralised nature of financial infrastructure. No-doubt we’ll hear more rumblings about the details and technical specifics of various CBDCs and whether these will empower the current cash privileges we enjoy today or not.
All I can say is: don’t get your hopes up.
You’ll still be able to tip the waiter at a restaurant, but not without a central bank knowing it.
The ECB, the IMF, the US Department of Justice and the move to allow custody of bitcoin and other digital assets speaks volumes about what’s to come. The drum beat for Central Bank Digital Currencies could not be louder.
Given that CBDCs could effectively bypass both the private banking and fintech sectors, they quickly raise questions as to whether the trade-offs make sense for several parties, not just the individual. Indeed, this is not just an issue for using cash freely without prying eyes, but it also raises concerns about the viability of the Swift payment system — the backbone of the US Dollar.
It’s no secret that China, and various other countries will eventually get off the US Dollar standard, and digital currencies are the most direct route to undermining and eventually replacing the USD with a fragmented currency landscape as global currency wars unfold. Bear in mind that this is years in the making and will not happen overnight.
Apart from the politics, however, there’s also a question of central banks being able to directly change fiscal policy. Today, monetary policy is dead in the water given that rates are at zero or in the negative in most countries. Indeed, monetary policy has nowhere else to go, which explains Central Bank interest in absorbing fiscal policy under their umbrella (i.e. monetary nationalism). Since Central Banks want this ability to credit people directly, then bypassing the current system via CBDCs makes complete sense. As of this moment, central banks print money which goes into the banking system, which is in turn hoarded due to the current credit crunch. Central Banks do not like this, so they’ll find a roundabout way (probably via some central bank mobile app) to give helicopter money to all (dramatically shifting financial reality in the process).
Finally, since central banks will get this direct credit line for everyone with a central bank account, then Universal Basic Income (UBI) will also be part and parcel with a shopping list of unintended consequences (or otherwise); phasing out physical cash will be one of such consequences (though this is deliberate).
Should the current crisis extend into 2021 and beyond, then its conceivable for the implications to be portrayed as a solution to banking woes. Of course, while things will be easier for the end user (and might automate taxes entirely), central bankers will then have the total control they so desperately desire (per comments from the IMF panel discussion last week).
Little do people know: there are no solutions, only trade-offs.
What would a forward-looking government do?
Amidst this landscape, a truly forward-looking government that believes in free-market capitalism would take the following route: Firstly, issue a CBDC or official fiat stablecoin in order to interact with legacy finance (1), and secondly, to adopt the bitcoin standard as the country’s reserve asset and alternative medium of exchange (2).
As things stand, central banks and governments do not recognise bitcoin as a threat, but this is technically irrelevant as no government or group of governments can take down the largest computer network in existence. However, as bitcoin’s game-theory plays out and the implications of central bank stablecoins are felt, the need for bitcoin will become even more pronounced.
Indeed, bitcoin is antithetical to the whims and tendencies of centralised entities with no skin in the game; this is the very essence of bitcoin’s value proposition, and it will be realised before long.
Stay sceptical. Buy bitcoin.
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