The dark truth behind Central Bank Digital Currencies
Your governments thinly veiled attempt to replicate the Chinese social credit system
On January 3, 2009, a mysterious figure known only as Satoshi Nakamoto launched Bitcoin, the world’s first cryptocurrency. Leveraging distributed ledger technology (also called blockchain technology), Bitcoin showed the world what a decentralised currency could look like.
With Bitcoin, there were no printing presses or minting facilities required. No central bank needed. And no one pulling the fiscal strings; arbitrarily changing interest rates, or engaging in quantitative easing. It was currency by and for the people. And anyone with a computer could begin mining it from day one.
In the thirteen years since Bitcoin’s launch, dozens of other cryptocurrencies have been born. Several have introduced innovative additions to Bitcoin’s core ideas, including the use of smart contracts. These self-executing programs run when certain conditions are met. And they’ve transformed simple cryptocurrencies into robust platforms, able to support Non-fungible tokens (NFTs), decentralised finance (DeFi) apps, and much more.
Today, the cryptocurrency industry is fast becoming one of the largest in the world. Recent estimates have valued it at over $3 trillion.
Crypto is entering the mainstream. And many political leaders and governments don’t like it.
The creation of central bank digital currencies (CBDCs)
For generations, governments have played a central role in the creation and distribution of money. They minted the coins and printed the bills. And they’ve been heavily involved in the banking industry through regulations and more. So, it should be no surprise that they are less than thrilled to hand all that authority away to a decentralised autonomous organisation (DAO), or to no one in particular.
The move toward decentralisation has led to governments around the world looking at how they might move into the digital currency space without sacrificing their control over monetary policy. This desire is an important driver behind the push for central bank digital currencies (CBDCs).
While CBDCs share some things in common with cryptocurrencies, they’re not the same thing. So, while they may have some advantages over traditional paper fiat money, they also come with some pretty hefty drawbacks. But in order to understand the good and the bad of CBDCs, it’s important to get a grasp on what exactly they are, how they work, and how they’re similar to and different from cryptocurrencies like Bitcoin and Ethereum.
What is a central bank digital currency?
Central bank digital currency is digital money that’s issued by a central bank, and which has its value pegged to its country of origin’s fiat currency. So, a USA-based CBDC would be issued in US dollars, while a UK-based one would be denominated in pounds sterling. Because of this, CBDCs aren’t viewed as a replacement for traditional fiat currency. They’re designed to live alongside it.
While creating a digital currency may seem like a huge leap, the reality is that most governments have been moving in that direction for years. In fact, there’s such a thing as wholesale CBDCs that have already been in place throughout much of the world.
Wholesale CBDCs are like banking reserves. A central bank provides an account to financial institutions that they can use in several ways, including for depositing funds and settling transfers between banks. Those same central banks can then use policy tools to influence lending and more through those reserves.
While wholesale CBDCs have been a valuable tool for central banks globally, their use has been limited to governments and financial institutions. Retail CBDCs, on the other hand, will bring this concept to the average citizen. Though for most people it won’t be completely foreign in practice.
As technology has advanced, governments, banks, and other financial institutions have supplemented physical currencies with a credit-based system that digitally records balances and transactions. Today, many people go months without ever touching paper money or coins.
Debit cards and credit cards have prepared the world for full-on digital currencies. And CBDCs are the final step in that direction. But if that’s the case, how will CBDCs work? Are they nothing more than an extension of our current system? Or is there more to them than that?
How would CBDCs work?
While there’s no required way for a CBDC to work, most will likely begin with a digital ledger created by the central bank itself. This is where all transactions will ultimately be recorded. In this sense, it will be like a blockchain, though it won’t be decentralised. Instead, it will be operated and controlled by the central bank.
Payment interface providers (PIPs) will include firms that have developed platforms which interface with the central bank ledger using an API. Only firms that are authorised and regulated by the central bank will have access to this API. Thus, the central bank will have complete control over how platforms access the central bank ledger and make the CBDC available to customers.
Generally speaking, people would use CBDCs as they do debit cards. As we’ve already noted, the CBDC would be denominated in the home country’s currency. So, users could make the same purchases with a CBDC as they would with a card, or physical cash.
However, there is one feature that could set CBDCs apart in a major way when it comes to how people use them. Depending on how the CBDC is set up, it could feature smart contracts. These programmable smart contracts could take many different forms and be used for a wide variety of purposes, from restricting its use for undesirable activities to automatically collecting taxes.
How are CBDCs different from cryptocurrencies?
At first glance, CBDCs and cryptocurrencies may seem like the same thing. After all, both are forms of digital currency that consist of transactions recorded onto a secure ledger. And both can take advantage of smart contract technology.
But while CBDCs share several core concepts with cryptocurrencies, they’re not the same thing.
Cryptocurrencies are built using distributed ledger technology and rely on a decentralised network of nodes, each acting as a check and balance on the others. Because of this design, cryptocurrencies depend on a consensus mechanism like proof-of-work (PoW) or proof-of-stake (PoS) to ensure the stability and security of the crypto coin.
Most cryptocurrencies aren’t backed by anything tangible like gold, silver, or even the “full faith and credit” of a nation or institution. Instead, Bitcoin and other cryptocurrency’s value comes purely from the demand people have for it.
All these things differentiate cryptocurrencies from CBDCs. Central bank digital currencies could use blockchain technology or a more traditional, centralised digital ledger. Each country considering a CBDC would have to look at the advantages and disadvantages of both, deciding which fits their goals the best.
A CBDC built on a centralised solution wouldn’t need a consensus mechanism like cryptocurrencies. The central bank could simply define the number of digital coins for circulation.
In addition, CBDCs would be like other fiat currencies, backed up by the country issuing them. Thus, they would have something more behind it than simple demand.
The advantages of CBDCs
CBDCs would offer many of the advantages and benefits of all digital currencies.
They’d make it easier for people to pay for goods and services in convenient ways. People are already using cash less and less. CBDCs will provide them with a digital replacement to bills and coins. Some advocates have argued that this will increase financial inclusion by bringing streamlined financial access to the unbanked and lowering transaction costs. Obviously, this is a major goal for countries around the world, and it’s one of the more publicised driving factors in the push for CBDC development.
One of the other attractive things about CBDCs is the way they could simplify cross-border payments. This would lower costs and boost overall interoperability, making it easier to engage in our world’s globalising markets.
But the draw of CBDCs goes far beyond streamlining financial processes. They would also make it more difficult to counterfeit and launder money. Smart contracts would open the door to all kinds of innovations.
Unfortunately, many of these exciting possibilities could quickly turn into terrifying, totalitarian dangers, especially if the digital currency was in the hands of an oppressive government.
The drawbacks to CBDCs
Critics of CBDCs believe their creation and implementation would lead to far more disadvantages and dangers than benefits. And that’s not just because they could be abused and manipulated by politicians.
As with all digital currencies, CBDCs will bring out cybercriminals and hackers. The crypto industry has already seen numerous examples of hackers creating chaos within certain blockchains. While there would likely be a high degree of security with CBDCs, their nature makes them a target for independent or state-sponsored criminals from across the world. Thus, they’re at a disadvantage in this regard when compared with paper money.
There are also questions about the broader changes CBDCs could bring. While analysts can hypothesise what would happen if CBDCs were introduced to an economy, the actual impact is unknown. How would these digital currencies affect household expenses? Interest rates? Banking reserves? Investments? These are questions that have no clear answers.
On top of these questions, there’s uncertainty as to how a CBDC would affect a central bank’s ability to implement monetary policy. Would changes in interest rates have the same impact with a CBDC that they do now? Or would they create new complications to the way central banks influence inflation, lending, and more?
Many privacy advocates are also sounding the alarm on CBDCs. If a central bank develops its digital currency using a centralised ledger, that bank (and therefore the government) would have access to details regarding personal expenditures and other transactions. That intrusion into personal privacy would only increase as the authorities monitor for financial crimes like money laundering or terrorism financing.
The biggest concern about CBDCs though, is their potential for being used similarly to China’s social credit system. Over the past ten years, China has implemented a social ranking system that monitors its citizens’ behaviour, ranks them based on their social credit, and responds accordingly. Social credit can be lost for any number of reasons, including playing too many video games and allowing a loan to become delinquent. If their social credit score drops too low, Chinese citizens can face a host of punishments, from having a pet taken away to limiting internet access and more.
Any CBDC that makes use of smart contracts could be programmed in dozens totalitarian, oppressive and controlling ways. They could be prohibited from being used on purchases that are deemed socially harmful or otherwise problematic. A person’s entire savings could be frozen with no recourse. In other words, there are only a few steps between many proposed CBDCs and China’s social credit system.
And that should concern even the most ardent of CBDC supporters.
Are any countries currently implementing CBDCs?
There are already dozens of countries around the world that are looking into the possibility of CBDCs, including here in the UK, but also being considered by India, the US and Canada. However, there have only been nine countries and territories that have officially launched CBDCs:
- Antigua and Barbuda
- The Bahamas
- St. Kitts and Nevis
- St. Vincent and the Grenadines
- Saint Lucia
For anyone who’s interested in learning more about the state of CBDCs around the world, CBDCTracker.org offers a central hub that features up-to-date information about every country’s CBDC-related efforts.
The future of CBDCs
If the current state of CBDCs is any indication, their widespread adoption is almost inevitable. Kristalina Georgieva, the IMF Managing Director for the Atlantic Council, recently wrote, “The history of money is entering a new chapter.”
But this new chapter hasn’t already been written. Countries and financial institutions around the world still have a great deal of hard work to do when it comes to CBDCs. The challenges and risks may not be insurmountable, but they are significant.
If the past century has shown the world anything, it’s that politicians and governments cannot be trusted to police themselves. Corruption spreads, and it works its way to the very top of institutions.
Citizens cannot simply take a politician’s word when it comes to issues of privacy and monetary control. Something exacerbated by the growing number of recently published false truths, misdirections and political agendas seen throughout and catalysed by the pandemic.
For any CBDC to truly work, there must be a good faith effort on the part of those developing CBDCs to formulate them in a way that will protect the people from governmental overreach. Until then, challenged and resisted at all costs.