CBDCs

Thought-Leadership Input — Food for thought brought to you by the Industry Defi Council

On 21 March 2023, Florida’s governor Ron DeSantis proposed legislation to ban Central Bank Digital Currencies (CBDCs) in the Sunshine State. So what are CBDCs all about and is this a good move?

CBDCs are digital forms of fiat money issued by a country’s central bank, which are intended to complement or even replace physical cash. CBDCs are similar to cryptocurrencies (like Bitcoin) in that they normally use digital ledger technology to record transactions. But, they differ in that they are centralized, meaning that they are issued and backed by a central authority, typically a country’s central bank.

The concept of CBDCs has been gaining attention in recent years, with many countries around the world currently exploring the potential of CBDCs. China, as the clear leader in this field, has already launched a digital version of its currency, the digital yuan, which is being trialled in several cities. Other countries are also in the process of developing their own brand of CBDC. The EU for example is looking at a “digital euro” (here is another article about this specific topic). The website https://cbdctracker.org shows that there is hardly a jurisdiction not interested in the topic.

There are two main types of CBDCs: wholesale CBDCs and retail CBDCs. Wholesale CBDCs, on the one hand, are designed for use only between banks and other financial institutions, and will not have a large impact on the average citizen’s life. Retail CBDCs, on the other hand, are designed for use by the general public in daily life. Most observers believe that the initial thrust will be in the direction of introducing wholesale CBDCs, but that inevitably at a later step retail CBDCs will also be rolled out. These will first complement and then replace cash.

After the complete replacement of fiat currency by a CBDC, citizens and companies would ultimately have neither cash nor bank accounts. Instead, they would have an account directly with the central bank (direct central banking). The central bank would have to take over the functions of account opening, customer service and compliance with KYC/AML regulations, tasks which were previously performed by banks and which might in this new situation be outsourced to banks. It is on this likely end scenario that I will focus.

From a state’s point of view, there are many good reasons for introducing CBDCs, including the following:

• No physical banknotes and coins: With CBDCs, the physical currency would no longer be needed, which could save the costs (and obviously the environmental footprint) associated with designing, printing, transporting, storing, and disposing of banknotes and coins. Think of the logistical and security nightmares of stocking up ATMs with banknotes, all of which would be gone. Also a thing of the past would be counterfeited banknotes.
• No unbanked individuals: With retail CBDCs, the promise would be that finally, everybody would have the possibility to get a bank account and that there would be no more unbanked individuals. Financial exclusion is a problem in many underdeveloped parts of the world, but also in the US and (to a smaller extent) in Europe is there a certain part of the population for whom banks will not open checking and savings accounts. A retail CBDC would allow anybody to get an account with the central bank.
• Easy implementation of monetary policy: CBDCs would provide central banks with greater control over monetary policy, allowing them for example to implement negative interest rates and helicopter money. At the touch of a button, every citizen could for example receive money from the central bank (e.g., during a pandemic or a period of inflation), which would vanish into thin air if it is not spent within a certain period of time.
• Easy detection of crime: Since all transactions with CBDCs are recorded in a ledger and thus traceable (in contrast to anonymous cash payments), crimes such as bribery or money laundering would become far easier to detect and could possibly be eliminated once and for all. A suitcase full of cash handed over in a dimly-lit parking lot would be a thing of the past.
• Easy safeguarding of tax compliance: Similar to the above, tax evasion through moonlighting and offshore banking will not be possible any more if a taxpayer does not have cash or bank accounts, only a CBDC. Not only would underreporting not be possible but the tax (e.g., income tax or value added tax) could actually be levied directly at the source. Today it is impossible to introduce a worldwide annual wealth tax imposed on deposits held at whatever bank. If there are no more bank accounts, but only one account with the central bank, such a wealth tax could automatically be deducted from every taxpayer’s CBDC account, and the applicable tax rate could even be progressive.
• Easy enforcement of financial sanctions: Individuals subject to financial sanctions can easily have access to their CBDC accounts withdrawn the moment they are put on a sanctions list, without having to rely on banks to implement sanctions decisions. The same applies to unruly government protestors (like members of the Canadian Freedom Convoy) who could quickly be cut off from their funding.
• No deposit insurance schemes: With retail CBDCs, there would be no need for deposit insurance schemes, as people’s money would be held directly with the central bank rather than with commercial banks. Bank runs would be a thing of the past.
• Prestige: Central bankers and other government bureaucrats likely see the successful introduction of a CBDC as a project that enhances their prestige, demonstrates their ability to innovate and keep pace with technological advancements and marks them as forward-thinking and modern leaders.
• Response to crypto: Importantly, CBDCs can be seen as a flashy alternative to decentralized crypto assets and stablecoins, which fill regulators with dread and unease exactly because they are decentralized and cannot be controlled.

From a citizen’s point of view, there are however three important disadvantages of CBDCs:

• Privacy: With CBDCs, central banks would have a full overview of movements in the monetary system. CBDCs will in no way grant a degree of anonymity comparable to cash. This raises concerns about privacy and government surveillance. Even if clever cryptography is used to obfuscate most transactions and reveal only a few flagged transactions, there is always a risk of misuse or that the parameters of the system are later on changed. It is no wonder that China, a dangerous authoritarian state, was the first country to provide the government with a powerful toolkit to directly monitor the financial activities of its citizens.
• Hacking: The decentralized system with thousands of banks that exists today can obviously not be hacked as easily as a centralized honeypot that a CBDC system would constitute. Experience has shown that the private sector is way better at defending against cyber threats than government agencies.
• Sovereignty: CBDCs just extend the antiquated system of money with no real sovereignty. Money that you hold with a bank, or a central bank, is not truly yours. You merely have a claim, that may or may not be honoured. Only crypto assets controlled through a private key really constitute your property.

Everybody who has concerns about an all-powerful surveillance state, doesn’t believe bureaucratic promises of supposedly hack-proof systems, and who likes self-sovereignty must be against CBDCs. Satoshi Nakamoto, the founder of bitcoin, would have been strictly against CBDCs. I am with Satoshi.

This article for the “Thought-Leadership Input” series of the IDC was written by Dr. Niklas Schmidt.
He is a partner with the Austrian law firm Wolf Theiss. His details can be found here: https://www.wolftheiss.com/lawyer/niklas-schmidt. This article reflects his personal views.