Cryptoland Episode 3: What’s this CBDC you talk about?
A few weeks ago, we talked about stablecoins. In the last episode, we dug deep into how various coins could bridge the gap in this world of decentralized finance. As of the close of 2022, more than 100 countries joined the race of piloting and developing their own CBDCs ( Central Bank Digital Currency ). Countries like Saudi Arabia and Tunisia focused their energies on wCBDC (wholesale CBDC), wherein commercial banks could use this product to settle transactions between them. Norway and Russia focused on rCBDC (retail CBDC), with a more consumer-based user persona.
Wait, hold up; we still need to talk about what a CBDC is! Let’s take a step back and see how we came about this concept. CBDCs are similar to fiat-based stablecoins but are issued by a central bank and backed by the specific country’s currency. Every country has its central bank, which is the mother of all banks within the country. They are the governing body of financial regulations and banking within each country. For example, in the US, the central bank is the Federal Reserve System, India has the RBI (Reserve Bank of India), and Sri Lanka has the CBSL (Central Bank of Sri Lanka).
So as detailed above, there are two types of CBDCs, retail and wholesale. Within retail CBDCs there are token-based, and account-based CBDCs require authentication of the account via methods such as KYC. Countries are taking their stances on which they want to focus depending on the challenges they are independently facing. Some countries, like India, are piloting the entire ecosystem.
COVID-19 accelerated the growth and need for CBDCs as many cash-rich economies needed a quick digital transition. In November 2022, RBI drove its e-rupee program with five participating banks. The feedback was that they didn’t find any advantages to the system but had quite a few drawbacks while using them from an infrastructure point of view. China started developing the e-Yuan program in 2019 within a few of its provinces. By August 2022, China will have adoption within 26 large cities and upwards of 5M merchants with a total volume exceeding 100B Yuan.
That being said, is the solution for this need CBDC? Let’s dive into its positives and negatives.
The Positive
Free from credit and liquidity risk
The CBDC removes any third-party risk, such as bank failures or runs. However, all risk rests stands with the central bank. It is similar to our current centralized financial system.
Less Financial Intermediaries
With the access of every end-user having a phone, payments will be instant from peer to peer, with the central bank doing the hand-off as an intermediary. Since the CBDCs could talk to one another, as certain countries are collaborating on building CBDCs, we could have faster international payments. Since there are lesser financial intermediaries, fees are eliminated, driving costs down.
Financial Inclusion
End users can have accounts, opening up the avenue of cashless payments to everyone. This allows retail customers ease with payments and access to the entire fintech stack. During COVID, the US found it challenging to deliver stimulus payments to those in need. With a CBDC, payments can be processed with a button and a few lines of code.
The Negatives
Financial Structure Changes
This could severely affect the way the financial system works today. It is unknown how this could affect economic behavior, interest rates, investments, banking reserves, and the entire economy. For example, there may need to be more liquidity in the central bank to withstand massive withdrawals similar.
Centralization
As seen in Episode 0, the whole point of Cryptoland is to decentralize finance, as history has taught us that too much control by a single party causes high inflationary risk and monopolization of the financial system. In addition to that, CBDCs could single-handedly remove private providers from the picture as they can control where the funds can go. For example, if a particular country does not recognize bitcoin, they could ban you from purchasing it, thereby killing healthy competition.
Privacy Out Of The Door
With the help of CBDCs, central banks have complete access and control over retail consumer purchasing behavior. Certain authoritative governments could abuse this power leading to high corruption and economic collapse. Privacy is not even a luxury at this point.
Cybersecurity
Since a single government body holds everything, a targeted cyber army could hack the central bank and cause havoc. In a future where cyber wars pose the biggest threat, we should be mindful of them as it gravitates toward a single point of weakness that could destroy a country’s future overnight.
In India, the UPI system poses the biggest threat to CBDC because it competes directly with account-based rCBDC. In the USA, many of CBDC’s advantages are being solved by companies such as Cashapp and Venmo. So, what will happen to these private sector institutions after CBDCs are minted? It is still being determined how this will be solved. According to financial journalists, the USA and Canada are treading lightly concerning CBDC, but cash-rich economies in Asia and Africa are moving fast to push CBDCs into the market with little success. For example, Nigeria found out that only 0.5% of Nigeria’s 217 million citizens are using e-Naira whereas 30% are dependent on bitcoin for transactions.
Until we get clarity on all the negatives and a path forward, CBDCs pose a threat. The good news is that many scholars are working closely to solve this problem and create trust between conventional and non-conventional communities. During 2023, a lot of big moves are going to be made behind closed doors to test the efficiencies of these systems by governments. I am only sold on the concept of a CBDC once the Central Banks do their due diligence and ensure privacy and the greater good of a socio-economic system is their priority. I will bank on the conventional world of cryptocurrency that has stood the test of time till they do so.
In the next article I talk about Crypocurrency exchanges so that we can get out feet a little wet on the dark side hehe.
