CBDCs: The Good, The Bad, And The Ugly

By Reuben Jackson

The upward climb in global popularity of decentralized currencies like Ethereum and Bitcoin has inspired central banks to create their own digital versions of existing fiat currencies, known as central bank digital currencies, or CBDCs for short.

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The People’s Bank of China has already dipped its toes into the pool with digital yuan experimentation since at least 2019. According to recent reports, $5.3 billion in digital yuan has already been spent as part of its trials.

The Bank of Korea recently enlisted the support of Ground X for its own CBDC pilot. Japan, Malaysia, Cambodia and other Asian nations are also following suit with experiments. However, this is far from a regional development.

A recent Bank of Canada report highlighted that a CBDC could provide a nonbank deposit option for Canadians, helping fight monopolistic practices and anti-competitive behaviors exhibited by financial institutions and technology companies. Major G7 central banks, including the Federal Reserve and Bank of England, are also researching and exploring the possibilities.

CBDCs are growing more realistic and feasible with each passing day.

Even though the concept of CBDC is in a nascent stage, as with any other coin, it has more than one side.

The good

There are several excellent reasons why introducing CBDCs can be an impactful decision and, by extension, benefit millions, if not billions, of people.

First, central banks can quickly and easily increase financial inclusion. Allowing citizens to create and hold funds at a central bank account can conceivably provide greater access to financial services for unbanked and underbanked members of society.

Private companies transacting in local currencies will be forced to become more transparent, reducing the proliferation of corruption and other illicit activities. More specifically, removing large denomination bills from circulation might score a direct hit on the drug trade and tax evasion.

CBDCs could prove serious competition for existing payment systems like credit cards. Adding a transparent central bank-backed option could conceivably reduce fees while preventing monopolistic behaviors and usurious practices.

As rosy as the above sounds, things can go sideways.

The bad

CBDCs might result in heightened levels of control central banks and governments exert.

Financial regulators are already worried about losing control over the money supply given the rising adoption of Bitcoin and other cryptocurrencies. From their perspective, this momentum can loosen the bank’s grip on economic stability and money in general.

Modern monetary theory, or MMT, espouses the idea that the government can spend in deficit and transfer funds directly to citizens to ease economic distress during downturns without worry about the national debt. The obvious danger in this idea is inflation.

With regards to CBDCs, the most concerning aspect is the possible politicization of MMT for partisan aims, instead of taking a more independent central bank approach to monetary policy separate from fiscal policy.

Another possible negative aspect to consider is bank runs. If anyone can open an account with a central bank and deposit CBDCs (even maybe without fees or transfer costs like in an ordinary bank), traditional institutions may experience serious deposit outflows.

Since this is a digital currency, theoretically, it can have a third side as well.

Guest author Reuben Jackson

The ugly

The ugly aspect of CBDCs is that they centralize money even more and preserve the oligopoly power of financial institutions. Unlike cryptocurrencies that aim to democratize and decentralize finance, CBDCs grant near-complete control to central banks.

The tradeoffs of greater central bank oversight and control are privacy and transactional anonymity. Central banks can conceivably use their new digital toolkits to monitor, record, analyze and tax every transaction.

It would also enhance control over an ordinary citizen’s level of access to a financial system, especially if a citizen is engaging in behavior that central banks may deem threatening, for whatever reason.

In China, social credit scores prevented 23 million people from buying plane and train tickets in 2018 for so-called “behavior crimes.” Now imagine that central banks, with a newfound ability to oversee accounts thanks to their CBDC rollout, can build similar systems to punish businesses or consumers for behaviors they deem as untoward.

What would stop central banks from abusing this power in conjunction with state security or political officials to confiscate user funds for what otherwise may be lawful activities? This dystopian, “Black Mirror”-esq approach could easily be a byproduct of CBDC implementation.

The bottom line

CBDCs are a certainty as global digitization demands innovation from central banks. The benefits for central banks are straightforward: Firmer control, outstanding tracking and monitoring capabilities, the ability to quickly implement monetary policy measures, and the power to counter the growing influence commanded by fintech and financial institutions.

Yet, these novel innovations also have a darker side to them. They depend on faith and trust that a central bank and other related government offices will not abuse their newfound power.

Sure, some of the benefits are worth capitalizing on, but if no governance mechanism protects people from state-sponsored overreach, what will be left to defend the people these institutions are supposed to care for?

No matter the benefits and drawbacks, central banks have no choice but to enter the digital fray; without it, decentralization threatens to upend the very systems and institutions they will spend every last fiat note trying to save.

Reuben Jackson is a blockchain security consultant, helping organizations with data structures. Outside his non-existing-office hours Jackson reports and writes opinions on the blockchain/crypto space.

Illustration: Li-Anne Dias.

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