Central Bank Digital Currencies: How Will They Work And Could They Kill Crypto
Most people who have heard about central bank digital currencies (CBDCs) hate central bank digital currencies. The only people who like central bank digital currencies are the central banks devising them, and maybe a few monetary policy geeks or savvy bulge bracket banks who think they can make a lot of money off them. For now, CBDCs are not for the masses. They don’t really exist, actually, except once in a pilot project in a small region in China. But let’s try and imagine their roll out, and what – if anything – would be the impact on cryptocurrencies that compete with fiat today as a source of wealth accumulation.
“There’s clearly huge potential here,” says Jonathan Wu, president of Ava Labs, the guys behind the Avalanche AVAX blockchain. “The Fed balance sheet is about $9 trillion today. Even 50 basis points of that moving into CBDC is $45 billion moving into digital; that’s nothing to sneeze at.”
This assumes the government contracts out private blockchain companies like Avalanche. Or the market is able to create money market funds pegged to these things. Nobody knows yet. It’s all very pie-in-the-sky, and sci-fi. In their “best” form, CBDCs are programmable. Meaning the central banks that run them can more easily control consumer spending, which is like controlling inflation without having to raise interest rates and get bond lords all mad.
CBDCs: What Are They? What’s Wrong With Them?
The Federal Reserve describes CBDCs as “a digital form of central bank money” available to the public.
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A CBDC will be a central bank liability and controlled by the central bank. There are two types of central bank money right now: physical dollars issued by the Federal Reserve and digital balances held by commercial banks at the Federal Reserve, like a debit card is “digital”.
Americans have long held money this way, utilizing credit cards and online payment apps tied to bank accounts. A CBDC is different from existing money platforms like credit and debit cards because a CBDC is run by the Fed, not a commercial bank. The Federal Reserve’s job is to oversee the supply of money and keep inflation in check. Programmable currencies are a way to do that. This is the lynchpin of CBDCs, however the concept of programmability is not yet defined. CBDCs are still in their early phase of development.
There are two types of CBDCs in the works: retail and wholesale. Governments will need to determine the level of access to their stablecoin, whether it is permissionless, permissioned or semi-permissioned.
These paths will determine geopolitical efficiency and how other cryptocurrency ecosystems will ultimately be affected.
For instance, if working in a permissioned environment, application-specific blockchains like subnets on Avalanche will be able to provide the compliance requirements of the Central Bank.
Bitcoin BTC features a permissionless blockchain network. Anyone with a working internet connection and a compatible device can access and maintain without restrictions. Permissioned blockchains require permission to use them and are used mainly by businesses and governments.
Steve Forbes, in a post on December 15, said CBDCs were an “ominous threat to our freedoms.”
Digital money would “enable governments to track every single purchase or sale you make. It would be a frightening tool of control, as officials could easily seize or freeze part or all of your money. No wonder Beijing is so gung-ho for CBDCs,” he said.
How Governments Will Sell CBDCs to Citizens
One guess is that CBDCs will be rolled out as universal basic income. If you want universal basic income, you will need to apply for a chip reader credit card, and that will hook you into the CBDC blockchain matrix. Another way is to offer it en masse in a crisis – say hyperinflation. While inflation is coming down now from its highs, if inflation remained in the 8% and above range in the West, where CBDCs are most discussed, one could envision the government using this to convince businesses and consumers that a digital dollar will be a good way to control inflation.
The media would then be summonsed to call everyone who thinks CBDCs are a bad form of programmability and control a “conspiracy theorist” or other sophomoric strategy to vilify those who question such wisdom from central bank technocrats.
“A digital dollar, in my opinion, is going to be the equivalent of paper currency, although held virtually in your banking checking account or an account opened with permission via some fintech application overseen by an authorized subsidiary of the Federal Reserve,” thinks Dr. Praveen Buddiga , Co-Founder of Terareum, a crypto currency exchange in Dubai and Chennai, India. “The digital dollar would maintain its exclusive line item for record keeping. The Fed CBDC would have advantages over cash, such as guaranteed funds transfer, safety, convenience, speed of remittance, and immediate debt settlement.”
Whatever the central bank uses for its blockchain protocol, that blockchain would be where transactions and settlements in the CBDC takes place, and could be backed by other assets such as hard currency, fixed-income securities, or commodities such as gold.
“I imagine a fiat-backed stablecoin designed to maintain a similar level of stability as the currency has now,” Buddiga says. “Only it will be pegged to the dollar, like USD coin (USDC USDC ) and Tether USDT (USDT).”
It is hard to imagine life as a USD coin or Tether with a CBDC in the market, but who knows. CBDCs, for now, still do not exist, and those digital coins do. This could be an issue of first-mover status, and central banks are late to the digital currency game. Consumers may forever be happy with Tether, so long as it has the dollars to back up its token. But if the central banks wanted to kill that market, their presidents would have the full taxing and legal authorities of government to do so.
Bitcoin vs CBDCs: Will Bitcoin be Banned?
Based on the “Digital Dollar Project” report from January 2022, the Federal Reserve’s goal is to cautiously approach CBDCs without too much turbulence in the status quo. For those worried a CBDC will be the end-all be-all of financial transactions, that report favored the sustainment of the current commercial system. This suggests that the CBDC dissemination, distribution and finally redemption would function the same as physical cash or a credit card.
“It would be best to have CBDCs and bitcoin instruments together in a free market society,” says Buddiga. “The respective CBDCs function as stablecoins pegged at 1:1 to the Digital Dollar while bitcoin functions as an instrument subject to global market conditions of macroeconomics.”
Central banks have been working on this for at least the last three years. China was the first, with its most recent trial conducted in October.
The European Central Bank put out its first digital euro report in 2020.
On Nov. 7, ECB president Christine Lagarde gave her reasoned approach to consider CBDCs. She noted that 16% of Americans and 10% of Europeans held bitcoin and other altcoins in 2021. “They are too volatile to act as a means of payment,” she said. “Stablecoins are designed to be less volatile, and therefore more suitable for payments, they are vulnerable to runs – and often not backed at all as we witnessed earlier this year,” she said, likely referring to the Luna coin fiasco.
Lagarde also warned that the entry of Big Tech into payments increased the risk of market domination and dependence on foreign payment technologies. “This has consequences for Europe’s strategic autonomy,” she said. Over two thirds of European card payment transactions are run by foreign companies.
The Bank of England created its CBDC task force in April 2021. As of this month, they are beta testing a CBDC wallet.
Since the fall of FTX, the Federal Reserve has teamed up with 12 financial institutions, from banks to credit card processors, to look into CBDCs once again.
The Bank for International Settlements (BIS), known as the central bank of central banks, and co-owned by 63 central banks headquartered in Switzerland since 1930, suggests three fundamental concepts for instituting CBDCs:
Do no harm: When central banks supply new instrument types of money, the conversion of currencies to this new format should occur as smoothly as possible, allowing the financial institution to retain its stability while meeting policy objectives and other mandates.
Coexistence: The various currencies issued by the Central bank, such as paper currency, coins & digital currency, should coexist to reinforce public policy goals. Alternative instruments of central bank money must ubiquitously meet the public call for cash withdrawals and allow for uninterrupted private and commercial banking procedures and transactions.
And lastly, innovation: National governments should allow and encourage both public and private sectors to promote various instruments in payment services, fulfilling a need to provide safe and available payment services to both parties.
Sounds reasonable. But is it?
It’s too soon to tell. And for CBDCs to be the worst of what the naysayers believe, it would have to force people into digital dollar transactions and ban the rising alternatives, in this case cryptocurrencies.
“I’d respectfully disagree that any central bank would ban the existence of bitcoin at this time,” says Buddiga. “It’s the engine that drives the crypto (and blockchain) space.”
Key phrase here is “at this time”. Will it happen in the future? Crypto investors will have to stay tuned.
Earlier this month, European Central Bank senior executive Fabio Panetta proposed a ban on cryptocurrencies with an “excessive ecological footprint” (translation — bitcoin), and likened investing in crypto to gambling.
Panetta warned investors against buying bitcoin and said, “the house of cards is falling.” His preference was for CBDCs.
“This requires a risk-free and dependable digital settlement asset, which only central bank money can provide,” he said in a speech in London on Dec. 7. “That is why the ECB is working on a digital euro…for the future of settlement in central bank money.”
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