Last month I explained why cryptocurrencies aren’t ready for mainstream retail. The reasons for this are rampant volatility, lack of regulation and extraordinary risks. All are good for speculators but bad for ecommerce retailers.
With the aim of creating stability and potentially avoiding a financial crisis if the crypto speculative bubble bursts, governments around the world are considering central bank digital currencies – CBDCs.
A central bank digital currency is a country’s recognized currency in electronic form. For example, the United States’ CBDC would be the digital dollar. Today the US Federal Reserve issues paper bills and metal coins. Consumers physically use these bills and coins or store them in bank accounts.
In the future, digital currency – with unique serial numbers like the dollar – could replace paper and coins. A digital dollar could be suitable for common transactions (loans, investments, salaries, bulk payments) and represent the best of both worlds: the convenience of cryptocurrencies and the regulation and stability of a money supply backed by reserves.
CBDC owners would likely have digital wallets, likely on smartphones. Bank accounts would probably stay more or less the same. A digital dollar in your checking or savings account would look exactly like a paper dollar stored in those accounts. Thus, the value of a CBDC would correspond to the currency of a country – a digital dollar would be redeemable for a paper dollar. This differs from existing cryptocurrencies with values based on speculation and hype.
Monetary policymakers offer several justifications for creating CBDCs, including:
- Convenience in an online world. Cash and coins (and credit cards) are expensive to handle and store. The proliferation of real-time payments shows that consumers and businesses need easy, inexpensive, and secure ways to transfer money. CBDCs could make real-time payments more accessible and reduce the burden of handling cash.
- Prevent an international financial crisis. In China, digital payments are controlled by technology companies, namely Alipay and WeChat Pay. In Europe and North America, private investors own the majority of cryptocurrencies. Should one of the major cryptocurrencies (or WeChat or Alipay) fail, a financial crisis would arise. Governments are now realizing that CBDCs can offer the benefits of cryptocurrencies and e-payments without the risks of a global financial crisis.
- Promote innovation. Investors and inventors understand that the lack of ubiquity and stability is preventing the widespread adoption of cryptocurrencies. Who would want a bitcoin payment app when the future value of bitcoin is unknown? A stable, government-backed digital currency could facilitate payment and financial innovation.
- Protect your privacy and prevent crime. Cash payments are private. Card-based payments are not possible. Whenever we make a credit card payment, someone watches and tracks us. If governments allow, CBDC payments can be anonymous or semi-anonymous. Merchants, credit card companies, and financial institutions wouldn’t know who was paying (similar to cash payments). Still, governments could monitor the use of CBDCs to prevent money laundering and other financial crimes.
- Financial inclusion and equality. According to proponents, digital currencies of the central banks would enable equal access to financial services, especially for people with and without bank details. However, this claim is difficult to substantiate. Some proponents believe that a digital dollar doesn’t require bank accounts and creditworthiness. However, this would require modern (expensive) smartphones and access to high-speed internet.
CBDCs offer a lot of potential for good. But they can also cause problems, such as:
- Privacy concerns and government oversight. CBDCs would likely require digital wallets and accounts. But who has access to these accounts? And who controls and protects the data? Do consumers trust governments more than private companies? With CBDCs, governments, including authoritarian regimes, would have unprecedented access to a person’s transaction data.
- Consumer protection. Who is responsible in the likely event of a cyber attack or honest mistake (CBDC transferred in error) and what does consumer protection look like? CBDC promoters rarely address real-world events such as chargebacks, refunds, and errors.
- Internet access. A strong, reliable, and affordable internet connection is required to operate a CBDC system. However, such internet access is not universal and hinders the widespread adoption of CBDCs.