CBDCs – the What, Where, and How?

This is written by an external blogger, the views and opinions expressed within the post belong solely to the author

When Satoshi Nakamoto wrote the original Bitcoin white paper, they probably didn’t imagine their invention would keep world governments busy as a beaver. From what we have seen, governments in most countries have been scrambling to figure out what to do with the massive rise in popularity for digital currencies. Some have been favourable to the industry, while others, not so much. Most are still trying to figure out how to best regulate and adopt digital currencies according to the situation in their respective homelands. One major country, China, seems to be ahead of the game, creating and testing out their own Central Bank Digital Currency – dubbed the E-Yuan.

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To understand what China is doing and why, let’s first have a look at what Central Bank Digital Currencies, or CBDCs are –

In simple terms, CBDCs are the equivalent of digital cash, Issued by the central bank of a country. It is an electronic record, or digital token, that represents the fiat currency of that country. By being under the control of the country’s financial regulator, they come with all of the benefits of fiat money, like having someone responsible in case things go wrong, the issuing being backed by another currency, among a host of other benefits. So far, countries have only backed CBDCs by their own currency, unlike the traditional financial systems where USD holds the status of the world’s reserve currency. 

The premise of CBDCs is to create a digital equivalent of traditional banknotes that is secure and unique. Each token issued by the government would have a unique identifier, much like serial numbers on banknotes, except CBDCs utilize blockchain technology to achieve that.

How are CBDCs different from existing cryptocurrencies?

The fundamental difference is that while Bitcoin, along with most other major cryptocurrencies, are decentralised, with no control over the network by one state authority, CBDCs are as centralised as money can get. The rules of the authorities in the country apply. Since they are issued by the central bank, they’re a debt contract and are a liability for the bank. The below venn diagram attempts to explain how different forms of money are classified.

That one fundamental difference, however, creates a lot of philosophical differences. It is important to note that decentralised cryptocurrency, starting with Bitcoin, was brought into existence in the midst of the 2008 worldwide banking crisis to lower people’s dependence on banks, which have historically proven that they do not always have people’s best interest in mind. According to a lot of people in the crypto community, including the author, it’s best to think of CBDCs as the modern version of cash, instead of anything related to cryptocurrencies. 

There is also no indication till now about CBDCs causing an impact on the prices of current cryptocurrencies. They could either replace the current batch of stablecoins with a much more reliable version to trade against current cryptocurrencies, or they could lead to a ban on trading cryptocurrencies. There’s not enough evidence till now to conclude.

What is China doing with their CBDC experiment?

Contrary to popular belief, China isn’t the country with the most advanced CBDC program yet. That country, according to the report published by PwC, is the Bahamas where the Central Bank issued digital currency is already in use. However, China is the world’s second-largest economy, and the Bahamas is at number 130, so the former naturally grabs many more eyeballs. 

China has been working on its Digital Yuan since 2014, with the project now in a pilot launch phase. During the tests, China said that the digital Yuan is meant to be faster and cheaper to use than digital wallet apps like AliPay and Apple Pay, and one day, it will even work offline. 

However, in a country that is famous for the government having a tight grip on society, it has raised some eyebrows, both from individuals, and the companies operating in China. 

Financial privacy is all but gone in the new system. But that’s not where the concerns end. In the trials conducted for the rollout of China’s digital Yuan, the Central Bank indicated a willingness to put a limit on the amount of money someone could have on them. The digital Yuan is programmable, which means that the state can impose expiry dates on individual’s money if it wants to stimulate spending. China has the world’s largest state surveillance program with hundreds of millions of facial recognition cameras to monitor its citizens, sometimes using them to issue fines for crimes like jaywalking. However, now the government would just be able to deduct the fine from the offender’s wallet directly. The government could also ask Chinese companies to only accept payments in the digital Yuan, leveraging its position in global trade, to attempt to de-throne the US Dollar as the de-facto currency of choice for international trade. China has already proposed a set of global rules for CBDCs.

How would CBDCs affect our current monetary systems?

According to Benoit Coeure from the Bank of International Settlements, 90% of the world’s central banks are exploring CBDCs, and 40% are experimenting with it, including most of the world’s major economies like the US, UK, and the European Union. That is a strong indication that CBDCs are here to stay. 

“More than 60 central banks have already entered the central bank digital currency race. CBDCs will be a game-changer, providing access to alternative payment solutions for citizens and corporates, as well as reinventing financial market settlement and interbank monetary transactions.”, Benoît Sureau said in the PwC report.

The motivations for adopting CBDCs are different for every country. Venezuela, for example, started using CBDC after hyperinflation ravaged the economy, with the government widely seen to be using it in order to circumvent sanctions imposed by the US. Russia, too, sees it as a way of conducting business without international oversight . Other countries see it as a way to reduce people’s dependence on banks. If there was another financial crisis like the one in 2008, the government could take a more active role in providing and distributing cash throughout the economy. 

India’s central bank, RBI too, is exploring CBDCs. Although it showed some scepticism when it comes to regular cryptocurrencies, in a statement released on January 25th, 

“Nevertheless, the RBI is exploring the possibility as to whether there is a need for a digital version of fiat currency and in case there is, then how to operationalise it,” the RBI said, releasing a booklet of payment systems in India. 

There is no doubt that CBDCs would simplify individual finance to a large extent and allow a lot of the world’s population that is currently excluded from the financial systems to join in. They would probably also help reduce money laundering and tax evasion. However, the amount of trust required in governments for that to happen makes a lot of people in the crypto community, (a community founded on the principles of trustless systems and decentralization), very uncomfortable.

About Guest Blogger (Parv)

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