What are CBDCs, aka Central Bank Digital Currencies?
What CBDCs are, why you should know about them, and my thoughts.
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Digital cash is not new.
If we look back in history, there have been some previous attempts, primarily with the objective to provide faster cross border transactions.
From this point of view, one can even argue that Central Bank Digital Currencies (CBDCs going forward) have some shared history with crypto, in the sense that both started off as initiatives to optimize the existing payment system.
With time, just as crypto is no longer only about the financial system, digital currencies are no longer here just to provide a more optimized payment system.
Whereas BTC was created in response to the 2008 financial crisis, CBDCs were essentially the response to cryptocurrencies, particularly stablecoins.
So today, the fight to maintain the control is on.
Currently, almost all countries are working on some kind of CBDCs.
Based on Atlantic Council’s research:
in May 2020, only 35 countries were considering a CBDC. Today, 114 countries, representing over 95% of global GDP, are exploring a form of CBDC.
As of December 2022, all G7 economies have now moved into the development stage of a CBDC.
18 of the G20 countries are now in the advanced stage of CBDC development. Of those, 7 countries are already in pilot.
11 countries have fully launched a digital currency. Jamaica is the latest country to launch its JAM-DEX.
There are now 9 cross-border wholesale CBDC tests and 7 cross-border retail projects, nearly double the number from 2021.
And it seems like over 20 countries will take a significant step over piloting a CBDC during this year.
Let’s not forget that China’s e-YEN pilot alone already reaches almost 300 million people, with plans to further expand to most of the county.
So what are Central Bank Digital Currencies?
CBDCs are basically the digital money that is issued and controlled by a country’s Central Bank. You can think of it like the digital version of Fiat currency.
What are the types of CBDCs?
It seems that there actually are two types of CBDCs:
a wholesale CBDC, which is for select individuals and financial institutions,
and a retail CBDCs, which is for regular folks like you and me.
That means there will be one financial system for those in power, and another one for everyone else.
Scary? Wait for what is in scope…
Thanks to the blockchain technology and programmability, Central Banks can have a much higher control over this digital currency.
Let’s remind ourselves that coins/tokens created in a blockchain are customizable for all sort of functionalities. Therefore, when Central Banks create their Digital Currencies, they can also give themselves total control over every aspect of the token.
So based on this, governments will still be able to freeze individual accounts. But in addition to this, a whole list of other control functions can be unblocked: they can prevent you to spend money in particular things, set limits on holdings, set expiring dates for holding, how you spend or save them, set location limits to where, set time limits to when, set limits on how much can be spent, decide what can and cannot be bought using CBDC, add taxs, flag or block CBDCs transactions, customize parameters for different individuals depending on whatever criteria they decide. And others…
What’s the point of giving back all the power to the governments, and some more, you ask?
Well, my assumption is that we don’t really know too much about it, and what it means.
I believe if we all know what a highly centralized digital currency owned and controlled by the government entails, we will not be very happy about it.
Hence, today’s article. Education is critical.
Let alone the fact that this will represent a single point of failure. If all data and funds are held in one single place, then one successful hack can leave the government in a very critical situation.
The Thesis on the Magical Solution…
Some believe that CBDC offers a solution for the Central Banks.
Why?
Let me set up some context.
Central Banks around the world are tasked with encouraging economic growth while keeping inflation under control. We explained before the mechanism: they can do this by raising or lowering interest rates:
When its low, its cheap to borrow, making saving less atractive and therefore incentivizes people and institituions to spend more rather than save, which increases growth. However it also increases inflation, as there is more money in circulation.
On the other hand, when rates are high it becomes expensive to borrow and therefore saving is more attractive. This incentivizes everyone to save, which lowers economic growth. However it also decreases inflation.
This mechanism combined with money printing to inject liquidity is supposed to balance the economy.
But the problem is…
While money can be printed out of thin air, it’s a lot harder to take it off circulation.
This means that this mechanism of interest rate vs money printing will inevitably lead to more inflation in the long term.
Thanks to the pandemic as a catalyst, governments decided to go full in with money printing. Now we reached a point where the money supply has grown so much that inflation is off the charts and raising interest rates is not an option because of all the debt that’s been built up over the years.
The Thesis?
CBDC offers a solution for the Central Banks. This is because in a CBDC system it will be possible for them to easily destroy money as well as issue it, thanks to, again, the programmability of the blockchain technology.
Additionally, if CBDCs are successful, governments can technically just give up on the Fiat version, and do a 1-1 conversion of your holdings from the Fiat version to the new CBDC, and voilà… goodbye debt, hello brand new currency… Full reset!
How is this possible? Our holdings in the bank is nothing more than just a database similar to an excel sheet that keeps moving number from one place to another. And with the foreseeable increase in centralization with CBDCs, it is possible for Central Banks to do this kind of “edit”.
Of course this would be an extreme case, no unfortunately, not impossible.
My Thoughts
- For better or for worse, however the future of crypto plays out, CBDC will likely be a reality.
What we cannot be sure about is the reach and scope. Hopefully, it will be limited.
This is because there is much to consider when launching a CBDC:
The impact it might have in commercial banks, government bonds, fiat currency, etc.
CBDCs being digital will require everyone to have the means and the knowhow to transact with CBDCs, which is no easy task.
Central Banks don’t have the technical knowhow to build CBDCs and blockchains, so they will need to partner up with existing blockchain companies.
- Because of these points, CBDCs might help the broader public to get closer to cryptocurrencies
Even though CBDCs are not the same than the rest of crypto, it still has shared components and technology.
Particularly considering governments and Central Banks partnering up with blockchain companies, it also provides a level of validation in the eyes of the public.
- This trend might actually boost the adoption of Bitcoin
Why? Well, all the countries exploring CBDCs are experiencing Fiat currency losing value.
Smaller countries are further ahead in the CBDC journey, as their size allows them to be more agile, but mostly also due to them knowing that they currency is more fragile compared to bigger countries.
Additionally, macro events such as the financial sanctions on Russia have led countries to consider payment systems that avoid the dollar.
However, the CBDC development is a complex task that takes a lot of time.
This timeline constrains, alongside the lack of better options, might push for wider adoption of Bitcoin.
This doesn’t necessarily mean using BTC as the currency, it can simply become part of governments and Central Banks’ reserve.
Lastly…
Money has been around for Millennials, and is one of the most greatest inventions in the history of humanity. Throughout time, we’ve gone through different systems, but the underlying concept of money or capital has not changed.
What changed, is what we collectively believe and trust in to represent that value.
Therefore, I do not believe it is as simple as replacing an existing Fiat Currency with a digital version of it.
Coming from from Argentina, I’ve seen the government issue other Fiat currencies that supposedly had the same value than Argentinian Pesos, such as “Patacones”, “Australes”, etc. And today, they do not exist no more because people did not adopt them.
Hopefully, this remains the same with CBDCs.
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