The Dark Side of CBDC: Are Governments Giving Themselves Too Much Power?

Points we will review

• Governments around the world are developing Central Bank Digital Currencies (CBDCs) to ward off competition from private digital currencies and participate in international trade without dependence on the US dollar
• 114 countries, representing 95% of global GDP, are currently exploring the development of CBDCs, with over 20 countries expected to take significant steps towards piloting a CBDC in 2023
• India, Australia, Brazil, South Korea, Russia, the EU, and the US are examples of countries that are currently developing their digital currencies
• The development of CBDCs raises the question of trust in government with such powerful tools. It also raises concerns about government surveillance and potential control over citizens' finances
• The relationship between the government and commercial banks is complex and contentious, with banks historically having a significant level of power and profitability within the financial system
• Governments have a few options when implementing CBDCs, such as creating a network where commercial banks act as nodes (Wholesale Model) or creating a network where there is only one node, the central bank (Direct Model)

Central bank digital currency (CBDC) refers to digital versions of fiat money issued and backed by central banks, such as the Federal Reserve in the United States or the European Central Bank in the European Union.

CBDCs can take on different forms and can be broadly classified into account-based and token-based.

1. Account-based CBDCs: This type of CBDC is a digital version of traditional bank accounts, where central banks maintain a record of all transactions in a ledger. Transactions are then settled between central banks rather than between commercial banks. This type of CBDC is designed to work within the existing financial system, and transactions are recorded similarly to traditional bank accounts. Examples of account-based CBDCs include The FedNow from the Federal Reserve in the United States and the e-krona from the Riksbank in Sweden
2. Token-based CBDCs: This type of CBDC is a digital token that can be exchanged between individuals and entities, similar to cryptocurrencies like Bitcoin. These tokens are not linked to a traditional bank account, and transactions are recorded on a blockchain or distributed ledger. This type of CBDC operates outside the conventional banking system, allowing for greater financial inclusion and accessibility. An excellent example of this is the ongoing pilot project of the People's Bank of China called Digital Yuan.
3. Hybrid CBDCs: This type of CBDC combines features of both account-based and token-based CBDCs. They are digital tokens that are linked to a traditional bank account. Hybrid CBDCs can be exchanged like other digital tokens. Still, they are also linked to existing banking infrastructure, meaning transactions are recorded similarly to traditional bank accounts.

In addition to the account-based and token-based categorization, CBDCs can be classified into two broad types: general purpose or retail (CBDC-R) and wholesale (CBDC-W).

1. General purpose or retail CBDC (CBDC-R): This type of CBDC is intended for the general public and can be used for various transactions, including everyday purchases, bill payments, and more. The main aim of retail CBDCs is to provide a digital alternative to cash and to increase financial inclusion. This type of CBDC would be accessible to all citizens, regardless of their banking status, and it would be designed for general use.
2. Wholesale CBDC (CBDC-W): This type of CBDC is intended for use by financial institutions and businesses, and it would be used for interbank settlements and large-value transactions. The main aim of wholesale CBDCs is to increase efficiency and stability in the financial system. Therefore, this type of CBDC would be accessible only to authorized financial institutions and not be designed for general use.

It's important to note that, unlike the account-based and token-based categorization, which is based on the technology and infrastructure used, the general purpose or retail and wholesale categorization is based on the intended usage and target audience of the CBDC.

Also, it is worth mentioning that some Central Banks, like the Bank of England and the European Central bank, tend to distinguish between two types of CBDCs, General Purpose CBDC and Settlement CBDC, where the former is intended to be a general-use form of digital cash. The latter is designed for use by financial institutions and central banks themselves to settle significant value interbank transactions.

CBDCs are a relatively new concept, but central banks worldwide have been exploring the idea for some time now. The motivations for central banks to explore CBDCs have varied but have primarily been driven by the need to:

• Enhance the efficiency and stability of payment systems
• Increase financial inclusion and accessibility
• Address the challenges posed by the emergence of cryptocurrencies and other digital assets
• Address the challenges posed by the decline in cash usage
• Establish an alternative to the US dollar-based global financial system.

It's worth mentioning that, currently, most of the Central Banks exploring CBDCs are choosing the account-based approach and mainly experimenting with the idea of a digital version of cash, which are more familiar and less disruptive to the current financial system rather than creating a whole new ecosystem like it's the case with token-based CBDCs.

In recent years, governments worldwide have been working to develop their digital currencies, known as Central Bank Digital Currencies (CBDCs). This trend is driven by various reasons, such as competition from private digital currencies and a desire to participate in international trade without being dependent on the US dollar. This article will explore the various motivations behind governments' push for CBDCs and closely examine some countries currently developing their digital currencies. We will also investigate the potential risks and drawbacks of CBDCs, such as the possibility of increased government surveillance and whether we can trust governments with such powerful tools.

Motivations for Developing CBDCs

One of the primary reasons that governments have been accelerating the development of CBDCs is to prevent competition from private digital currencies. With the rise of cryptocurrencies like Bitcoin and Ethereum, governments are worried that people will begin to rely on these decentralized, private currencies rather than traditional government-issued money. By developing their digital currencies, governments hope to maintain control over their monetary systems and retain the trust of their citizens. In more detail, the emergence of cryptocurrencies and the fast-evolving nature of the financial system has made governments, and central banks feel threatened and want to maintain control over the money printing press; this has put CBDCs developments in high gear. CBDCs are seen as a way to maintain control over monetary policy and financial stability and combat illicit activities while also addressing the declining use of cash and alternative payment systems.

Another key motivation for governments to develop CBDCs is participating in international trade without dependence on the US dollar. Currently, most international transactions are conducted in US dollars, which gives the US government significant influence over global trade. By developing their digital currencies, governments hope to reduce their dependence on the dollar and gain greater autonomy in international trade.

List of Countries Developing CBDCs

Nearly 114 countries, representing 95% of global GDP, are currently exploring the development of CBDCs. In 2023, over 20 countries are expected to take significant steps toward piloting a CBDC. Here are a few examples of countries that are currently developing their digital currencies:

• India: In January 2021, the Indian government proposed a bill to ban trading and investments in cryptocurrencies while giving legal power to the country's central bank, the Reserve Bank of India (RBI), to develop a CBDC. The finance minister has announced plans to roll out the “Digital Rupee” by 2023. India has already launched a pilot of its retail and wholesale CBDC.
• Australia: The Reserve Bank of Australia (RBA) is expected to complete its CBDC pilot by mid-2023. The central bank launched the pilot of its CBDC in August of 2022.
• Brazil: The Central Bank of Brazil has announced plans to introduce a CBDC by 2024.
• South Korea: The Bank of Korea has tested a program that allows cross-border remittances by linking different CBDCs from other countries. South Korea has completed the first of two phases and is expected to launch a more comprehensive version by 2023
• Russia: To bypass international sanctions, Russia is planning to launch a cross-border settlement system using a CBDC by next year.
• European Union: The European Central Bank is also expected to launch its CBDC pilot this year.
• United States: In May 2021, Federal Reserve Chair Jerome Powell announced plans to publish a detailed paper on CBDCs, highlighting the possibility of issuing a US CBDC. The Federal Reserve Bank of Boston has already released initial details of “Project Hamilton,” a potential CBDC.
• UAE, Ghana, South Africa, Malaysia, Singapore, and Thailand have all launched pilot projects of their central bank-backed digital currencies.

CBDCs and the Role of Banks

The power and profitability of banks have been closely tied to their government-granted charters to legally create money through loan creation and the legal system that enforces financial contracts. This has allowed banks to recover pledged assets through the threat of state-sanctioned violence. However, the relationship between the government and banks is complex and often contentious, as the banks' desire for profits may not align with the government's desire for power.

Historically, the government has had to tolerate the actions of banks, even when they have led to financial crises, as they were essential for the functioning of the financial system and were better equipped to assess credit risk. However, with the invention of CBDCs, the government now has a tool to take over many of the critical functions of commercial banks, such as accepting, storing, and loaning deposits at a fraction of the cost.

Models of CBDC Implementation

The government and the central bank have a few options to choose from when implementing CBDCs. They can either create a network where nodes are commercial banks, known as the Wholesale Model, or they can create a network with only one node, the central bank, known as the Direct Model.

The Wholesale Model would involve creating a network where commercial banks act as nodes, and the end-user has an account with the bank. The nodes would be able to move data (i.e., money) around the network, and the central bank would backstop the commercial banks to prevent digital bank runs.

On the other hand, the Direct Model would involve creating a network with only one node, the central bank, and every citizen would have an account directly with the central bank.

The government has several options to choose from when implementing CBDCs, including the Wholesale and Direct Models, which will significantly impact how CBDCs will be used and received by the public. Therefore, careful consideration and planning must be taken to ensure that the benefits of CBDCs are realized while minimizing potential risks and drawbacks.

Potential Risks and Drawbacks

One of the main differences between a CBDC and a decentralized digital currency is the central authority that controls the currency. With a CBDC, governments can track and monitor every transaction made with the currency. This could be used as a mass surveillance tool, allowing governments to monitor the financial activities of their citizens. Additionally, if a government's CBDC becomes widely adopted, it could give that government significant control over the global economy and financial systems.

Can we trust the government with CBDC?

Whistleblower and digital privacy advocate Edward Snowden has voiced concerns that CBDCs could give governments too much control over citizens' finances. In a recent talk at Camp Ethereal, Snowden likened CBDCs to a giant magnet that would pull money out of people's pockets, just like Scrooge McDuck in the cartoon show DuckTales. This analogy highlights the potential for CBDCs to be used as a tool for mass surveillance, giving governments the ability to track and monitor every financial transaction made by citizens. In the end, governments may replace cash with CBDCs, leading to a dystopian world where money is closely watched.

While CBDCs can bring about many benefits, such as increased financial inclusion and improved efficiency in international trade, it is essential to consider the potential risks and drawbacks. One of these is the question of trust; can we trust our government with such powerful tools? Governments must be transparent and accountable in their development and implementation of CBDCs to ensure that they are not used as a means of mass surveillance. Additionally, citizens should be able to opt out of using CBDCs and should have access to physical cash alternatives.

Moreover, the deployment and adoption of CBDCs must be done with a multi-stakeholder approach and with the inclusion of citizens, privacy experts, and technologists to ensure that the rights and welfare of citizens are protected.

Final Thoughts

Governments worldwide are accelerating the development of CBDCs for various reasons, such as competition from private digital currencies and a desire to participate in international trade without being dependent on the US dollar. However, there are also potential risks and drawbacks associated with CBDCs, such as the possibility of increased government surveillance and the question of whether or not we can trust governments with such powerful tools.

As countries continue to develop and pilot their digital currencies, it will be necessary to carefully consider these issues and take steps to mitigate any negative impacts.