The growth of the cryptocurrency market fuels the interest of society and business in the industry and does not allow states to stay on the sidelines. Dozens of countries are developing their digital currencies, and some of them will be launched as early as 2022. In this article, we will help you understand what digital currencies issued by the state are and how their appearance will affect citizens.
What is CBDC
The CBDC, or central bank digital currency, is a government-issued and government-backed digital analog of fiat money. CBDCs are created using blockchain technology, just like other cryptocurrencies. However, the digital assets of the Central Bank are not the usual cryptocurrency due to the centralized nature of the issue.
The CBDC exchange rate is stable and equal to the exchange rate of the state currency in a ratio of 1:1. This is the principle of a stablecoin — a digital analog of the state currency, whose rate is tied to it and secured by it. For example, USDC or USDT are stablecoins tied to the value of USD. The main difference between those coins and CBDC is that the central bank of the country acts as the CBDC’s issuing center, and not a private company or a community of people.
Two Ways of Financial Evolution
The emergence of CBDC is designed to change the banking systems of all countries and strengthen the role of central banks. There are two points of view on what these changes will be.
Supporters of state regulation of crypto believe that all crypto assets, except for the digital currency of the state, should be banned. This is the way that China's central bank cryptocurrency goes. Operations with CBDC will be transparent and will make it possible to track the history of each transaction and each participant in the chain. Banks will only have to work with companies and citizens: to serve customers and improve their products and services. The burden on financial monitoring will disappear. In a sense, the banks even want it.
The second option for CBDC development is recognition and regulation. In this model, digital coins and crypto will be equated to shares, considered a digital value or a payment asset. In this case, the cryptocurrency market will develop systematically, and CBDC will be a full participant in the crypto world. This is Singapore's way.
How CBDC Works
From the point of view of the approach to the issue, the Bank for International Settlements identifies two basic concepts of digital currencies of central banks (combinations are possible):
Account-based (balanced): according to this concept, the creation of a Central securities exchange takes place by opening personalized accounts in the central bank for all economic agents. The features of this concept are the growth of the regulator's costs for maintaining accounts and the risks of disintermediation (reducing the role) of traditional financial intermediaries. Indeed, for commercial banks, the consequences of the emergence of such a retail CBDC can be revolutionary. For example, if individuals and legal entities have the opportunity to receive and store funds in accounts with the central bank, this may provoke a massive outflow of funds from commercial banks. Some European commercial banks are already raising the question of how, in such a system, the central bank will provide funds to banks for lending to the economy.
Value token-based concept assumes a digital cash issue (token) distributed through commercial banks, replacing cash. In this case, the central bank relieves itself of a significant part of the costs and risks associated with checking and servicing customers, providing them with additional services, as well as creating and operating technologies. Tokens in such an ecosystem will effectively represent digital versions of cash. However, commercial banks fear that the launch of such digital money may simplify the entry into the financial sphere for large technology companies, which will increase competition in an already low-margin and competitive market, further reducing the industry's revenues.
The form in which the Central Securities Exchange will be launched in a particular country can vary greatly from state to state, depending on the specific tasks assigned to the regulator.
When and Where Will the First CBDC Appear
If you do not take into account the Sand Dollar issued by the central bank of the Bahamas, no major country in the world has yet reached the stage of launching its own CBDC.
As of November 2021, more than 50 countries of the world were developing CBDC. China has come closest to real use, where the digital yuan has been tested for about a year. South Korea, Canada, France, the United Arab Emirates, South Africa, Nigeria, Ghana, and Uruguay are at the pilot testing stage.
There is another approach to using crypto as the official currency of the state. This is an example of El Salvador, which in September 2021 recognized bitcoin as a means of payment on a par with the US dollar.
Why Do States Need CBDC?
One of the main tasks of the Central Bank's digital currencies is the security and transparency of financial transactions.
Firstly, the technology underlying CBDC is the most modern means of controlling cash flows. Secondly, central banks strive not to be late for the trend and monitor each other. It is impossible to ignore the development of cryptocurrencies, therefore, to avoid a new round of money flowing into the gray zone, the state needs its digital currency. As they say, if you can't stop them — lead them.
For many years, some states have been struggling with the outflow of money to offshore and other jurisdictions that are more favorable from the point of view of taxes and doing business. Previously, this happened with cash, then with non-cash, and now the process has almost entirely switched to cryptocurrencies.
There is a threat that people and companies that create stablecoins will control too many processes and resources and will become stronger than some states. Therefore, CBDC for states is also a tool to combat gray financial flows.
Are We Moving to Digital Currency?
Most likely, a link between CBDC, stablecoins, and crypto will exist and their exchange for cash will be possible for quite a long time. But it is possible that in some countries, cash and digital values, except for their own CBDC, will remain in the gray zone and will be banned. For example, in China.
Writer Dominic Frisby, author of the book "Bitcoin: the Future of Money?", believes that the main disadvantage of CBDC is its programmable capabilities.
While fiat currency presupposes certain freedom, digital currency completely excludes it. Governments will also have direct access to users' wallets, which will make it easy to collect taxes or fines — you just need to change a couple of lines of code to do this. The programmable functions of money can be used against certain undesirable persons or as a weapon in an economic war. Integration with social rating systems opens up even wider opportunities for punishments or rewards.
Your bank knows almost everything about your spending model, knows where you live, who you work for, and which store you prefer to buy groceries at on Mondays. He is well aware of your financial situation and state of health. Knows what devices you use, and in some cases even has biometric data. All this information opens up great opportunities for analysis, including behavioral analysis. However, information about consumers is of interest not only to the private sector but also to the state. Moreover, central banks are among the first to queue for user data.
In the current realities, the introduction of national digital currencies by several countries is a matter of "when", not "if". As with fiat currencies, their strength will be determined by the strength and influence of the central banks behind the issue.
A former employee of the NSA and the CIA, Edward Snowden, considers the tool "the newest danger hanging over society."
In a world where CBDCs are a priority means of settlement, including cross-border ones, there will be no room for privacy. After all, a tool that is positioned as a way to increase financial inclusion, in the end, can only tighten the noose around the neck of economic freedom.