Bitcoin and Ethereum have made cryptocurrency and blockchain technology extremely popular in the last few years.
So popular that some governments want to use this technology to create digital currencies for themselves.
While it sounds awesome to be able to pay for everything using your phone or not have to carry cash, there are a few big reasons why central bank digital currencies might not be a good thing.
Remember, governments aren’t always the nicest.
We’ll cover what a central bank digital currency is, what purpose they serve, why they might not be a good thing, and a few countries who are using them.
What is a Central Bank Digital Currency (CDBC)?
A central bank digital currency is a digital token issued by a country’s central bank and is pegged to the country’s fiat currency (like the U.S. dollar).
First was physical money like banknotes and coins. Then computers came, and money became a little bit more digital with the credit-based system. Central bank digital currencies are just the next evolution of government-backed money.
This digital currency can be used anywhere by consumers and businesses to pay for goods and services or for storing value. Except this money is stored on a digital wallet on your phone instead of in a bank account.
Both CBDCs and cryptocurrencies take advantage of the same type of technology -
blockchain and distributed ledger technology (DLT). That means the security benefits and peer-to-peer transactions. It also means that every transaction that ever happened will be saved.
The difference between a CBDC and cryptocurrency is that a CBDC is backed by the government while most cryptocurrencies are backed by supply and demand (the value people think it should be). A CBDC will always be pegged to the country’s currency.
Central bank digital currencies are starting to be taken more seriously by governments all around the world.
What is the Purpose of a CBDC?
There are a few benefits of CBDCs.
To give access to those without bank accounts financial inclusion. Right now, 1.7 billion people on Earth don’t have access to a bank account, but they may be able to spend their currency through their phone or some other form. This will give more people accessibility, convenience, privacy, transferability, and financial security than ever before.
All of this simplifies the financial system. It allows people to send money to each other easier, even across borders for those who send remittance to their families. Transactions don’t have to go through a bank, so there may be smaller fees to transfer money. You also might be able to earn interest through the government just for having money.
CBDCs reduce risk of other digital currencies like cryptocurrencies since they are extremely volatile. There are stablecoins like
Tether, but they rely on the backing of reserves instead of the government. Sometimes stablecoins have been known to depeg from their fiat counterpart. This could not happen with a government backed coin. The government can also easily control the supply by minting or burning tokens to combat inflation.
But the real purpose is so that governments can control money. Facebook tried to launch their own digital currency, but governments made payment providers pull their support from the project until it died. They didn’t like the idea of a private company being in control of a currency.
Why a CBDC Might Not Be a Good Thing
There are some things that might make CBDCs dangerous to the country’s people.
Central Bank Digital Currencies are Centralized
One of the main benefits of cryptocurrency is decentralization. Decentralization means that no one party has control, and instead is controlled by many parties.
A CBDC is regulated by the central bank, which means that the central bank will have full control over the currency. This is a centralized currency.
What makes cryptocurrencies so great is that no one can control the supply. There is no way for Bitcoin to ever print more than 21 million coins. A digital currency’s government can choose to increase the supply whenever they see fit (not that this doesn’t already happen.) They could easily print money, spend it, and pass the inflation on to you.
Another downfall of centralized currencies is that they create a single point of failure. They may be an easy target for hackers.
Cryptocurrencies like
Bitcoin are impossible to hack due to the network being spread out over thousands of computers. Just hacking one isn’t enough, and would have to hack half the network in order to change Bitcoin. A CBDC will most likely be held on government servers, and if they get hacked the entire money supply is in someone else’s control.
There Will Be No Privacy
Another benefit of cryptocurrency is that the transactions are anonymous. Unless someone knows your wallet address there is no way to know who personally sent or received the tokens.
With central bank digital currencies transactions might not be anonymous. At least not to the government.
One of the scariest things about a CBDC is that they are programmable. It’s an immense power that the government will wield.
Governments will be able to track your exact spending, how much you have spent, where you have spent it, and how much you currently have. They will be able to see every single payment or transfer and will be readily available for them whenever they need it. This could be done for tax purposes, but also could be used for surveillance reasons.
The reason this is so dangerous is because the government would be able to block certain transactions. Sending your friend money for dinner could look like a drug deal, or sending money back home to your family could be blocked based on your country.
Governments could also freeze your assets without having to go through the bank. Depending on how strict your country’s government is, this could be really bad for political opponents. It can also be bad for ordinary citizens too, like in China with their social credit system.
The government can control your spending based on things like work history, online activity, and political views. They can also force you to spend your money by setting an expiration date on your money. If they see you haven’t spent X amount in a month, they could just take your money.
People should be able to peacefully transfer money without the government’s eye constantly on them.
Which Countries Have a CBDC?
So far, only 2 countries have a working CBDC. They are China, with the Digital Yuan launched in 2020 and being slowly phased in, and The Bahamas, with the Sand Dollar also launched in 2020.
China is using distributed ledger technology to challenge the U.S. dollar as the world’s currency. They are trying to replace all the cash in circulation with their Digital Yuan. It makes sense why
China banned cryptocurrency.
The Bahamas were the first country in the world to create a digital version of its currency. Users can only use the dollar if they go through a Know Your Customer (KYC) process first.
Another country running a trial of a digital currency is Sweden. Their currency called the e-krona is looking to replace cash as its use declines. Other countries that have looked into launching CDBCs are Nigeria, South Korea, Japan, Canada, the United States, and the United Kingdom.
Even the European Union has looked into creating a digital euro if other countries are successful in their launches.
Summary
A central bank digital currency is a digital version of a country’s fiat currency built using blockchain or distributed ledger technology. It can be used to buy and sell things just like regular money.
CBDCs can help a country’s citizens by giving more financial inclusion, simplifying the finance system, reducing the risk of other digital currencies, and controlling money.
The problem with CDBCs is that they are centralized, giving the government too much control over the money supply, and creates a single point of failure. They are not private and the government will be able to see each transaction that is ever made using their currency.
So far, not many countries have a CBDC. China and The Bahamas are the two best examples. Other countries including the United States have looked into CBDCs for their currencies.
Now that you know what a central bank digital currency is, learn about the
different types of cryptocurrency.
