CBDC – The Eventual Demise of Cash?

What is CBDC?

Stands for Central Bank Digital Currency. About 80 countries are considering a CBDC to better control money. It would be produced by each country’s Central Bank (CB), sometimes referred to as Federal or Reserve Bank. China is experimenting with the digital yuan because they want to stop the $US dominating world trade. CBDCs would be introduced alongside physical cash, but cash would eventually be phased out. This is considered inevitable and accelerated by COVID19. Cash is being used less and less and has its own problems. See graph below.

Governments don’t want a non government business like Facebook to introduce a cross border system like Libra. If it goes ahead, Libra would be a stable coin linked to a basket of world currencies and could eventually become a world currency like the Euro for Europe. Also cryptocurrencies’ expansion  (world valuation US$237Bn) has put pressure on central banks.

CBDCs could work on the blockchain which provides high security but under government control, the assumption is it will be secure anyway. The Australian Reserve Bank is investigating the use of the cryptocurrency Ethereum blockchain for their CBDC*.  However, to identify fraudulent transactions and perpetrators, conventional blockchains would need to be modified in some way, as users are anonymous.

* The Australian Securities Exchange, ASX is already replacing CHESS with a blockchain.

The blockchain is a mystery to most people, so the section below explains it.

Blockchain

There is no central controller like banks and the blockchain sits on a large quantity of computers as a distributed ledger. Each new transaction creates a block and the data on the block must be agreed to by the connected computers before it is accepted. It is almost impossible to hack, as all blocks and ‘proof of work’ would need to be altered on all the computers within seconds. Experts agree even quantum computers won’t be able to hack the blockchain, but that would require another blog.

To understand the blockchain further, watch the video below

Cryptocurrencies

While the term cryptocurrency suggests the blockchain is for a variety of different ‘currencies’, the applications are more for trusted certification and authentication, not necessarily financial, such as:

1. Checks on the validity of pharmaceuticals so that a user will know without doubt, where and by whom the product was made.  See FTT. A million people die each year from fake pharmaceuticals!
2. Validating the authenticity of high value art works or gems, etc. See NFT Art Report
3. Ensuring correct ownership of property by documenting every transaction back to its origins. See Land Registry
4. Voting – would be fast, eliminate recounts and fraud. See Voting App
5. And many more, see CB Insights

The Advantages of CBDC

1. Cost of printing and distributing cash is high, whereas digital cash provides faster, cheaper, and more efficient payments, both domestically and cross border
2. The cost of converting currencies through commercial banks is high with physical cash. Take a real life example of $Australian dollars exchanged for $New Zealand. Although the exchange rate is $A1 = $NZ1.05, the exchanger receives only $NZ99 for each $A100.  A digital cross border blockchain would theoretically net the exchanger $NZ105, as there is no middle entity and negligible cost. 6% is a huge take, caused by high fixed costs as well as commissions. Even credit card transactions cost the seller or buyer more than 1% and higher for cross currency conversion
3. Digital currency recipients don’t need a bank account, so ideal for the 2 Billion people in poorer countries without one, but most have a mobile phone which acts as a digital wallet
4. Tax avoidance would be almost impossible and tax could be extracted easily by governments. Through design and control, it could be a way of stopping bank runs.
5. Bank transfers would settle in real time instead of days
6. Central banks could issue money directly into people’s accounts or mobile phones
7. CBDCs are easy to understand. The government owns this money. It organises and dictates the details of this system.
8. As a monetary policy tool, Interest including negative rates could stimulate spending which is not possible with cash

Cash payments. Source: Reserve Bank of Australia

Disadvantages

1. Urgency. First major country to implement a CBDC could dominate. This could be China whose beta model is running under test
2. It is a major change to the long used conventional and successful banking system. Unknown difficulties may arise, although this is the same for any first time change. The advantages will force change
3. As central banks become direct competitors to payment service providers, e.g. banks that might lose income and then raise deposit interest rates, so reducing available bank credit, etc.
4. Risk of a bank run, but the design of the CBDC should prevent this as explained above. This can occur with conventional systems

Will CBDCs Devalue Cryptocurrencies?

A major problem with cryptos is the number of cowboys, Ponzi schemes, etc. involved, causing high volatility. However ‘stable coins’ linked to fiat currencies are emerging to overcome this problem. Governments are reluctant to regulate cryptocurrencies because of the competition financial cryptos would provide against fiat (government issued) currencies. Also they don’t want a non government world currency, even though it would make life much easier and may eventually occur.

Blockchain technology is sound, low cost and the issue of genuine cryptos such as Bitcoin, Ethereum, etc. is limited, so will increase in value with increased use, in the same manner as physical gold. So CBDCs are not expected to devalue genuine cryptos, which are increasing in value. They could ban them as China has, but in a democracy, it would be a very hostile move with huge investments affected.

References

Based on a variety of sources including:

• Wikipedia, IMF
• U.S. Federal Reserve
• European Central Bank – ECB
• Bank of England – BoE
• Bank of Japan – BoJ
• Swiss National Bank – SNB
• Bank of Canada – BoC
• Reserve Bank of Australia – RBA