Central Bank Digital Currency (CBDC) – Digital Money for our Central Banks

What is it and why should I care as a business owner and consumer?

Central Bank Digital Currency (CBDC) is digital central bank money issued on a new technical infrastructure. While technically similar to private cryptocurrencies like Bitcoin and Ethereum, it is a legal tender issued by central banks. What businesses and especially consumers need to know about it.

The Chinese central bank has already launched it on the market as a test, the ECB is working on it, and it is also a high priority for the U.S. Federal Reserve: the issuance of digital central bank money, or CBDC, as it is called in new German. But the term is misleading because by far the largest share of global central bank money is already digital. So what is it about this new money that is being worked on at full speed? What is CDBC that is such a high priority for Democrats in the U.S. House of Representatives that they wanted to enact legislation to make CDBC accounts available to all U.S. companies and residents as early as Jan. 1, 2021? [1]

Legal tender on new infrastructure

CBDCs are legal tenders that are issued and administered on a similar infrastructure as cryptocurrencies such as Bitcoin, Ethereum, Tether, Ripple, Polkadot, and others already use today.

This infrastructure is commonly referred to as blockchain, but this term falls short. It is in fact distributed ledger technology, i.e. infrastructure that runs geographically distributed on numerous databases and is operated transparently by a network of users according to clearly agreed principles. Data is stored in chronological order, and cryptographic algorithms ensure the authenticity of the data.[2]

The advantages of this technology lie in the distributed and redundant storage of data across thousands of nodes. This makes the system highly resistant to physical interference as well as cyber-attacks, making data loss virtually impossible. Furthermore, this infrastructure is characterized by high data integrity, i.e., subsequent manipulation of data is virtually impossible. Furthermore, the complete transparency of the system allows every user to perform ad-hoc audits: an audit of every data entry is possible for every user at any time, as long as the system is based on a so-called public blockchain. Moreover, this audit trail extends back to the commissioning of the system. By means of programming logic, so-called smart contracts, which are also stored in the blockchain, entire decision-making processes can also be robustly automated.

The user – be it a company or the end customer – will no longer have CBDCs in his wallet, but in his digital wallet, an app that will be installed on a smartphone or PC. Using this app, the user will then also be able to make transactions as well as payments at the physical point of sale or on the web.

From gold to CDBCs

If we look at the history of money, gold or silver was initially deposited with a trustee at some point and securitized by paper. From then on, paper money was used instead of precious metal. In the next step, paper money became book money, which often appeared only on account sheets. Over time, the physical ledger of the central bank became a digital register, and digital money also landed in consumers’ wallets in the form of debit and credit cards. Companies have always had to map this development on the corporate side as well in order to offer customers convenient payment options.[3]

Mastering each of these evolutionary steps was a Herculean task that took decades – both on the central bank side and on the corporate side. One could now describe the introduction of a new distributed cryptographic infrastructure for digital money as a normal progression of this technological development. But that would be to massively underestimate this project, because CBDCs open up entirely new technological possibilities, especially for central banks.

What are the benefits of CDBCs?

In general, new infrastructures aim to deliver higher efficiencies to their users, or to guarantee higher security, or both. This will also be the case with CBDCs, as there will be relatively fewer false bookings, fewer technical failures and less fraud. It is also possible that there will be higher transaction speeds, but this will depend on the exact design of the technical system.

Whether corporate customers or even end consumers will notice anything at all about these improvements, however, remains to be seen for the time being, because transactions with digital central bank money are already carried out quickly, highly efficiently and largely error-free today. But it is possible that the user of CDBC will at least enjoy increased transparency. Although it can be assumed that CBDC will not be implemented on public blockchains, which can be viewed by everyone, but on private blockchains, which will have a restricted access circle for central banks and authorities, there could still be increased transparency for the users of the system. At least in theory, the new infrastructure will allow users to see in real-time when a transaction was initiated and whether it reached the recipient. This could be particularly useful for accounts receivable.

But why, so suddenly, more than a decade after the first cryptocurrencies were issued, have an entire group of central banks come together to define common principles and core characteristics of CBDCs? Why are lenders of last resort, from the ECB to the Bank of England, the Swiss National Bank, the Bank of Japan, the U.S. Fed, etc., suddenly so interested in CBDCs when this Herculean task yields only very limited benefits for companies and consumers alike? [4] Where does the sudden interest of these central banks in a crypto euro, crypto franc, crypto yen and crypto US dollar come from?

It’s because of the central banks’ immediate reach into users’ wallets, or rather, their digital wallets. So far, companies, as well as consumers, are only indirectly connected with the central banks. Between them and the central bank stands a commercial bank, which quite substantially controls the flow of money from the central bank to the corporate or retail customer. Subject to the necessary legal changes, the central banks will have direct access to the money holdings of companies and consumers in the future.

Monetary and Fiscal Policy under CDBCs

This access, coupled with the ability to track all transactions in detail for years, gives the executive unprecedented control: A government that has CDBC can implement monetary and fiscal policy directly, right from the government table to individual businesses and citizens. From a purely technical point of view, tax and interest rates can be set as often as desired and in a highly differentiated manner, both positive and negative. The purchase of certain products could be directly subsidized. The purchase of other products could in turn be directly sanctioned with punitive taxes. Undeclared work would no longer be worthwhile in view of the transparency of the system. But the possible applications go far beyond monetary and fiscal policy, if we move to the consumer level: certain groups of people could be banned from buying goods altogether, such as the sale of cigarettes to under-16s or of luxury goods to welfare recipients.

In crises such as the current Covid19 pandemic, the public administration could, for example, prevent shopping tourism by no longer allowing transactions if the buyer is more than 15 km away from his or her place of residence. In addition, the state could design stimulus money or even salaries as shrinkage money and thus force consumption: Every day the money remained in the wallet, it would become worth less. Conversely, a government could prevent bank runs by preventing the withdrawal of funds. Inflation or even hyperinflation could be concealed by simply making it impossible for users to spend money above a fixed amount.

From a purely technical point of view, it has never been easier for a state to balance its budget by means of compulsory bonds than in the times of CDBC. The state could simply issue compulsory bonds by temporarily blocking companies or citizens from using part of their cash balances in the wallet. A debt cut or a currency reform would also be very simple: the user would simply be deprived of part of his balance or the current currency in his wallet would be compulsorily exchanged for a new one, naturally at an exchange rate defined by the government.

Conclusion on digital central bank money

The current digital money system is not free of flaws. CDBCs could make the current payment infrastructure more secure and transparent, and possibly faster. At the same time, the additional benefits that corporate or end customers would feel from the introduction of CDBCs are severely limited. On the other hand, there are previously unimagined advantages for public administrations. The new management and control options that CBDCs potentially make available to public authorities are immense.

In view of these incentives that the public sector will have through the introduction of CDBCs, it is safe to assume that CDBCs will soon be introduced in Europe as well. Companies would be well advised to familiarize themselves with cryptocurrencies and their underlying technologies today and budget for the implementation of the new payment channel. In addition, companies should prepare for much greater government control and oversight of their business.

While CDBCs are hailed as innovation and progress by some, close attention will need to be paid in the future to the impact they will have on users. Entrepreneurs could be more restricted in their entrepreneurial freedom than ever before, but the rights of customers, i.e., individual citizens, could also be affected. In times of CDBCs, these rights are best safeguarded by always offering the option of cash payment with notes and coins from companies in addition to CDBCs.

Paradoxical as it may sound, such cash payment could once again become a unique selling point for companies in times of advancing digitalization. After all, Dostoevsky referred to coinage when he remarked “money is coined freedom.”[5]

Further readings

  1. Waters, M., H.R.6321 – Financial Protections and Assistance for America’s Consumers, States, Businesses, and Vulnerable Populations Act, House – Financial Services; Ways and Means; Education and Labor; Small Business; Judiciary; Agriculture, Editor. 2020, 116th Congress (2019-2020): Washington D.C.
  2. Schueffel, P., N. Groeneweg, and R. Baldegger, The Crypto Encyclopedia: Coins, tokens and digital assets from A to Z. 2019, Fribourg /Bern: HESSO / Growth Publisher.
  3. Ferguson, N., The ascent of money: A financial history of the world. 2008: Penguin.
  4. Bank for International Settlements, Central bank digital currencies: foundational principles and core features. 2020: Basel.
  5. Dostoevskij, F.M., H. Moser, and V. Dimitrijević, Memoiren aus einem Totenhaus. 1929: P. Reclam jun.
    Dr. Patrick Schüffel ist Adjunct Professor an der Hochschule für Wirtschaft Fribourg, Schweiz. Seine Forschungsschwerpunkte sind Banken, Finanzierung und Unternehmertum. Als Berater und Gründer wirkt er mit an verschiedenen asiatisch-europäischen Crypto-Projekten. Vor seinem dreijährigen Aufenthalt in Singapur arbeitete er jahrelang im Bankwesen in Zürich. Er besitzt etliche Universitätsabschlüsse.

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