Suren Ayriyan is Managing Partner and CEO of TEMPO Paymentsa digital money transfer company.
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Today, 15 countries – including China, Saudi Arabia and South Africa – are testing their own centralized digital currencies: Central Bank Digital Currencies (CBDCs). 87 other countries are exploring the virtual minting process and how they can adopt a national electronic currency.
CBDCs are often touted as a panacea for achieving financial exclusion, combating fraud and enabling greater monetary stability. At the same time, experts have concerns on data privacy, abuse of power by central banks and adoption of technology in areas without internet/phone access.
Let’s explore the benefits and risks of CBDCs, as well as their suitability for wide adoption.
CBDC Basics
Central banks are currently overloaded with foreign exchange due to heavy bureaucracy and difficulty in managing cash flow. Digital currencies allow data to be stored centrally, eliminating unnecessary complexity and printing money. Additionally, by allowing citizens to deposit and hold funds in a central bank account, countries could improve access to financial services for unbanked or underbanked members of society.
Usually, CBDCs are powered by blockchain technology. The blockchain enables the issuance and control of money which can then be used by payment institutions, banks, retail customers and anyone participating in the country’s financial system. As transactions on the blockchain – both domestically and internationally – do not require a middleman or communication between competing banks to complete a transfer, CBDC users will benefit from real-time processing and easy accessibility. .
Citizens of early adopter countries can access their digital currency through an e-wallet – without cash or credit cards. Currently, typical credit card processing fees range from 1.3% to 3.5%. By using CBDCs, neither consumers nor merchants will have to pay fees, reducing the high cost of transfers for economic activities of all kinds.
The Conundrum of Power: CBDCs Must Be Resilient Against Abuse
Private crypto-assets have stoked fears among financial regulators: what if countries lose control of the money supply? With CBDCs, governments are looking for a way to provide a state-regulated and controlled digital currency – taxable and subject to legal obligations.
The most macroeconomic theories taught us a big lesson: when the government has too much control over spending and abuses that power during an economic downturn to stimulate growth without tackling debt, inflation is an immediate risk. Countries like Venezuela or Argentinapolluted by hyperinflation and a staggering poverty rate, are good examples of the consequences of uncontrolled government spending.
Second, the more transactions are conducted through CBDCs, the less money the private financial system will have available to lend to individuals and businesses. This means that the central bank will have to centralize the credit system and provide loans to companies, which will lead to long-term corruption risks.
Before CBDCs become a widely adopted currency, we must face the dangers of politicizing the coin. In any future scenario where people use CBDCs on a daily basis, the central bank will need to take an independent approach to fiscal policy. If governments want to have a say in global monetary policy, a dual system with a technocratic element, similar to the European Central Bankcan help to mitigate the risks of politicization.
Alternatively, one could imagine an independent tribunal of monetary policy experts having the final say on fiscal policy measures and controlling how governments use the money. Finding a regulatory system that mitigates these risks is therefore essential for countries before they can fully embrace digital currency.
Transparency vs confidentiality? The need for better cybersecurity
If there is no central place where the money is kept and managed, it is easy for businesses and individuals to pay for goods on the black market or overlook taxes. CBDCs would provide the ability to verify entry and exit and monitor money laundering.
CBDCs mean fully transparent transactions, and citizens rightly fear that their private data could be exposed. Therefore, countries should establish precise procedures to allow or prohibit the Central Bank from sharing transaction data – for example using coin-based transactions rather than account-based. This means that the CBDC coin stores transaction data, not user accounts.
According to this guidance document, privacy can be achieved through a cryptographic technique called blind signatures. Before the user interacts with the central bank to obtain a digitally signed coin, the digital value representing a coin is hidden from the central bank before the signature is requested. In any case, the law must prevent governments from using this data to analyze consumer habits or individual payments and use it against people if we don’t want to wake up in a state of surveillance.
With more transparency comes the need for better cybersecurity structures. Any central bank issuing CBDCs must have a strong risk mitigation framework in place. Blockchain transactions could work with a multi-signature wallet, where at least two other trusted parties hold the credentials for the same wallet (this could be the central bank or an independent court). The downside of multi-signature wallets is that they are less user-friendly, as you have to coordinate with at least one other party for each transfer – which means the world is still waiting for the best cybersecurity solutions.
CBDCs cannot fulfill their mission without the right infrastructure
CBDCs have the power to become a serious competitor to existing financial systems – but only if our nations prepare for it.
In countries like Vietnam or Morocco, about 70% of the population is unbanked. In contrast, 61% of people in Vietnam have a cell phone. In Morocco, the smartphone penetration reaches 137%. What does this data tell us? This financial inclusion is complex. In Morocco, a digital currency e-wallet would most likely improve access to financial services. However, in countries where mobile phone and internet access is still low, digital currencies first require investment in technology infrastructure. Infrastructure expansion will ideally be encouraged by the government.
It also highlights the problems that a fully digital monetary society will face: only if the internet connection is stable and people have access to a personal mobile phone will this type of payment work reliably. Hopefully, these requirements will ultimately push governments around the world to invest in technology and provide better internet access to people living in rural/remote areas.
Currently, the bottlenecks lie in adoption, regulations and the law. The world is not yet ready for full digital currencies. Yet the more governments and entities experiment with the necessary security use, deployment and infrastructure, the sooner we will expand its service and get a taste of the benefits.
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Learn more:
– Work on a multi-CBDC platform revealed “more questions than answers” – BRI
– CBDC in 2022: New trials and competition with Crypto
– BRI says CBDC issuance may depend on collaboration with private sector
– Russian sanctions could prompt more countries to consider CBDCs, says former central banker
– China’s Digital Yuan app receives update as police handle first-ever case of CBDC ‘fraud’
– The Caribbean CBDC is functional again after a two-month outage
– Joe Biden’s Executive Order on Crypto Calls for Consumer Protection, CBDC Consideration, Tech Innovation Support
