Suren Ayriyan is the Managing Partner and CEO at TEMPO Payments, a digital money transfer company.
Today, 15 countries – including China, Saudi Arabia, and South Africa – are testing their own centralized digital currencies: Central Bank Digital Currencies (CBDCs). Another 87 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, fighting fraud, and enabling greater currency stability. At the same time, experts have concerns about data privacy, power abuse by central banks, and technology adoption in areas without internet/phone access.
Let’s explore the benefits and risks of CBDCs, as well as their aptitude for large adoption.
The basics of CBDCs
Central banks are currently overburdened with cash currencies due to prominent bureaucracy and difficulty managing cash flows. Digital currencies allow storing data centrally, eliminating unnecessary complexity and money-printing. Moreover, by enabling citizens to deposit and hold funds in a central bank account, countries could improve access to financial services for members of society who are unbanked or underbanked.
Usually, CBDCs are powered by blockchain technology. Blockchain enables the issuance and control of the money that can then be used by payment institutions, banks, retail customers, and anyone who participates in the country’s financial system. As transactions on the blockchain – both nationally and globally – do not require an intermediary or communication between competing banks to complete a transfer, users of CBDCs will benefit from real-time processing and easy accessibility.
Citizens of early-adopting nations can access their digital currency through an e-wallet – no cash or credit cards involved. Right now, the typical processing fee for credit cards ranges from 1.3% to 3.5%. Using CBDCs, neither consumers nor merchants will need to pay a fee, reducing the high cost of transfers for economic activity of all kinds.
The power conundrum: CBDCs must be resilient against misuse
Private cryptoassets 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 digital currency regulated and controlled by the state – taxable and subject to legal obligations.
Most macroeconomic theories have taught us a great lesson: when the government has too much control over spending and misuses that power during the economic recession to spur growth without addressing debt, inflation is an immediate risk. Countries like Venezuela or Argentina, polluted by hyperinflation and a staggering poverty rate, are good examples of the consequences of uncontrolled governmental spending.
Secondly, the more transactions are conducted through CBDCs, the less money will be available to the private financial system to lend to people and businesses. This means that the central bank will have to centralize the credit system and give loans to companies, leading to corruption risks in the long run.
Before CBDCs can become a widely adopted currency, we must address the dangers of politicizing the coin. In any future scenario where people use CBDCs daily, the central bank will need to take an independent approach to fiscal policy. If governments want a say in overarching monetary policy, a dual system with a technocratic element, similar to the European Central Bank, can help mitigate 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 money. Finding a regulatory system that mitigates those risks is therefore key for countries before they can fully adopt the digital currency.
Transparency vs. privacy? The need for better cyber security
If there is no central location where money is kept and managed, it is easy for businesses and people to pay for goods on the black market or neglect taxes. CBDCs would provide the ability to check inflows and outflows and monitor money laundering.
CBDCs mean completely transparent transactions, and citizens are rightly concerned that their private data may be exposed. Therefore, countries must establish precise procedures to allow or prohibit the Central Bank from sharing transaction data – for example by using coin-based instead of account-based transactions. This means the CBDC coin stores the data of the transaction, not the users’ accounts.
According to this policy paper, privacy can be achieved with a cryptographic technique called blind signatures. Before the user interacts with the central bank to obtain a digitally signed coin, the numeric value representing a coin is hidden from the central bank before the signature is requested. In any case, governments must by law be prevented from using this data to analyze consumer habits or individual payments and use it against people if we do not want to wake up to a surveillance state.
With more transparency comes the need for better cybersecurity structures. Any central bank issuing CBDCs must have a robust risk mitigation framework. 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 tribunal). The disadvantage 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 cyber security solutions.
CBDCs can’t fulfill their purpose without the right infrastructure
CBDCs have the power to become a serious competitor to the existing financial systems – but only if our nations get ready for them.
In countries like Vietnam or Morocco, about 70% of the population is unbanked. In contrast, 61% of the people in Vietnam have a mobile phone. In Marocco, the smartphone penetration is as high as 137%. What does this data tell us? That financial inclusion is complex. In Morocco, a digital currency e-wallet would most likely improve access to financial services. However, in countries where cell phone and internet access is still low, digital currencies first require an investment in technology infrastructure. Infrastructure expansion will, ideally, be encouraged by the government.
This also pinpoints the problems a fully digital cash society will encounter: only if the internet connection is stable and people have access to a personal cell phone this type of payment works reliably. Hopefully, these requirements will ultimately push governments worldwide to invest in technology and provide better internet access to people living in rural/remote areas.
Right now, the bottlenecks lie in adoption, regulations, and law. The world is not ready for complete digital currencies yet. Still, the more governments and entities are experimenting with the use, deployment, and security infrastructure needed, the faster we will expand its service and get a taste of the advantages.