This article first appeared in Digital Edge, The Edge Malaysia Weekly on July 5, 2021 - July 11, 2021

It appears likely that central bank digital currencies (CBDCs) will become a reality in the near future.

CBDCs, also known as govcoins, are essentially digital money backed by a country’s central bank. Projects involving CBDCs have been gaining traction around the world, with more than 60 central banks exploring its use since 2014, according to a recent PwC report.

“Some CBDC projects are now entering the implementation phase. Institutional involvement in CBDCs continues to strengthen the ecosystem at large, with public stakeholders such as the Bank for International Settlements, the World Bank, the International Monetary Fund and the World Economic Forum, active on the topic,” says the report.

“The history of CBDCs probably goes back to a paper written by the Bank of England in 2014, recognising the opportunity to take some of the ideas within Bitcoin and apply them in a central bank context,” Haydn Jones, director and senior blockchain market specialist at PwC (UK), tells Digital Edge.

There are two main operational designs of a CBDC — retail, where the digital currency is held directly by citizens, and interbank or wholesale applications, where its use is restricted to financial institutions for interbank transactions and financial settlements.

The focus is not on eliminating cash but about diversity in money, says Jones. “We need diverse forms of money to be able to support the different tiers in the economy.”

More than 88% of CBDC projects, at pilot or production phase, use blockchain as the underlying technology, says the report. While a blockchain is not necessary to create digital tokens, there are several benefits to using the technology. A key selling point is the creation of automated money, which leads to automated commerce, says Jones. 

“Now, if I get into an agreement with someone, it will be some kind of paper-based or email-based agreement. There’s a frictional cost associated with that agreement. I have to create a document, the person has to deliver the services to me and I have to eventually release the payment. In the case of digital currencies, I can automate the release of payment when the goods or services have been delivered.”

Digital footprints enabled by blockchain can also result in transparent audit trails as well as increased interoperability with other digital assets. Most, if not all, central banks are either neutral or positive on the position of cash, says Jones. A more diverse form of money could point towards “less cash” instead of a truly cashless society, which can have some repercussions on disadvantaged groups.

“Only 4.8 billion of us are actually connected to the internet. There are about three billion people who do not have access to the internet or are not connected digitally whatsoever. No matter how advanced your society is, there will always be people who cannot use or have access to the internet, or even a phone or device,” he points out.

The key factor is understanding what a central bank does, Jones continues. “The central bank provides confidence in a nation’s currency and ensures financing ability in terms of how the money market operates. We’re applying the efficiencies derived from digital currencies such as in terms of speed of settlements.”

The problem with the current arrangement is that it’s not government-emanated, he adds. “If we have a government-derived digital currency, it has the state sitting behind it. It means I can create automated digital frameworks, as well as extend the idea to digital securities like debt and equity. This is interesting and powerful considering the capital-raising perspective, which sits at the heart of economic growth.”

This could also be beneficial for individuals who may have a high-risk profile. “The central bank can deliver a cheaper service offering to address the problem of different profiles of individuals who may be unbanked because of their credit risk or socioeconomic demographic — a risk that a retail bank does not want to potentially take on,” says Jones.

“Payment is one of those things that happens at the end of a process. So, nobody really thinks about the strategic payment narrative. But people get very upset if they don’t get paid.”

There needs to be a better understanding of what money is and how technology can be used to improve efficiencies around it, he points out.

With every new technology, there are benefits and drawbacks. CBDCs promise speedier transactions that should benefit everyone, including corporations, says Dr Wolf von Laer, CEO of Students For Liberty, a non-profit organisation with student volunteers in 114 countries focusing on free markets, free speech and benefits of a free society.

“However, this ignores the risk that comes with centralised-controlled money that is tied to people directly, as compared to cash, which is fairly anonymous. CBDCs will likely be tied to personal accounts that include personal data, transaction history and other forms of relevant information. Money will be identity-based rather than token-based,” Von Laer tells Digital Edge.

Currently, a lot of organisations have snippets of our personal data. “Instagram has some, our banks have more data, but it is fairly distributed. Now, if all of our spending data is connected to a single entity, a lot of power is centralised in the hands of the government and it can be used as political weaponry,” he says.

This future may sound fairly dystopian but it is important to keep in mind that there is a possibility that it may happen, he continues. “China has already implemented widespread financially punitive measures on the basis of people’s behaviour. If you criticise the regime, they will disallow you from travelling or using your WeChat payment account, which prevents you from interacting with society.

“China and its digital yuan already have the power to decide whether to destroy the currency, to create a new one, to limit people’s access and more. It is just a matter of time until the country links the digital yuan to the social credit score system.” China’s Digital Yuan project has already reached an advanced level of trialling, with more than RMB2 billion (about US$310 million) in transactions and is reportedly preparing for broader usage at the Beijing 2022 Winter Olympics, according to the PwC report.

“Anyone who thinks our data is safe or the government will use it in a responsible way has not studied history all that much. Power corrupts, and absolute power over money corrupts absolutely,” says Von Laer.

Another vital thing to note is that informal markets make up a significant part of the economy, especially in developing countries. “It is in the interest of big business as well as governments to reduce the role of informal markets and control that people only spend in a way that generates taxes. One could imagine that the change will come about gradually but the goal would be that at some point, people will only use CBDCs and cash will be forbidden,” he continues.

Using Sweden as an example, he says the Nordic country “has already taken a lot of steps to eradicate cash. It is just a matter of time, and politicians and pundits will have good arguments as to why the antiquated cash system is unnecessary and outdated. That may be true, but it ignores the dangers to privacy”.

There are different variations of CBDCs, according to each country’s goals and modes of operation. Alongside understanding new evolutions of money, people also need to question the intention of policymakers, Von Laer stresses. “Most importantly, people should understand why Bitcoin is so popular and why it is fundamentally different from CBDCs.

“Bitcoin was founded upon and continues to be developed with the idea to take money out of the hands of supposed independent central bank control. Money is the lifeblood of the economy and the manipulation of interest rates has widespread effects that lead to boom and bust cycles and misallocation within the economy. The clearest sign of this is the K-shaped recovery that has taken hold in many countries.”

According to US personal finance website The Balance, a K-shaped recovery occurs when different segments of the population recover from a recession at a different pace. In some cases, it could be that different industries are recovering at different speeds.

Bitcoin is decentralised, open, public, borderless, neutral and possesses tamper-proof and censorship-resistant properties, says Von Laer. “CBDCs are the opposite since by their very nature they are closed, run by government, centralised, localised and their supposed feature is that monetary and fiscal policy can be implemented directly with them. That means, for instance, governments could decide to give different people different interest rates on their money or even punish people for saving according to some political calculus.”

However, CBDC adoption can even lead to the increase of Bitcoin adoption due to the public being more familiar with digital currencies in general. On top of this, “…Bitcoin will soon be the only true store of value and money that cannot be manipulated completely by governments,” he says. 

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