Central Bank digital currencies: Arguments for and against

10 November, 2019

If nothing else, all the Libra hype has lit a fire under central banks to consider their own positions on cryptocurrency. A number of them have raised the specter of introducing their own central bank digital currencies (CBDCs) to either preempt Libra or compete against it. The end result is a sudden discussion of the practicality of CBDCs and whether central banks will actually start rolling them out.

Needless to say, there are many arguments both for and against CBDCs. We will explore two of them in this post. What is truly fascinating is that the debate is beginning to reveal what the world's power players actually think about money. Such revelations could lead us down paths we never intended to take when Bitcoin started the whole cryptocurrency thing a decade ago.

Argument for: Consumer tracking

A central component of cryptocurrency is anonymity. Whether it is true anonymity or pseudonymity, the idea is to protect the identities of crypto users so that prying eyes cannot trace their financial movements. Heavy cryptocurrency users appreciate the fact that they are not leaving behind electronic paper trail that could be tracked by anyone with a desire to do so.

That leads us to a story out of Canada. According to Cointelegraph, the Bank of Canada is reportedly exploring the possibility of releasing its own CBDC. That much is not news. We have known for several years that Canadian authorities were working on a cryptocurrency project. The surprising part of their most recent revelation is one of the reasons given for issuing a CBDC.

Cointelegraph reports that a presentation offered before the Bank of Canada in 2018 outlines the many reasons they should release a CBDC. Among them is the "ability to collect more information on its citizens than is possible when people use cash," according to the report.

The report goes on to explain the official position that any data harvested from a CBDC platform would not be shared with payees. It could be shared with taxing authorities, local police, etc. Indeed, that is the troubling part. The idea that a government would encourage citizens to use a CBDC in order to collect data that could be used to spy on them is the very epitome of chilling.

Something many people fear

Whether or not the average person on the street fears government spying is not clear. But we do know such fears do exist. There are plenty of people within the cryptocurrency community who use Bitcoin and other digital monetary systems specifically because they are afraid of the government spying on them. That is just reality.

Conspiracy theories aside, most people never stop to think just how much personal information the government already possesses. They also do not take into account how that information can be used. By linking data pertaining to everything from tax payments to property records and driving licenses, governments know more about their people than they ever have in the past.

Governments also have access to financial data. Every time you or I pay for something with a credit card, debit card or online payment system, the transaction is recorded and made part of a permanent record easily accessible from networks all over the world. Governments can subpoena transaction data on a whim.

That makes the idea of Canadian authorities issuing a CBDC so that they can get their hands on even more information truly disturbing. Even if there were no other reasons to support private, decentralized cryptocurrencies like Bitcoin, the thought process now being entertained by Canadian regulators is reason enough.

Argument against: It is costly and inefficient

The argument against government-backed cryptos comes from none other than Bloomberg Digital executive editor Joe Wiesenthal. He apparently views government investment in CBDCs a waste of time because the technology is costly and inefficient. Wiesenthal recently made his opinion known in a Bloomberg Markets newsletter and subsequent tweet.

Wiesenthal has a point. As things stand, cryptocurrency technologies are terribly inefficient when compared to similar technologies that power the global networks behind Visa and MasterCard. What those networks can do in seconds takes the Bitcoin network as long as 10 minutes. There is no arguing that.

It is also true that mining hardware is extremely expensive. The amount of power Bitcoin mining consumes only adds to the expense. It is certainly less expensive to continue handling electronic payments in the traditional way. Fiat acts is the foundation for digital transactions that take place across global networks with efficiency, speed, and low overhead.

Worries of bad actors

Wiesenthal argues that governments investing in their own CBDCs would be investing time and resources in a system whose only purpose is to enable bad actors to buy things their governments do not want them buying. Again, his argument has some validity on its face. But it only applies to private, decentralized cryptos like Bitcoin and Monero. The argument would not apply to a CBDC.

Any CBDC that managed to make it to market would not be decentralized. It also would not be private. It would be controlled from top to bottom by government regulators and a central bank. And as Canada has demonstrated, transaction information and personal data would not be kept private in a CBDC system.

Canadian regulators would not have to worry about people using their CBDC to buy things the government didn't approve of because all transaction records would be open and easily accessible to authorities. Any information suggesting illicit activity would be passed on to police as well. So the idea of CBDCs being used to fund certain kinds of unsavory behavior just don't hold water.

Costly government projects

In terms of cost, Wiesenthal's concerns are legitimate. It takes an awful lot of computing power and electricity to make a cryptocurrency system work. Moreover, costs only increase over time due to the inherent nature of blockchain. Remember that blockchain is immutable. A system's ledger continues to grow in perpetuity as new data is added. The longer the chain grows, the more work required to keep the network in operation.

Governments could get around this issue by redefining the blockchain paradigm. In much the same way the Lightning Network seeks to speed up Bitcoin by reducing the total number of transactions needing to be processed, government coders can build a system that forces a complete turnover of the blockchain at regular increments. It would be like starting a new ledger every month. The old ledger would be archived for reference purposes; it would be kept separate from the new ledger for transaction purposes.

Only a matter of time

So, what does it all mean? Very little other than the fact that there are plenty of arguments for and against CBDCs. More important than those arguments is the realization that it's probably just a matter of time before CBDCs become the norm. It just doesn't make sense to continue minting coins and printing bills.

The irony of it all is that central banks could create viable digital currencies without having to rely on the blockchain concept. As good as it is, blockchain is not the only way to accomplish the end goal. It is a great technology with a lot of potential. Yet it is not the be-all and end-all of digital monetary systems.

Think of it this way: the Bank of Canada could decide to recall all minted coins and printed bills by the end of the year. They could tell citizens to take their fiat to the local bank and turn it in for digital credits. Each consumer's credits would be added to his or her bank account and be made accessible through the same means fiat is accessed: credit cards, debit cards, and paper checks. Nothing else has to change.

The Bank of Canada and the country's retail banks could continue with no large-scale changes necessary. Businesses could do the same. Simply put, you do not have to change the way financial systems currently work to replace minted coins and paper bills with a digital equivalent.

Dominoes waiting to fall

What we are now looking at in the digital currency space is a row of dominoes waiting to fall. The only question is which domino will start the process. Will it be Canada? Will it be the U.S.? Maybe it will be China. Time will tell. More importantly, the first country to release a viable CBDC will set the example everyone else will follow.

Rumor has it that China has been working on a CBDC in hopes of preempting Libra. Some were speculating they would be ready to launch by the end of 2019, but Chinese officials have publicly said that's not the case. Those same officials have acknowledged the existence of a CBDC project and plans to launch in one way or another.

There are arguments for and against CBDCs. Regardless of which side you're on, there is no need to get anxious about things. When they eventually do arrive, CBDCs will not be the same thing as true cryptocurrency. Bitcoin will still be there. So will the rest. And they will continue to serve as alternative monetary systems for people who are not all that thrilled with central bank currencies.