When Satoshi Nakamoto, creator of Bitcoin, hit the “run” button for his new invention for the first time in early 2009, he probably had no idea how much he was about to change the world.
Or perhaps, given the incredible amount of foresight built into the design, he actually did. One thing is for sure, once the concept of digital scarcity was out in the open, the technology was never going to go away.
Arguably, Nakamoto wasn't the first to play with the idea of blockchain, but he was certainly the first to come up with something that worked perfectly, had a compelling vision behind it and could be easily disseminated around the world exactly as it was designed.
After all, a completely decentralized, disinflationary monetary system that could not be controlled or corrupted by a legacy power structure was just what the world needed, but perhaps didn’t quite know it yet.
Our existing monetary system, a mere 38 years old at the time, was already under extreme pressure as result of excessive money printing, wars, shady international deals and protectionist policies.
Now, nearly 13 years on from that pivotal moment in history, that pressure has created noticeable factures that are becoming harder to repair without more and more extreme measures. It’s a bit like a trailer behind a car that has started snaking uncontrollably — each over correction by the driver leads to a bigger oscillation that needs a even larger corrective measure.
Until, of course, the inevitable happens.
All of this could be fixed, so the theory says, by switching to a decentralized, impartial system that takes human intervention out of the equation.
So, what’s not to like?
Well, quite a lot if you’re a central bank or a government used to being control of these things. How exactly would you manage monetary policy, for example? How would borrowing work if you can't expand the money supply? How, exactly, would taxation work? How would you track velocity of money?
These are genuine questions for a central body that is tasked with managing the economy of a nation, so why not instead come up with a “third way?”
That is, take the tech that is blockchain, create a new digital currency based on the existing fiat currency, and manage it centrally using the efficiencies it brings to bring benefits to your people. After all, it’s now certain we’ll be using digital currency in one form or another anyway.
That “third way” has now been developed into the concept of Central Bank Digital Currencies, or CBDCs for short.
So maybe they’re the best of both worlds?
CBDCs at work
Most countries have already announced that they will be developing some form of CBDC over the next few years.
Some countries have even tested or actually deployed them — think China or, perhaps surprisingly, the Bahamas. However, sooner or later all governments will fully understand that in a fully digital world money will ultimately only exist in a digital state.
It’s still the early stages and trying to get a precise answer from most central authorities on how exactly they plan to do leads to vague answers, largely because in many cases they’re not entirely sure themselves.
At this stage there are few rules— except what economic laws may provide as a framework — and plenty of room for interpretation.
However, for the purposes of this article, we can afford to keep the concept as simple as possible, so let’s assume that central authorities will simply digitize what’s already there.
So, for example, the British Pound could become the e-pound with the same overall money supply. The mechanics, delivery and implementation of this are not relevant in this discussion, but we are interested in what it is likely to mean for the citizens of the country concerned.
Should we be welcoming … or afraid?
The positives of a CBDC
There’s no question that governments will sell the positives of a digital system based on a what would effectively be a centralized block chain. The impact of such an implementation would appear to carry a number of significant benefits, at least at first glance.
Transactions are likely to be faster and cheaper, possibly even free, via wallet to wallet transfers, including those that might be held across borders. We might also expect security to be better as the amount of cards and payment mechanisms is streamlined and wallets can be better protected and integrated.
Even in the UK, around 4% of the population is unbanked, a fairly typical number for many countries in Europe, according to this report. The most common reasons for this are to do with ID issues, low income and trust of the state or financial institutions. Using a CBDC system is likely to solve some of those problems and increase inclusion.
Crime could also be reduced since the complete removal of cash (the ultimate goal in a cashless society) would mean that payments would need to be made through a system that could be traced and, if necessary, stopped or reversed.
Tax evasion would become much harder to achieve, thereby increasing the sovereign coffers.
The government would also have access to “real time” economic data rather than having to wait weeks or months for aggregated (and almost certainly less accurate) data, allowing better macro economic decisions. Economic policies could be delivered directly to industry sectors, age groups or certain types of spend.
Social care programs could be more easily administered and delivered more quickly, more cheaply and directly to the people who need it.
And so on.
This list isn’t even exhaustive, but the point is that may of these benefits seem to be a net positive across the board.
But is that really the case?
Be afraid, be very afraid
Closer examination reveals that the primary benefits actually come to those who are in control and not so much to those who use it.
CBDCs will carry counter party risk, meaning that each e-pound (or “Britcoin” as it has been dubbed) will actually be a measure of debt owed by the central power to those who use it. This is a simplification, but the bottom line is that this differs from something like Bitcoin which doesn’t carry that risk. Your money is still only as good as the government who promises it has value in the first place.
Essentially this is a reminder that you will never really own your money if you’re using a CBDC, similar, in many ways, to a traditional fiat currency. In other words, you still need to trust your government.
And trust is a big problem for central authorities, especially in the modern world.
Worse, it’s not just trust in the value of that currency, but an additional layer of trust in the powers that be to do the right thing.
As easily as money can be disseminated in a CBDC driven economy, it can just as easily be taken away. It’s a question of justification.
Imagine, for example, spending your money on something the government doesn't like. You might be financially black listed or even have your funds frozen.
Of course, this can be done under the existing system if transactions are shown to be linked to crime, but it’s not easy to do and involves many parties from legislative enforcers, courts and banks. It could, almost literally, be done at the press of a button under a CBDC system — who could we trust to ensure this is not abused?
This could even be taken further. Since your spending habits could easily be traced on the centralized blockchain and visible to authorities either on a case by case basis or, more likely, on some algorithmic model, spending controls could easily be enforced.
Certain products, for example, could be effectively outlawed by disallowing purchase transactions that involve them. Cigarettes, alcohol and junk food are probably prime contenders for the “good of the health of the nation” and, while this seems far fetched at this point, do we really want to allow that possibility to even exist?
Even if these more extreme cases didn’t materialize, the mere fact that an individuals entire financial history could be reviewed by the state at any time is unlikely to sit well with many. History tells us that this information is all but guaranteed to be abused, sold or lost to those who would take advantage of it through sloppy security.
What about new legislation that allows immediate payment of fines or penalties either by direct deduction or freezing of funds until they are paid?
Or the targeting of ethnic or economic groups via their finances?
What if the government linked Covid injections to your ability to spend money, turning it off if you didn't comply?
What about the fact that the sheer level of surveillance built into a CBDC would allow authorities to assess where you were at a certain time? What if you were present at a rally protesting something the government wants to enforce?
Could we really trust them not to look at your spending (perhaps through buying tickets for travel to the event for example) and not putting you on an automatic blacklist? Or even prosecuting you?
These seem to be a very high individual prices to pay for any macro economic gain.
Some, including myself, would argue they are too high.
The bottom line
This all comes down to that one single and extremely powerful word:
Trust
In a traditional fiat system, we have to trust that our government will not mismanage our currency to oblivion, even though we know that historically the odds of this not happening are close to zero.
There’s an interesting summary of currency failures over the last few centuries that demonstrates this exact point that can be found here.
However, in a CBDC system we now have to trust that our government will not only not devalue our currency, but can also be trusted not to abuse the incredible surveillance power it brings.
If governments can’t succeed at the former, then why can we assume they will succeed at the latter? It seems an impossible ask given our collective flaws as humans.
And can we even trust a government to correctly deliver a CBDC in the first place? Central authorities have woeful records with any IT project, somehow managing to spend ten times as much as the private sector would, taking three times as long and ending up with a product that works half as well.
But more than anything else a seemingly innocuous quote from RBI (Reserve Bank of India) Deputy Governor T Rabi Sankar in a recent article sums up the whole situation beautifully.
When asked what would be the disadvantages of a CBDC system, he offered up this answer:
Flight of deposits can be much faster compared to cash withdrawal
In other words, in the event of a bank run or currency failure, people would be able to get their money out faster than they would than if they had to go the bank.
Probably inadvertently, he highlighted the big problem with CBDCs; that they could — and almost certainly will — have the exact same failure proposition as the fiat currency it replaces. You’re not actually solving the problem, you’re simply changing the delivery mechanism.
And where would people move their rapidly failing CBDC to in these circumstances? Perhaps something out of the hands of any centralized power or something that doesn't carry counterparty risk and can’t be surveilled, corrupted or controlled.
Something, perhaps, like Bitcoin.
Want free access to articles, analysis, podcasts and training webinars? Why not subscribe to the ‘Bitcoin and Global Finance’ newsletter? Subscribers over 18, resident in Europe (see list on subscription page) & new to Bitcoin can claim £10’s worth of Bitcoin on joining! Unsubscribe at any time.
Disclosure: The author of this opinion piece has been heavily involved with bitcoin for several years and holds a substantial cryptocurrency portfolio, including bitcoin. He also has a mining operation running the SHA-256 algorithm based in Siberia and is a published author on the subject of promoting the understanding of cryptocurrency. Jason is an analyst at Quantum Economics and consultant to Luno.
Disclaimer: This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.
If you found this content engaging, and have an interest in commissioning content of your own, check out Quantum Economics’ Analysis on Demand service.