Headline: Central Bank Digital Currency



What Is a Central Bank Digital Currency (CBDC)?

Central bank digital currencies are digital tokens, similar to cryptocurrency, issued by a central bank.(This is important, they are not cryptocurrencies as they are controlled directly by a centralized authority and each unit has an individual identity, like a serial number.) They are not pegged to the value of that country’s fiat currency, rather, they are that country’s fiat currency..  Fiat money is a government-issued currency that is not backed by a physical commodity like gold or silver.  (Please remember that we are not on the gold standard any more.)  If you look at any banknote that you happen to have, it is now backed by “the full faith and credit of the United States.” It is considered a form of legal tender that can be used to exchange goods and services. Traditionally, fiat money came in the form of banknotes and coins, but technology has allowed governments and financial institutions to supplement physical fiat money with a credit-based model in which balances and transactions are recorded digitally.  (Today, you can call TreasuryDirect and over the phone, invest in government bonds, and you do not get a contract for each one.)  This has been going on for a while now, so, a digital currency was frankly, to be expected. 

So, what are the objectives of having a CBDC?

The stand-up goal of the CBDC is essentially to help the unbanked and under-banked in our society   In the U.S. and many other countries, many people do not have access to financial services. In the U.S. alone, 5% of adults do not have a bank account. An additional 13% of U.S. adults have bank accounts but use expensive alternative services like money orders, payday loans, and check-cashing services.  The main goal of CBDCs is to provide businesses and consumers with privacy, transferability, convenience, accessibility, and financial security. CBDCs could also decrease the maintenance a complex financial system requires, reduce cross-border transaction costs, and provide those who currently use alternative money transfer methods with lower-cost options.

Other objectives would be obtained too:

  1.  The CBDC facility would allow the nation’s regulators another way to implement monetary policy.   This would be good to provide more control over price stability and modulating inflation.
  2. The CBDC would also encourage many other new investors to adopt the digital currency as it would much more stable in its pricing than say Bitcoin or Ethereum.
  3. Transferring money to other countries would be made much easier.
  4. The one central digital ledger would increase transaction speeds.
  5. Illicit activities would be nearly impossible with a CBDC as all transactions are routed thru a central ledger.  Money laundering concerns (a concern with cryptocurrency) would be eliminated.
  6. Much of the current banking infrastructure within this nation could be eliminated, and the labor and capital used in a more productive manner.  Currently, it requires about $600 Bilion per year to maintain this infrastructure.  So, we’re talking about real money here.
  7. The CBDC would lead to a direct payment system, and this would allow the U.S. to enjoy its status as a world reserve currency for just a little while longer.  

Are there different flavors of CBDC?

Yes, there are 2 main types: Wholesale and retail.   The wholesale variety is mainly held by financial institutions, and are like holding reserves in the Federal Reserve.  Retail CBDCs are used by consumers and businesses.  They can be token-based or account-based.

All of this sounds great, what are the problems?

The issues largely boil down to uncertainty and privacy concerns.  First, it is important to realize that, as humans, we really don’t handle change that well, and this could be a seismic shift in our approach to money.  Any time that there is such extensive change, there are unintended consequences, and people are understandably concerned about this.  Second are privacy concerns.   There will have to be some facility for the Fed to regulate the CBDC, but at the same time, the system has to be hardened and protected against hackers.    This is a very difficult balance to achieve and maintain.

Not for nothing, if there is one central authority, the remaining banking institutions could be motivated to try and influence the decision-making processes of this Central Body.  Perhaps there would be undeniable political connections to what institutions get loans on great terms, and what banks get just normal terms.  Corruption would almost guaranteed, and this is antithetical to a smoothly-functioning financial system.

Are there examples of CBDCs that are being tried?

It would appear that Canada is trying to implement such a system.   It would also appear as if China is preparing to use such a system (digital Renminbi)  to further empower citizens to make payments from their phones.  Europe has announced the creation of a digital euro and the U.S. Federal Reserve is working hard to design its own version.  The Bank of Japan and the Bank of England are also working on digital versions of their fiat currencies.

Researchers have been hard at work exploring the technical issues raised by a CBDC. One of these efforts is Project Hamilton, an MIT/Boston Fed collaboration. Their recent Phase 1 report suggests that simple dichotomies such as token-based vs account-based and centralized vs. decentralized are only a starting point for understanding the design issues. In their view, these categorizations aren’t enough to encompass “the complexity of choices in access, intermediation, institutional roles, and data retention in CBDC design.” It cited the example of a digital wallet, which “can support both an account-balance view and a coin-specific view for the user regardless of how funds are stored in the database.” In a similar vein, a central bank can maintain a centralized ledger while delegating much of the system’s customer-facing work to private sector intermediaries, such as banks.

The Verdict

The world is going digital, there is no real doubt of that.  So, it would seem that we are left with a choice of involving the State or excluding the State.  I would suggest that the CBDC is a pretty good negotiation of this  question.  For years now, the question has been raised in many courts, “Is our cryptocurrency a security?  Unsurprisingly, there are experts lined up on each side, but one argument really was convincing to me.  In order to be a security, the investment must be a stable store of value.   The extreme volatility in pricing for cryptocurrencies suggests strongly that it fails the “store of value” part of the definition.   But, the CBDC would be issued by the government, and this would be a very stable form of currency (hopefully.)  I think that the CBDCs of several governments worldwide are inevitable, but perhaps the Treasury Department can study the success and challenges in other smaller countries before they get the holographic presses running.


What Is a Central Bank Digital Currency (CBDC)? (investopedia.com)

What are CBDCs? A beginner’s guide to central bank digital currencies (cointelegraph.com)

What If Central Banks Issued Digital Currency? (hbr.org)

Fed Eyes Central Bank Digital Currency | Richmond Fed

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

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