The emergence of decentralized cryptocurrencies, like Bitcoin and Ethereum, replaced the basic control of money that governments traditionally enjoyed. However, CBDCs have come about as a direct response to this challenge. In an attempt to be one step ahead in a game they feel is strongly against them, many governments have gone on a spree to develop their digital currencies (CBDCs).
Most nations believe that adopting CBDCs is a key factor in restating monetary sovereignty in this modern era where cryptocurrencies and DeFi threaten traditional financial models. According to current data, however, only 3 countries have fully operational CBDCs. These countries include Jamaica, the Bahamas, and Nigeria. Additionally, over 44 other countries are running a pilot test on CBDCs, and 20 more are in development.
The momentum behind CBDCs reflects economic ambition, geopolitical strategy, and the desire for governments to harness digital innovation. But, there are concerns about the risks that these government-backed digital currencies could pose to privacy, financial freedom, and the broader economy.
Decentralized Cryptocurrencies on the Rise: A Challenge to Central Banks
The concept of Bitcoin, the first decentralized cryptocurrency, is in tune with decentralization and freedom from government control. Cryptocurrencies operate on peer-to-peer blockchain networks, enabling their users to have greater financial autonomy by removing the middlemen – banks.
Bitcoin’s success, the proliferation of altcoins, and the growth of DeFi have proved that monetary transactions can exist well outside the reach of government regulation. DeFi protocols, for instance, allow users to lend, borrow, and trade in digital assets without the interference of any central entity. This has created an ecosystem in which financial operations fall well beyond the reach of state control.
While every crypto enthusiast is celebrating this, the immense development of cryptocurrencies has sent alarm bells ringing among governments and central banks worldwide. While early cryptocurrency fans believed that Bitcoin would replace fiat money, the governments see things differently; crypto is hampering their monetary control. Instead of letting fiat currencies disappear, the real risk is an erosion of governments’ power to affect economic life.
Cryptocurrencies have also introduced risks to both capital controls and tax collection, making such activities much more difficult for states to oversee. In this setting, CBDCs have become a manner in which central banks can strike back.
What is So Attractive About CBDCs for Governments?
Central Bank Digital Currencies have been all the rage, but the government’s drive to enforce their use does stir some concerns. CBDCs boast of bringing forth financial inclusion, efficient payment systems, and other benefits. However, there is criticism that the motive for these digital currencies seems to relate more to a need to regain lost ground due to cryptocurrency developments.
But how do the governments intend to use the double-edged sword in the name of CBDC?
Monetary Sovereignty Control and Curbing the Threat of Crypto
The rise in decentralized cryptocurrencies like Bitcoin and Ethereum has challenged the supremacy of central systems. Cryptocurrencies do not depend on central authorities to oversee them, so governments cannot manage the money supply or enforce monetary policy.
In a 2021 Bloomberg Report, Juda Agung, Assistant Governor at the Central Bank of Indonesia expressed how Indonesia intended to use CBDC to fight crypto. Ayung stated, “a CBDC would be one of the tools to fight crypto.”
Such pronouncements certainly make clear that a CBDC is fundamentally ill-suited to serve the public’s needs for freedom and privacy. By issuing CBDCs, governments can reestablish their monetary sovereignty by ensuring they are providers of legal tender and that private cryptocurrencies will not take over core financial operations.
Tighter Control of Citizens’ Financial Behavior
Another negative aspect of CBDCs is that they may very well be used to curtail one’s freedom to spend money. This may include encoding cash for restricted use, for instance, on specific purchases or running expiry dates on cash to compel people to spend during slowing economies.
The level of governance over financial behavior never experienced has begged questions of freedom and individual financial self-determination. Unlike cash, which does not link the user to any action, place, or time, CBDCs would grant the government an unprecedented, real-time insight into how, when, and where monetary expenditure happened.
Based on remarks by Augustín Carstens, the BIS General Manager, “We don’t know who’s using a $100 bill today, and we don’t know who’s using a 1,000 peso bill today. The key difference with the CBDC is the central bank will have absolute control over the rules and regulations that will determine the use of that expression of central bank liability. Also, we will have the technology to enforce that.”
Surveillance and Erosion of Privacy
CBDCs will give governments a level of impossible surveillance in cash-based economies. Each transaction conducted using a CBDC would leave behind a digital footprint, possibly giving governments the ability to track and analyze spending habits. This could provide authoritarian control over the citizenry, which some critics have said might make a CBDC an implementable tool for political or economic coercion.
During the Cato Institute’s 40th annual monetary conference in 2022, Jerome Powell, the current chair of the U.S. Federal Reserve (the Fed), recognized the privacy risks that could be posed by CBDCs. Powell noted, “We would not want a world in which the government sees, in real-time, every money transfer that anyone makes with a CBDC.”
This technology can be massively exploited in countries with poor human rights records and equally bad privacy protections. CBDCs are under development because they promise governments much more control and power.
Weaponizing Monetary Policy
The great powers that a CBDC would grant to governments over money flows, in ways not possible under a fiat currency, are uncanny. The government can change interest rates, limit savings, or even apply taxes to any transaction in real time. Such a system may help policymakers in their fight against inflation, but it is fraught with risks.
By taking away the ability of citizens to opt out of financial systems as they may, for instance, with cash, CBDCs could take away healthy economic fluctuations. These include aspects such as personal saving patterns, thus harming individual financial health.
According to statements by Bo Li, the deputy managing director of the International Monetary Fund (IMF), “CBDCs will allow government agencies and private sector players to program…targeted policy functions”, such that “money can be precisely targeted for what people can own”.
The Dual Nature of CBDCs: Innovation or Control?
Critics say CBDCs, while promising efficiency, inclusivity, and controlled monetary policy, come with considerable risks. Many people fear that CBDCs could destroy financial privacy. Unlike anonymous cash transactions, CBDC transactions are traceable, which has evoked fears that governments will use CBDCs to monitor and control spending habits.
But programmability also opens a Pandora’s box of potential state control over personal finance. Governments can restrict how their citizens can spend their money, adding expiration dates to digital funds or spending thresholds. In the most extreme scenarios, CBDCs might become a coercive tool for governments to punish dissent or even manipulate behavior to achieve specific policy goals.
The Future of Money: CBDCs and DeFi
While governments continue to develop CBDCs, the fight for monetary sovereignty is nowhere near achieved. Decentralized cryptocurrencies have found their niche in the world’s financial ecosystem for those seeking financial freedom and supplementing traditional banking.
CBDCs allow governments to modernize their financial systems while retaining control. For central banks to succeed in this vision, they must achieve a delicate balance between allowing innovation and imposing control. Overly controlled policies on CBDCs could result in more citizens adopting cryptocurrencies and decentralized platforms for their financial needs, which could haunt governments forever!
