There’s a recent upswing in interest in central bank digital currencies, with China piloting DCEP (its version of a digital yuan) aggressively and several of the most prominent central banks in the world (including the Federal Reserve and the European Central Bank) commenting on their implementation of a CBDC — indicating that central banks around the world are looking at the positives and negatives of offering a general-purpose central bank digital currency.
About 80% of central banks in a recent survey were looking at implementing CBDCs, and more than half have already started running experimental pilots.
It comes at a critical moment, with cryptocurrencies such as ethereum and bitcoin having weathered the storm of market-based economics — serving in both retail use cases and as an institutional hedge, as well as a new philosophical approach to computational resources. The economy is being reshaped in fundamental ways during COVID-19, and digital retail currency backed by central banks might be next.
With the rise of cryptocurrencies, the natural comparison for any new central bank digital currency is to their standards. Yet, in many important ways, many of the proposed implementations of central bank digital currencies run completely counter to cryptocurrency principles. In fact, a primal argument for the adoption of cryptocurrencies has always been that they would serve as a hedge for people who wouldn’t want to be forced into digital alternatives to cash propped up by central banks.
The first and most important difference is that cryptocurrencies are propped up by network incentives by a node of internationally distributed participants while a central bank has one central objective: public policy for one country or perhaps a bloc of countries at best. This makes for a critical difference.
Any one of these central banks are prone to focusing on employment while observed shifts in wage inflation are seen as less of a priority. This has largely been the case during COVID-19, with both the ECB and the Federal Reserve racing to loosen restrictions on inflation while aiming for “full employment” for their domestic countries.
Secondly, the idea of privacy and self-custody is not going to be inherently respected with CBDCs as it is with cryptocurrencies. Central banks are adjacent to the tax authorities that work hardest to enforce anti-money laundering provisions — their relationship is akin to the relationship between police officers and prosecutors, or between different departments in a university. The key policy question facing CBDCs that are being built in accordance with the regulations of their adjacent agencies is who should have access to the data — not whether the data should exist at all.
It wouldn’t be hard to see forced metadata attached to every transaction with a CBDC selectively disclosed to certain agencies. In practice, only cryptocurrencies would allow you to transact between borders without forcing yourself into the regulatory regime of one country or another, allowing you to express how much data you want to share about yourself.
The default assumption that people using privacy-preserving technologies as being presumptive of criminal activity (something the Department of Justice in the United States recently opined) and the recent push by many of the same countries advocating for limits on end-to-end encryption while pushing forward on digital central bank currencies should give people pause as to how faithful governments will be towards privacy and the ability for people to conduct financial transactions in the manner they choose.
Lastly, one other point of emphasis is that cryptocurrencies are relatively battle-tested. There are many reasons to attack the underlying system across a variety of attack surfaces: vulnerabilities in the exchanges that many people use to transact, issues with self-custody and identification of wallet addresses after reuse, the possibility of a chain-wide attack (such as the 51% attack) and more.
The fact that these systems have reached the scale where they are now is all the more impressive because cryptocurrencies don’t have armies behind them or a monopoly on the use of force. Central bank digital currencies present an even larger attack surface with the imprimatur of the state — protections for paper currency have iterated over centuries, while attacks that are cybersecurity-focused will come hard and heavy from rival states, and financially motived hackers.
Instead of a game-theoric evolution of incentives, states will face a barrage of attacks nearly all at once while lending legitimacy and trust to a digital currency might not deserve it yet. After all, as large-scale hacks have shown, states struggle with protecting critical information about internal employees and critical services such as election servers or politically sensitive email inboxes — adding money and financial flows to the mix expands the possibilities of state negligence.
It can be tempting, with the rise of cryptocurrencies and central bank digital currencies, to correlate the two. But there are important, essential differences between the two that are necessary to enumerate. The creation of new central bank digital currencies can be seen by some as a correlate to the success of cryptocurrencies, but in truth, they are more competitive than collaborative offerings. The inevitable creation and distribution of central bank digital currencies is a key reason for why cryptocurrencies exist — not only as a financial hedge, but a technical one as well.
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