In our second instalment of CBDC series, Barry Topf, Chief Economist at Saga Monetary Technologies, discusses the potential CBDCs hold but also the great hidden risks, especially in terms of privacy
Central Bank plans to issue digital currencies (CBDCs) have generated considerable buzz recently. But while they could be a significant development, they do not necessarily herald a revolution – and certainly not as they are currently envisioned. That public institutions are looking into digital currency issuance may be reassuring to some – but, while I agree that Central Banks lend a degree of legitimacy to any digital currency solution they may offer, and could give rise to integration with faster, more agile payments systems than ever before – I am not wholly convinced that CBDCs are a true solution for the future of currency.
As currently envisioned, CBDCs are simply a digital version of a traditional fiat currency. This is another step in the evolution of the forms of money: from coins to paper money, and then to electronic payments. Some CBDCs might be ‘wholesale’, only available to financial institutions, or ‘retail’, offered to the general public. In either case, they have the same characteristics as the non-digital version of fiat currencies. And though they carry with them some possible advantages, they have drawbacks as well. Indeed, they aren’t much more than ‘digital banknotes’.
So, why the surge of interest in CBDCs? The Coronavirus pandemic has caused an enormous uptick in consumer usage of digital services and products, rooted in lockdown measures and fear of contagion. Digital currencies eliminate many of the costs and risks involved in handling cash, including printing and distribution, security, (assuming they are hacker-proof) and counterfeiting. Their monetary implications and impact on financial stability remain unclear for now. They could facilitate the use of negative interest rates – but could also promote disintermediation of financial institutions. For many, CBDC projects could be a simple case of experimentation – for innovation’s sake, or for fear of being left behind by those already developing it.
CBDCs are poised to facilitate the development of faster, more efficient, and safer payment systems, and conceivably on an international scale. At present, private cryptocurrencies rely primarily on Distributed Ledger Technology (DLTs such as the Blockchain), which are slow and inefficient compared to centralised networks. CBDCs will rely on centralised platforms, which could enable faster, more secure, and less costly payments, while promoting integration and financial inclusion.
But some central banks may have their sights set higher. A digital version of a national currency could expand its role on the global stage – which could be more than enough motivation for some countries. Gaining the upper hand in terms of currency clout is not the only potential benefit for a country whose CBDC is widely used; a CBDC would be a quantum leap forward in the amount of data its issuer could obtain. Every financial transaction – including what one buys, where and when, would build a full picture of consumer preferences and savings behaviour – which could be recorded and used. Access to that information, with the ability to analyse it, would give an enormous advantage to the data’s owner.
This concern breathes life into one of CBDC’s major concerns: the loss of personal privacy. CBDC transactions will be pseudonymous, not anonymous. If the central bank wants to see where and how much an individual is spending, it can. Anonymity disappears when cash does. While that will make life difficult for money launderers and terrorists, it could also become a tool to punish political activism. Widespread usage of a CBDC could equate to huge numbers of people unknowingly granting unlimited and unrestricted access to data on their economic lives to a central authority. And there may not be a choice of opting out or being forgotten. There is no way of telling – or monitoring, much less limiting – how this information could then be used or manipulated. CBDCs could be easily used to limit human rights and political freedom. There has thus far been little clarity on how user privacy will be treated by the central authorities issuing CBDCs – and this is a sizable ask of blind trust from the many potential users. Nor will all central banks want to ensure privacy – their goals might be exactly the opposite. The risks are great, and so far, safeguards are not in place, nor will some CBDCs provide them.
Digital currencies hold enormous potential – but with these great opportunities, there could come great hidden risks. But the same technology which generates these risks can also be used to mitigate them. Broad and democratic governance of digital money – written into the technology which underpins it – can ensure that abuses are prevented, and that money is governed in the interests of its holders. This is what we set out to do when developing Saga (SGA), a stabilised non-private non-sovereign digital currency. And it’s precisely what we did.