Everything You Need to Know About Central Bank Digital Currencies (CBDCs)

We touched briefly on central bank digital currencies (CBDCs) when we broke down the cryptocurrency Executive Order, but if you’re anything like us, that probably left you with even more questions about CBDCs.

What is a CBDC?

A Central Bank Digital Currency is a digital form of a country’s fiat currency (i.e., a government-issued currency not backed by a commodity). Instead of printing money, as the Federal Reserve System has done since 1913, the central bank issues electronic coins or accounts meant to essentially function as a proxy for paper money — with enhanced security that standard banking methods cannot offer.

CBDCs are digital currencies, but it is important to note that they are not cryptocurrencies. Cryptocurrencies run on decentralized ledger technology, meaning that instead of one central hub verifying the transaction, there are multiple hubs worldwide involved in that real-time fund verification. However, if the Central Bank is issuing a digital currency, it will more than likely be centralized to one hub (the central bank).

The First CBDC (DCash)

On March 12, 2019, the Eastern Caribbean Central Bank launched its CBDC, DCash. DCash provides a platform to safely send digital currencies between friends, family members, businesses, and consumers. The standout feature of this CBDC — there is no minimum account balance requirement, no minimum transaction limit, and no bank account required, making it a genuinely accessible and easy-to-use CBDC.

Despite its ease of use, DCash crashed in January 2022 and is still inoperable at the time of publication. There was no concrete reason given for the crash beyond technical issues, but one can assume that the haste with which DCash was produced and piloted plays a role in these unforeseen issues.

eNaira

Nigeria was the next country to launch a CBDC, called eNaira, and is widely considered the first successful CBDC — i.e., it is still up and running with no problems, unlike its Caribbean predecessor. The driving force behind governments launching a CBDC is to simplify and improve that country’s economy for consumers and businesses alike. eNaira took the existing bank structure in Nigeria and turned it cashless and digital, providing enhanced security and faster payments.

eNaira began its consultations, presentations, and discussions in August 2017 and officially launched in October 2021.

The CBDC Race

Something of a space race for the digital age, the United States is competing against 70 other countries to be the next to launch a CBDC. Keep in mind how quickly DCash was launched and, in turn, how quickly it crashed. Add in the four-year timeframe for eNaira, which is continually growing and improving. How quickly could the United States launch a successful CBDC?

For our hypothesis, let’s assume the United States began working on its CBDC the very day the Executive Order on Digital Assets was signed. Let’s give them one year for research and development, another year for piloting and testing, and some wiggle room for problems and crashes. We could say that the soonest we can conceivably expect a successful United States CBDC launch would be in the Fall of 2025 — a little over three years.

Forty countries, including the United States, are in the “research” phase, while 16 are in the “development” phase and 15 are already in the “pilot” phase. As a result, the U.S. CBDC team will have to put in some serious crunch time if we want to come out ahead of Russia and China, both of whom are already in the “pilot” phase of their respective CBDCs.

Questions, Comments, and Concerns

Would a U.S. CBDC centralize finance?

Short answer: most likely yes, but it doesn’t have to be that way.

This article from CoinDesk posits that CBDCs will fail if they do not take advantage of decentralization, and we’re inclined to agree. Firstly, why would those already working and playing in the world of decentralized finance want to use a centralized digital currency controlled by the United States Central Bank? Similarly, if this will be someone’s first foray into digital currencies, they may be more likely to trust a decentralized digital currency, such as Bitcoin.

It is possible for the United States CBDC to be decentralized, however. This would involve the Federal Reserve System relinquishing some control over the transaction chain, i.e., sharing the governance with local and foreign entities — possible, but extremely unlikely. Still, a decentrally governed CBDC would allow easier and cheaper cross-border transactions, helping secure the United States’ place in the global digital economy.

What kind of fees might be associated with a U.S. CBDC?

If you’re reading this, you probably have a bank account and have fees you have to pay. Both eNaira and DCash, the forerunners in CBDCs, started fee-less but eventually introduced fees. Considering the history (and reality) of banking fees, it’s hard to confidently say that the U.S. CBDC will not have fees. The good news, though, is that CBDCs boast the ease of production and lower transaction costs. We can reasonably hope for fees lower than those traditionally associated with centralized banks.

Could a U.S. CBDC be beneficial to the national debt?

CBDCs are much more cost-efficient than physical cash because they have lower transaction costs and take a fraction of the time to produce than paper currencies. Seemingly, a digital avenue for currency in the United States would help offset, or at least slow down, the rate at which the U.S. incurs debt. The inclusive nature of CBDCs also could play a key role in mitigating our national debt — the more active participants in the economy, the more revenue flowing in for government municipalities.

What are the potential problems of a U.S. CBDC?

Most crucial are privacy concerns and cybersecurity risks. Regulatory processes are not currently equipped to handle new forms of money and need to be updated before implementing a CBDC. Basically, if it’s not running on decentralized blockchain technology, the potential cybersecurity risks are abhorrent.

Secondly is the potential backlash due to centralization, which we discussed earlier. There is also the potential for an ideological struggle: those who believe the government should be in charge of currency versus those who think we are all better off if the government doesn’t meddle with our money.

Last but certainly not least is the risk of destabilization. The existence of a CBDC itself can destabilize the United States’ two-tiered banking system by disrupting the processes in place meant to protect both consumers and the central bank. An unstable market also could trigger a “flight to quality,” where investors shift out of risky assets en masse.

Will a U.S. CBDC slide seamlessly into the digital economy we’re already creating, or will it rock the boat?

Unfortunately, there are bound to be some waves no matter what, especially if steps are not taken to decentralize the U.S. CBDC. The government centralizing a system meant to be private and decentralized? Backlash is practically a given. However, if done well, with diligence and care — and with a decentralized ledger in place — a United States CBDC could fit right into our digital economy with minimal fuss, becoming another thread in the rich tapestry of digital assets.