Around the world, central banks are flirting with digital currency. With plans for central bank digital currencies (CBDCs) underway in 46 countries including Sweden, France, Turkey, Uruguay, and China, the idea of “digital fiat currency” has rapidly escalated from a research project into something with very tangible implications.
CBDC is going to be a trending topic for years to come, and understanding what it is, how it compares with cryptocurrencies, how Covid-19 accelerated the debate, and what threats and opportunities it presents for Bitcoin is crucial for anyone in crypto to understand. In this post, we set the stage for this developing story and explore some of the key concepts and questions forming around this narrative.
What are central bank digital currencies?
Put simply, a central bank digital currency is fiat money — or money issued and controlled by a government through its central bank — in digital form. While no nation has formally launched a CBDC to date, a number of global jurisdictions are actively building and rolling out pilot projects.
In April, China’s central bank issued a notice stating they will “undoubtedly further research and development of the national digital currency with enhanced top-down design,” a strong signal of their commitment to creating a digital version of the yuan. China is already piloting a digital currency system in four large cities to replace some of its cash supply. Separately, central banks in Sweden, Switzerland, Japan, the U.K., the European Central Bank, and the Bank of International Settlements have joined forces this year to share knowledge and research on the potential adoption of CBDCs.
In theory, each CBDC unit will act like a secure digital equivalent of a paper bill, and can be used for payments, as a store of value and a unit of account. Much like a traditional currency bill that carries a unique serial number, each CBDC unit will be distinguishable to prevent imitation. As a part of the money supply controlled by the central bank, it will work alongside other forms of regulated money, like coins, bills, and bonds.
On opposite end of the spectrum
CBDCs might look and smell like crypto (both leverage a digital ledger that allows transactions to be recorded and viewed in real time by multiple parties), but they will be the furthest thing from decentralized currencies. Central banks will have fully transparent access to the ledger and will not be capping the supply of digital currency. The advantages and disadvantages are clear:
On one hand, CBDCs could help spread digital cash to the unbanked and help make traditional payment systems more efficient by reducing transfer and settlement time. In cases like China, a digital payment system coupled with identity tracking would also help in implementing monetary and fiscal policies more effectively.
On the flipside, CBDCs are highly centralized for maximum control by design and are in complete contrast to the permissionless and decentralized nature of cryptocurrencies like Bitcoin, thus raising privacy and surveillance concerns for its users. This invited significant criticism from organizations like the Human Rights Foundation, that see CBDC’s as potential economic tools for political oppression and social engineering.
How Covid-19 accelerated the debate
The CBDC discussion took center stage across the world this year as a potentially more effective way to deliver direct stimulus funds to people as a result of the coronavirus pandemic. Proponents believe that digital currency would solve the logistical question of how to quickly disperse large sums of money to many individuals and businesses with varying access to banking services.
In the US, millions of Americans are still waiting for the promised stimulus checks to arrive as either direct deposits or physical checks from the U.S. Treasury Department. The proposals made before Congress this March would have charged the Fed with issuing both digital currency and digital wallets to give Americans direct access to funds. While these proposals did not quite make it to the final stimulus act, the conversation has indeed been started.
Are CBDCs good for Bitcoin?
While the jury is still out on this one, a case could be made that CBDCs may pave the way for continued retail and institutional interest in Bitcoin and other cryptocurrencies. If billions of people will have digital wallets and possess a new understanding and familiarity with digital money, the onramp from there to a non-sovereign, global currency like Bitcoin becomes much shorter and faster. If every financial institution has to build out the tools and infrastructure to safely store and transact CBDC, that same infrastructure could potentially be used for Bitcoin.
More importantly, however, is the fact that CBDC is still government-controlled fiat currency and fundamentally similar to the fiat currency we have today. As such, it is still prone to selective money printing and inflation. To hedge against monetary inflation and the decreasing purchasing power of fiat, you may consider doing what Paul Tudor Jones and David Swensen did: buy BTC.
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