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Written by: Michael Costa | NextStep Portfolios LLC
Last year Federal Reserve Chair Jay Powell attended a panel discussion on digital currencies organized by the Bank of International Settlements and outlined what he thought a US CBDC, or “digital dollar” might look like. Since then, interest and experimentation with CBDCs has become widespread within and amongst central banks across the world. But just what is a CBDC, and do we need want one here in the US?
What is a CBDC?
Central Bank Digital Currencies are general purpose currency units equivalent to standard currency (like the physical US Dollar) which exist only in digital form. They differ from so-called reserves or settlement balances, which serve banks and wholesale funding markets because CBDCs are envisioned to be widely available and used by the general public. A CBDC already exists in China (the digital renmimbi) and many, other countries and currency zones are in some stage of CBDC development, including in the US, EU and UK.
CBDCs vs Crypto
CBDCs are entirely distinct from crypto in that they are issued and backed by governments (as opposed to anonymous people or grifting 20-somethings in hoodies). They also differ in that they may utilize centralized, rather than decentralized ledgers. Even where block-chains are used, control is likely to be held with the central bank, rather than distributed within a non-governmental network. While most crypto serves primarily as a speculative asset (at best), CBDCs are intended to function as currency and a store of value, in the traditional sense.
The Case for Retiring Physical Cash
There are many reasons to consider retiring physical cash or at least complimenting it with CBDCs:
- To begin with, cash is dirty. Dollar bills can carry as many as 3,000 physical organisms, including many linked to serious illness.[1] Something to ponder in a world where pandemics are an increasing concern and antibiotics are losing potency.
- Cash is expensive to produce and handle. The Department of the Treasury’s Bureau of Engraving and Printing had an operating budget of 1.1 billion dollars in 2022.[2] That’s roughly what it costs to produce and issue physical US currency in a single year. But that’s just a fraction of the broader costs associated with cash. Some estimates put the cost of handling cash transactions at between 4-15% of sales volume for retailers.
- Most of all, physical cash is inconvenient and unsecure. To state the obvious, physical cash can be (and often is) stolen. It facilitates illegal activity just as well as all other legal activity. And it’s just a pain to run to the ATM or bank.
CBDCs to the Rescue?
Theoretically, CBDCs solve many of the problems of physical cash. They could be relatively frictionless and low cost to use. That alone would generate major efficiency gains for the economy, which would be widely shared. They may also be more secure, at least insofar as they’re invulnerable to petty theft, robbery and the like. They might even help combat organized crime. Lastly, they could give policymakers something closer to a real-time picture of the workings of the economy, allowing for better, more finely tuned fiscal and monetary policy. A CBDC in the US might even be required in the long run for the US Dollar to retain its coveted status as the global reserve currency.
But the likely pitfalls of CBDCs are eyebrow raising:
- Where cash is inclusive and intuitive, CBDCs are less so. You don’t need to be technically literate or have a device to use cash. Will older people, or people with an aversion to having their economic activity being monitored be able or willing to use CBDCs?
- Cash is a resilient ‘technology’ in that it’s invulnerable to network failures, hacking or other system-wide failures. CBDCs (like other digital assets) simply aren’t. It’s also unclear how well CBDCs can defend against counterfeiting.
- CBDCs create potential for a major expansion of government power and capability, that rightly gives any liberty-minded citizen pause.
- Depending on exactly how a CBDC operates and is rolled out, there may be some risk of disintermediation of banks, which could destabilize existing financial systems.
CBDC as a threat to liberty
Most conversation around CBDCs in the mainstream press and the blogosphere focus on the potential for CBDCs to erode privacy and cede excessive power to government. No wonder, it’s provocative stuff. At the root of most of these concerns is a simple observation: to the extent that CBDCs replace physical currency, all transactions would become traceable. Whomever accesses that data will have an extremely detailed picture of the economy as a whole, but also the millions of individuals that make it up. Information is power and there is potential for extensive abuse.
There are also concerns about the possibility of so-called programmable money, wherein different types of CBDCs could be created, with limited (government approved) uses or expiration dates, to incentivize specific behaviors by the holders of the currency. For better or worse, all of these possibilities represent more direct interference by government (or at least the central bank) in the decisions of citizens and companies.
In countries that already operate as authoritarian states, these possibilities could ease the transition into something darker and more totalitarian. Unfortunately, China could be the canary in the coal mine here. However, in countries where governments are accountable to the public, it should be possible to mitigate and preclude the more dystopian outcomes posed by CBDCs, through careful design and legislative safeguards.
Conclusions
We’re rapidly moving towards a near cashless society already, without any government intervention. CBDCs are a natural, though not inevitable next step, and governments everywhere are beginning to discuss and experiment. The potential benefits are large, as are the risks. Power is often abused, and as the last few decades have shown, privacy isn’t something we can take for granted. In the US, discussions around a digital dollar have been slow, and that’s a good thing. A US issued CBDC could be a fantastic innovation, but only if it’s done carefully and thoughtfully with strong safeguards in mind.
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