CBDCs are not “digital currencies” as we know them to be…

Our financial system has an ethos. We tend to think of how we spend money as the core ethical issue and forget that the structure of our financial system itself expresses the values of those responsible for that system. Generally, we are habituated to our current environment and so we take for granted that things are ‘just the way they are’ and overlook the profound ethical issues at play. The rise of cryptocurrencies and the concomitant interest in Central Bank Digital Currencies (CBDCs) has suddenly brought to the fore a whole series of questions about our financial system that central bankers and other authorities would very much like not to address. Comparing the current values that underwrite our financial system to those of cryptocurrencies, it becomes adamantly clear why cryptocurrencies have become increasingly popular. Further, as central banks around the world and particularly the Federal Reserve of the United States look to adopt CBDCs the many ethical pitfalls of designing a CBDC become so apparent that it seems unlikely they will be adopted any time soon.

We are so used to our current system that we forget that it is manmade and therefore reflects the values of those who designed the system. For all the talk of cryptocurrencies and CBDCs, we already have an electronic payment system that accounts for nearly 70% of transactions in the United States. The values of our current system are clear and easy to articulate, if not necessarily those we would choose:

Centralized: The Federal Reserve puts money into circulation through reserve banks and has many levers for influencing the money supply.

Intermediated: Not only do reserve banks stand between the Federal Reserve and consumers, but also credit card transactions pass through numerous intermediaries to complete a simple transaction.

Tracked: Because of the web of intermediaries, a systematic electronic record of our financial transactions is created that banks, credit card companies, and others compile, store and sell.

Expensive: The fees associated with electronic transactions are significant. On most transactions, they are in excess of 1.5%, often as much as 3% or more, of the sales. Given the roughly $4 trillion in credit card transactions a year in the US this represents around $60-$100 billion in fees — equivalent to the total GDP of Ecuador.

Corporate: The intermediation in our current system is entirely in the control of a relatively small number of private companies and banks; hence the lack of privacy and high fees.

Nationalistic: There is significant expense and a great many barriers associated with transferring money outside of the US. The primary means used for large international money transfers, the SWIFT system, is, unsurprisingly, private and highly centralized.

While these values are implied by the US financial system, in most other countries we would find a similar set of implied values.

Therefore, while these may not express your personal values, they are, nonetheless, the ethos of the financial system in which most of us live. A core element of this is the amount of control that the Federal Reserve and other central banks are able to exert over both the money supply and the economy. Given the many financial crises that the world has experienced in the last century, it is unsurprising Central Banks want to continue to exert control.

Bitcoin and cryptocurrencies offer an alternative ethos within which money and finance can operate and that fundamentally challenges the supremacy of the central bank model. While there is a great variety of cryptocurrencies, in general they have been designed by people with a very different set of values, the three core differences that almost all coins share are:

Decentralized: There is no centralized issuing authority that controls the supply or distribution of the currency nor the operation of the network.

Public Ledger: The currency is secured through a public ledger that records transactions across decentralized computer networks.

Private: The use of private wallets and decentralized networks allows for unmediated, peer-to-peer transactions that are private. Further, these transactions can happen between two parties anywhere in the world.

These three simple principles create an alternative financial world that is very different from the legacy system with which we have grown up. As it turns out, it is also increasingly popular — the current market cap of crypto is nearly $2 trillion. It is the growing popularity of this alternative financial world that has led the central banks of the EU, the US and others to seriously explore the possibility of creating CBDCs that could be issued to compete with, and hopefully replace cryptocurrency. However, the ethos of cryptocurrencies is fundamentally opposed to that of a centralized, highly controlled monetary system. Again, they were specifically designed as an alternative to the existing system. A private, peer-to-peer network lets me send unmediated payments anywhere in the world. A lack of centralization means no one directly controls the money supply, and no one can disable access for a group of users. Private wallets largely obviate the need for intermediating banks that are controlled by central bank authorities. At every turn, the few, simple core ethics of cryptocurrencies undermines bedrock principles of our current system.

Just reading through the US Federal Reserve’s recent report on a possible CBDC makes the fundamental differences quite clear:

First, they assume any US CBDC will need to be intermediated. The Federal Reserve will not send money directly to citizens, but rather to accounts held at banks.

Second, private wallets will not be allowed. This means that all CBDC related transactions will be tracked by the Federal Reserve or other, perhaps even multiple, government agencies.

Third, cross-border payments would only be enabled within the context of a new international financial system. Functionally, this pushes the use of a CBDC for international payments out to some unknowable future and keeps the current system in place.

Fourth, to maintain control over the money supply, the Fed suggests limiting the total amount of the currency that any single person could hold as well the amount of currency that could be transferred at any given time.

In sum, the Fed values a centralized, intermediated, traceable national currency that works within the existing banking structure and offers little in the way of innovation while increasing direct government interference in private transactions. Suspecting that these values may not line up with those of the average citizen, the Fed has also suggested making some types of benefit payments exclusively through the digital currency and thus encouraging (forcing) adoption.

Of course, each of these design ethoses is fraught and subject to debate in both the EU and the US and therefore it seems unlikely we will see a fully functional CBDC from either in the near future. Indeed, given the Fed’s current thinking, any CBDC we did see would not really be a cryptocurrency at all but simply a more refined version of our current system. The difficulty for central banks is that issuing a CBDC that was more crypto-like would require them to relinquish a significant amount of power over the functioning of the monetary system and the economy in general. One can easily surmise how unlikely they are to do so. Functionally, it is impossible for the Federal Reserve or the European Central Bank to issue a CBDC that enables any of the core features of privacy, decentralization, or lack of mediation.

The creation of CBDCs raises a whole range of ethical questions. Given the complexity of both the ethical and technical issues, as well as the legislative and departmental in-fighting that will accompany the birth of a CBDC, it is easy to predict that it will be quite some time before any concrete proposals arrive. This will give time for cryptocurrencies to continue to evolve and gain wider adoption — making it even more difficult for a CBDC to be successful. While we wait to see what develops, we can reflect on our own values and how they could best be expressed in a digital currency. Then, we can better judge the merits of the design of any future CBDC.