July 6, 2022
  • July 6, 2022

Rise Fall Central Bank Digital Currency

By on July 16, 2021 0

Bitcoin’s popularity has sparked a race for digital currency dominance, which is expected to intensify with the emergence of central bank digital currencies (CBDCs). In a survey carried out in 2021 among central banks, 86% of respondents indicated that they are actively seeking the potential of CBDCs. The question is, how will CBDCs live alongside borderless cryptocurrencies like bitcoin?

This article is a three-part study of CBDCs in the context of currency evolution. Readers will find that CBDCs will play an important role in standardizing currency as a digital concept. The paper describes several factors that will contribute to the rise of CBDCs in the years to come, as well as the design limitations of CBDCs that will reduce demand for bitcoin.

  • Part 1: Humans and Change – We recreate old things before reinventing new things.
  • Part 2: How CBDCs fit into the evolution of different types of currency – How CBDCs compare to bitcoin, in the context of fiat money, representative money and commodity money.
  • Part 3: The challenges of CBDCs: digitization rather than innovation – How CBDCs are likely to be deployed and the four design limitations that will drive demand back to bitcoin.

Part 1: Humans and Change

History shows that humans rarely make the direct leap to revolutionary new technologies.

The cycle of human change often begins with adopting a semi-improved version of the old before reinventing a new frontier. The pattern of the old new of the obvious semi-new of the new is evident in many industries:

  • Transport: Horses ⇒ Horses on wheels ⇒ Automobiles
  • Visual images: Photos ⇒ Animated images ⇒ Videography
  • Money: fiat currency ⇒ Digital fiat currency ⇒ Bitcoin and crypto-currencies

Fiat money under any other name is still fiat money, dictated by land borders. Digital currency, on the other hand, is transnational in nature. CBDCs and stablecoins operate in a hybrid state, where they are an online version of offline currencies.

Switching from physical money to CBDCs and stablecoins is like switching from photographs to moving images – a new innovation but a semi-improved version of the old product. History shows us that semi-upgrades are usually a passing innovation. Typically, these versions are replaced by innovations that can reimagine the future rather than recreate the past.

Part 2: How CBDCs fit into the evolution of different types of currency

To better understand the evolution of money, it is important to understand the three different types of money: commodity money, representative money and fiat money.

  • Goods money: An asset that has intrinsic value based on market demand (eg gold and silver).
  • Representative silver: An asset that has no intrinsic value but offers a right to another asset (for example, checks and gold certificates).
  • Fiat money: A currency that has intrinsic value because the government says so (for example, today, national currencies are examples of fiat money).
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The two main types of money are commodity money and fiat money, while representative money is more of a hybrid state. Before the 20th century, gold and silver were the dominant forms of world money: it was the era of commodity money. At the beginning of the 20th century (gold standard), banknotes became popular, although they were still pegged to gold. Since 1971, our banknotes no longer need to be attached to anything else. This completed an evolution from commodity money to representative money to fiat money.

We are currently experiencing a trend in the opposite direction, moving from fiat money to digital representative money. Representative currency of the 20th century consisted of banknotes indexed to gold, and representative currency of the 21st century consisted of digital currencies indexed to fiat money. A century ago, banknotes solved a problem of divisibility and portability of gold. Today, digital fiat currency similarly solves a problem of divisibility and portability of banknotes. The next step in this cycle is digital currency with intrinsic value in itself – commodity money.

CBDCs are likely to be designed with features that digitize the existing monetary architecture with central banks at the center. On the other hand, a digital currency like bitcoin offers an entirely different concept of money, which completely forgoes middlemen.

Part 3: The challenges of CBDCs – Digitization rather than innovation

The first challenge with CBDCs is to explain why we need a central bank digital currency in the first place. Why digitize to a newer system that keeps all the old middlemen in place? There are short-term reasons, such as efficient payments and settlements, however, innovations in the private sector (like the Lightning Network) have already made it easier to transfer money – without the need for CBDC.

As a digital representation of a landlocked currency, CBDCs will always be subject to offline nation-state governance. While CBDCs will offer greater divisibility and programmability than paper money, their economic and social conceptions are likely to be contrasted by the elephant in the coin: how do they compare to bitcoin?

Four key themes are likely to emerge as limitations of CBDCs in the coming years:

  1. The store of value concerns: Fiat under another name is still fiat. When the central banks of countries like Argentina roll out a digital peso, it will still be prone to inflation and downgrade. CBDCs will standardize the concept of a digital medium of exchange, but the uncertainty of central bank monetary policies will give way to a digital store of value with great certainty. Whenever a CBDC engages in a major monetary policy debate, it is likely to become a stark contrast to predetermined monetary policy and the scarcity of bitcoin supply.
  2. Privacy and surveillance issues: Although cash has no memory, CBDC transactions will invariably leave a financial footprint that can be tracked by state governments. The need for privacy-preserving digital money will grow in popularity, especially in countries where minorities can be punished for their ideological beliefs or sexual preferences. We will likely see a black market in cash, as well as a demand for digital currencies like Monero and Decred that can guarantee privacy without central party oversight.
  3. Sanctions and censorship: When authoritarian regimes can monitor dissident individuals, they will also be able to censor their financial activity. CBDCs will strengthen the sanctioning powers of individuals, which in turn will create demand for an uncensored financial network. Just as SWIFT operates as a messaging network today, the demand for a neutral and tamper-proof financial network will draw people to resist censorship from the Bitcoin settlement network.
  4. No change fees for currencies: In a physical monetary world, countries are able to enforce their borders for currencies. But once all the money is digitized, the costs of changing currencies are likely to be eroded. Businesses will no longer have to worry about carrying the day’s money to their local bank, and merchants will be free to accept the best form of e-money, not just local currency. Money Online will not mind offline borders, freeing consumers to choose the best forms of money, which will go beyond their local currencies.

Once most governments deploy digital currencies, currency competition is likely to become fierce. Some nation states may try to ban the use of bitcoin and alternative currencies, while others will tie their national currencies to patriotic appeals.

The patriotic slogan of the day: “Buy local”.

The patriotic slogan of tomorrow: “Buy with local currency.

CBDCs will almost certainly be promoted through “helicopter moneyWhere governments can dump social assistance exclusively in local currencies. Legal tender laws will apply CBDCs as a medium of exchange, although people may choose to keep their savings in a higher store of value.

The lasting impact of CBDCs will be to standardize the concept of money as a digital native product, and their design limitations will create demand for an unauthorized, inflation-proof digital store of value. The main competitor to meet this demand is bitcoin.

This is a guest article by Ammar Naseer. The opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.