July 2, 2022
  • July 2, 2022

Rule # 1 for central bank digital currencies: do no harm

By on April 26, 2021 0

Central banks around the world have decided to compete with private cryptocurrencies and with each other in the race to issue central bank digital currencies. These efforts are important, but policymakers should pay the same attention to the financial stability risks that may be associated with CBDCs.

Digital currency has been used for some time in traditional payment systems under assumed names. In payment and monetary control systems, banks and the Fed constantly make digital transfers of value to clear and settle obligations between and among themselves. Direct payroll deposits as well as debit card payments, Zelle and Venmo all function as functional equivalents of digital dollars for consumers. But the deployment of an account-based digital token or dollar that directly connects retail users and the Fed creates a kaleidoscope of complex currency, policy and stability issues that require careful balancing of benefits, costs and associated risks.

CBDCs have become a sort of Rorschach financial test. Everyone sees something different when they look at them. They represent modernization, efficiency gains and cost savings for some, while others focus on the benefits – real or imagined – of real-time global payment transfers. It is hoped that it will better serve low-income, unbanked citizens. On the other hand, China sees it as a surefire way to monitor its own population and at the same time foil US dollar diplomacy and sanctions.

An April 7 Bank Policy Institute report written by President and CEO Greg Baer summarizes a number of important financial matters, noting that a CBDC could give the Fed an even more direct role in setting retail interest rates, transforming the flow of consumer funds that banks rely on to make consumer and business loans, and have an impact on the risk profile of US banks and therefore on the US economy. The report provides an excellent cost-benefit analysis of the many issues raised by CBDCs and deserves careful reading.

From the Fed is actively engaged in the feasibility study of a digital dollar, let’s focus on three critical questions that a CBDC would raise in the United States.

First, CBDCs will centralize and concentrate economic power in the hands of governments, which could allow them to monitor every financial transaction. This may be an incentive for China, which uses technology to monitor and control the behavior of its citizens. But the implications of these government-controlled databases are likely to spur repression in the United States.

Second, CBDCs will change current banking and payment models by eliminating some if not all of the financial intermediaries involved. Whether it’s checks, ATM transactions, automated clearing house transfers, or credit cards, most retail payment systems today use a processing model that includes validation and validation. transmission by the banks of the payer, the beneficiary and the system provider. All share the income stream. CBCDs will revamp these models and even CBDCs that rely on wallets issued by banks will fundamentally transform payments markets.

Third and most importantly, governments need to ensure that CBDCs do not increase the risk of a digital heist of the national currency? Before they get drunk on gleeful tech talk and deploy CBDCs, they need to consider their future vulnerability.

For example, today’s public-private key cryptography can be an insignificant challenge for the next generation of quantum computers, bringing us closer to the “quantum apocalypse” described by scientists. The National Security Agency intends to develop quantum-resistant algorithms by 2024, but the effectiveness of these is unknown.

A quantum computer with 4099 perfectly stable qubits could break RSA-2048 encryption in just 10 seconds instead of the 300 trillion years it takes today. Although such quantum computers do not yet exist, they are on my way. A future where malicious fanatics, terrorists and criminal cartels can get their hands on such powerful cyber attack technologies at relatively low cost must be avoided.

Every day we cede more of the country’s economic foundations to technology in the name of innovation and improving the quality of life. It is generally a positive thing. But to the extent that decision-makers become hypnotized by innovation and fail to fully appreciate the vulnerabilities that come with it, in the end, they will facilitate the dark side of technology.

Congress and the public must fully analyze the fundamental questions raised by a government-sponsored digital currency. The Fed is rightly taking a deliberate pace and envisioning a wide range of challenges for US monetary and fiscal policies, including those posed by replication, mayhem, hacking, theft and modification of CBDCs. But not all countries seem equally cautious or have the same thing to lose by wiring their central banks.

No CBDC should be launched just because it can be. We must first understand the answers to the difficult questions, because in many cases the answers can change the way we live. The geopolitical implications of CBDCs dramatically raise the stakes, making it perhaps one of the most significant existential challenges we can face.