As citizens around the world are confronted with the severe curtailment of political, economic and cultural freedoms associated with COVID-19 risk mitigation strategies (e.g., lockdowns, mandatory vaccinations and/or vaccine passports), new risks to economic freedom and prosperity are quickly emerging which citizens must be aware of and remain vigilant about.
One of these risks which is developing with rapid pace are Central Bank Digital Currencies (CBDCs). According to a Bank of International Settlements (BIS) 2021 survey:
86% of central banks are actively researching the potential for CBDCs;
60% were experimenting with CBDC associated technology; and
14% were deploying CBDC pilot projects.
The development of CBDCs potentially represents one of the largest changes to modern banking and finance (as well as the global financial system) in decades, even though, as noted by the BIS, the concept was proposed by American economist, James Tobin, in 1987.
CBDCs have been the subject of much speculation of late regarding their intent and implications within economic and financial circles (both mainstream as well as alternative circles). However, to date, they have generated little debate or scrutiny by the public-at-large.
This latter fact is rather astonishing given the potential scale of change to economic life that may result from the introduction of CBDCs.
Current Structure of Currency
As noted by the International Monetary Fund in 2021, economies around the world currently operate under a “dual monetary system” comprising of:
Publicly-issued currency by central banks in the form of physical cash (coins or banknotes) and central bank reserves which constitute legal tender (i.e., form of currency or money which are legally recognised as a means of payment to settle financial obligations such as debts, taxes, contracts, legal fines or damages); and
Privately-issued currency by private commercial banks, telecom companies and specialised private payment providers – that is, digital forms of legal tender that are issued and held by non-government financial institutions (e.g., bank deposits or balances held in payment systems such as Paypal or Alipay).
This dual system is able to co-exist and facilitate commerce and economic activity given that privately-issued currency can be redeemed at a fixed face value of legal tender currency issued by central banks.
Within this context legal tender currency is of a ‘fiat’ nature meaning that its nominal value is set by government decree and does not possess any underlying intrinsic value, such as forms of money backed by a physical commodity such as physical gold or silver bullion.
An important distinction of this dual system is that physical cash and central bank reserves are the liabilities of central banks, whereas privately-issued currency is the liabilities of private sector payment providers.
Historically, a commercial bank would become insolvent when they couldn’t meet their liability obligations, whether this resulted from a bank run, fraud or experiencing technical outages.
Under this dual system, commercial banks and other private sector payment systems play an important financial intermediation role, including:
managing customer facing activities – i.e., providing retail banking services such as payment accounts, authorisation, clearing, settlement and dispute resolution;
developing and releasing innovative payment products which more efficiently facilitate commerce both domestically and internationally; and
ensuring compliance with anti-money laundering (AML) and know-your-customer (KYC) obligations.
Thus, it is argued that central banks play an essential role in the monetary and payment system by providing stability and efficiency, whereas the private sector promotes innovation, diversity and competition.
Definition of CBDCs
Given the above explanation of the current structure of the modern fiat currency system, it is important to define what CBDCs are and what role they may play within this structure.
CBDCs are digital or virtual forms of physical cash represented through an electronic record or digital token that is issued and regulated by a country’s central monetary authority (i.e., its central bank) via a centralised ledger.
CBDCs are centralised, which stand in stark contrast to privately-issued cryptocurrencies (such as Bitcoin) which are decentralised and unregulated.
CBDCs are not uniform and central banks have an immense range of legal, technical, operational and administrative design options to achieve their stated public policy objectives. Importantly, the policy intent of CBDCs will be neither uniform across jurisdictions nor static in time. Instead, they will tend to be a function of a country’s economic, political and social context.
As discussed in greater detail below, CBDCs can both co-exist and operate in parallel with both physical cash and privately-issued currency.
Thus, in assessing whether a proposed CBDC will, in net terms, improve or impair the function of a monetary system and broader economy, each CBDC will require individualised scrutiny and assessment.
CBDC Public Policy Rationale
Advocates of CBDCs suggest that they are necessary, certainly useful, in addressing multiple issues emerging across the global financial system of late. These issues include:
Faster private sector payment systems – payment system providers such as Alipay are able to process 120,000 transactions per second, which is almost double the processing speed of credit card companies (such as Visa) and are much faster than traditional processing times of commercial banks.
Moreover, the emergence of stable coins – i.e., private cryptocurrencies that are backed by a reserve asset (e.g., this can include a basket comprising of fiat currencies (one or more), fiat currency equivalents, or short-term government securities) - means that private cryptocurrencies and their associated digital infrastructure can directly compete with the existing dual-currency central bank-commercial bank system (as described above).
Thus, private sector innovation in payment systems and private cryptocurrencies mean that the existing global financial system with its traditional forms of currency and bank payment systems are too slow and thus are at risk of becoming obsolete legacy systems.
Retaining sovereign control – the emergence of private sector payment systems means that central banks contain less control of the money supply thus rendering monetary policy less effective as an economic policy tool.
Financial stability – the potential failure of a private issuer of digital currency could disrupt the payment system and destabilise either the financial system of a nation (and even the global economy, if significant enough).
Financial inclusion – the rise of narrow and private money networks could exclude segments of an economy’s population from enjoying digital financial services or being able to consume particular goods and services (sometimes referred to as ‘unbanked’ customers).
Zero-lower bound interest rates (i.e., negative interest rates) – the existence of physical cash results in the severe curtailment of the ability of central banks to lower official interest rates below the zero bound (i.e., implement negative nominal interest rates) given the risk that citizens are likely to withdraw from the financial system by hoarding physical cash if negative nominal interest rates are implemented.
Enhancing the effectiveness of fiscal policy – the existing dual-currency system makes the deployment of fiscal stimulus payments (whether one-off payments or continual payments such as Universal Basic Income or UBI) highly cumbersome and inefficient for governments who deal directly with citizens or who issue payments through financial intermediaries.
Declining use of physical cash – the declining use of physical cash in particular economies coupled with the widespread use of alternative digital currencies by the private sector could undermine market competition – for example, where a company uses their dominant position in one industry/sector to control payments and competition in other entities (or sectors).
Cyber risk – with “Big-Tech” providing payment options through cloud-based technology, such technology presents risks to wholesale and retail market participants which may undermine confidence in digital finance as a means of facilitating transactions and storing value.
Thus, given the issues raised above, advocates for CBDCs argue that CBDCs are able to resolve these issues by:
settling wholesale and retail level transactions at processing speeds on par with private payments systems offered by “Big-Tech” firms (such as Facebook or Paypal) but at a much lower per-transaction cost, thus arguably generating a rise in productivity;
providing a resilient and universally-accepted form of digital payment;
preventing the leakage of the money supply away from central banks towards private payment systems, thus ensuring central bank relevance in the monetary system and that monetary policy retains its policy effectiveness;
allowing central banks to intervene and stabilise the payments system and by extension the financial system in the instance where private sector failures were to occur;
providing ‘unbanked’ citizens with the opportunity to participate in the digital economy;
providing central banks with greater policy flexibility to implement negative nominal interest rates (i.e., official interest rates below the zero bound) without the risk of cash hoarding; and
making fiscal policy transfer payments (including stimulus payments) more efficient by allowing governments to send central bank issued digital currency directly to the retail accounts held at central banks in the instance where a retail CBDC exists.
CBDC Operating Model and Design Features
Importantly, CBDCs are not a uniform technological innovation and, given the significant diversity in their possible design features, CBDCs can be developed to address different public policy and operational requirements. Access, the degree of anonymity and operational availability are just some of the core characteristics that central bank policy makers need to consider when designing their CBDCs.
Given this, CBDCs cannot and should not be uniformly praised or condemned. Instead, they need to be assessed at an individual nation-state level (i.e., on a case-by-case basis) given its design characteristics and operational effectiveness.
CBDC Operating Model
At its core foundations, each CBDC will have four components which will formulate its operating model. These four components are illustrated in Diagram 1 and include:
the issuance of CBDC (including what will be issued, how and in what quantity);
how the CBDC is then distributed through an economy;
what payment system will facilitate the widespread adoption of the CBDC; and
how the CBDC will/can be accessed by users (i.e., the user device).
Diagram 1: CBDC Operating Model
Across this operating model, central banks have a range of design options including critically which elements of the operating model will they define and be operationally involved in and which elements will they purposely vacate and allow the private sector to develop and implement.
CBDC Design Features
Within the context of this operating model, the key design aspects of CBDCs that need to be consider are:
Wholesale vs retail CBDCs – Wholesale CBDCs refer to those that solely deal with wholesale transfers and payments between central banks and commercial banks and other large non‑financial institutions. Retail CBDCs are instead digital forms of centrally-issued currency which can be accessed and used by the general public.
Centralised vs distributed – a distributed CBDC means that the digital currency (including the its electronic ledger) is able to be accessed and used across multiple devices that are communicating and co-ordinating over a network.
Especially for distributed retail CBDCs, digital wallets are an important infrastructure component. They allow users to view their balance in one or more accounts, receive currency or digital assets from other users and sometimes trade assets or execute other financial transactions.
Digital wallets offer three main types of functionality, including: user authentication, transaction authentication and user interface.
Account-based vs token-based – Account-based CBDCs are those held in individualised accounts at the central bank. Token-based CBDCs are instead units of digital currency issued by the central bank that are recorded on the blockchain and stored in digital wallets.
Interest-bearing characteristic - CBDCs that are held in accounts at the respective central bank and have the ability to generate interest income, or may even be indexed to an aggregated price index.
As research on CBDC develops, several risks have emerged that central banks will need to mitigate if CBDCs are to be both accepted and operationally effective. These risks include:
Disintermediation – some have argued that account-based retail CBDCs whereby citizens have the ability to deposit their currency holdings directly at the central bank may divert essential funding sources of capital away from commercial banks thus undermining their ability to issue credit with adequate capital reserves.
Privacy – retail and account-based CBDCs means that governments and central banks can monitor the financial transaction and economic affairs of individual economic agents, thus eliminating the benefits of privacy and confidentiality which physical cash affords individual economic agents.
Loss of economic freedom – beyond the privacy concerns raised above, retail-based CBDCs pose risks to the economic freedom of individual economic agents given that central bank officials will have the ability to impose conditions on account holders.
Technology risk – the technological infrastructure underpinning CBDCs and their operational performance may experience technical shortcomings which can hamper their effectiveness in facilitating commerce and economic activity. This risk may include cyber hacking which leads to the theft of CBDCs.
Miscalibration of government or central bank involvement – ill-conceived interventions by government or central bank officials may result in negative consequences either for specific market participants or for the broader economy.
Runs on commercial banks – as noted by the IMF in June 2020, retail CBDCs have the ability to facilitate a run on the deposits of commercial banks during periods of financial panic and distress resulting from a transfer of funds held at commercial banks to CBDCs.
Cross-Border interoperability – this may include multiple national level CBDCs unable to effectively interact and communicate which may hamper cross-border financial flows and harm the ability to invest and trade. Thus, if seamless interoperability is not achieved, this may result in harmful international spill overs.
The Dark Side of CBDCs
Critically, while having considered the public policy rationale and risks associated with CBDCs, it is also important to note their potential ‘dark side’ under certain design and implementation specifications – i.e., they have the capacity to be used to diminish both economic freedom and economic welfare.
Specifically, retail account-based CBDCs provide government and central banks with the ability to install totalitarian supervisory and control systems, enabling:
the monitoring of all economic and financial transactions within their jurisdiction;
the collection of bulk data to be then used for other purposes, including law enforcement, the targeting of political enemies and the silencing of political dissidents;
the implementation of social management policies such as social credit scores – i.e., imposing financial penalties or constraints on citizens who engage in activities that are disapproved by government agencies or authorities;
the imposition of financial costs (e.g., fees) on using physical cash or exchanging physical cash for CBDCs. Such costs do not necessarily require the outright elimination or prohibition of physical cash by governments and central banks;
governments and central banks to direct financial capital into asset classes preferred by policy makers (such as government bonds) or to divert capital from asset classes they disapprove;
the compelling of economic agents (businesses and individuals) to consume particular goods and services preferred by policy makers;
governments and central banks to impose particular conditions in the case of fiscal stimulus lump-sum payments, such as imposing time limits on when an allocation of digital currency must be spent, otherwise the digital currency may be electronically withdrawn from circulation; and
the confiscation of CBDCs held at the central bank, either through negative nominal interest rates, specific fees and charges or by outright confiscation (such as through haircuts or deposit “bail-ins”).
As citizens and businesses come to terms with the full range of implementations and consequences that CBDCS may impose, the potential ‘dark side’ applications listed above should not be considered as purely theoretical.
Rather, especially in the context of China and the Chinese Communist Party (CCP), significant concerns have been expressed by analysts that a Chinese digital yuan will enhance the CCP’s political power, including by allowing:
the CCP to more effectively impose party discipline within China; and
more effective implementation of China’s social credit score system.
Dangerously, while China is internationally known for embracing both direct and indirect forms of totalitarianism, CBDCs provide all governments and central banks across the world, including liberal democracies, with policy tools that facilitate the centralisation of economic and political power into the hands of government politicians and bureaucratic officials.
CBDCs in Australia
Consideration of CBDCs is also occurring in Australia as well.
In November 2020, the Reserve Bank of Australia (RBA) launched a collaborative study with the Commonwealth Bank, National Australia Bank, Perpetual and ConsenSys Software to investigate the public policy rationale, use and implications of introducing a wholesale form of CBDC using distributed ledger technology in Australia. This study is expected to be finalised and published by mid-2021.
At this stage, the RBA has ruled out the introduction of a retail CBDC for Australia stating that there is no strong public policy case. However, the RBA has indicated that it will monitor the developments in other jurisdictions to inform its future position.
Whether this is the real policy position of the RBA, or whether they seek to implement a wholesale CBDC as a first stage, before implementing a retail CBDC down the track, remains to be seen.
With no public debate to date, or democratic consent given to the introduction of a CBDC in Australia, any attempt to introduce a wholesale CBDC in Australia will require substantial scrutiny by industry experts and the public-at-large to determine the full range of effects and implications.
As the RBA and other Australian economic officials continue to pursue their CBDC policy agenda, they will be aware of the realpolitik limitations to implementing a full-scale retail CBDC in Australia – especially one that may curtail or eliminate of physical cash or risk further governmental controls over the economic or political activities of the Australian people.
The major political defeat that the Morrison Government experienced in 2020 regarding its attempt to implement a $AUD 10,000 cash transaction ban - formally called the Currency (Restrictions on the Use of Cash) Bill 2019 - is a key demonstration that ordinary Australians will resist any attempt by policy makers to either criminalise the use of physical cash or facilitate its elimination.
Across the world, the overwhelming majority of central banks are actively researching or developing CBDCs with plans, in some instances, to rollout either a wholesale or retail CBDC for operational use.
In many instances, a clear public policy rationale, democratic mandate and legal authority have yet to be established or secured.
While arguments have been advanced that private payment systems with extremely fast transaction and processing speeds represent a threat to:
the stability and orderly functioning of the traditional financial system; and
the ability of central banks to implement effective monetary policy,
little empirical evidence has been presented that support these arguments.
The diverse design options available to central banks present a wide range of pubic policy, legal and technical complexities and risks that must be considered and overcome before rollout and adoption can be initiated.
As no CBDC will be the same across jurisdictions, any proposed design and introduction should not be assessed and judged using a general broad-brush framework.
Rather, each individual CBDC, whether at the national or regional level, will need to be considered against its original intent, policy mandate, legal framework and operational effectiveness to determine whether it generated (in net terms) positive or negative economic and financial impacts.
Within this context, while CBDCs have been lauded as a positive development to the evolution of the modern financial system, any benefits that CBDCs are expected to generate to the economic functioning of modern economies, and to the financial system as a whole, are yet to be presented.
Despite potential benefits, CBDCs do possess a grave danger or ‘dark side’ given that, under certain design specifications, they can provide governments and central banks with the ability to deploy totalitarian systems of state surveillance and control which undermine basic freedoms, sovereignties and economic welfare in general.
Only vigilance as well as holding government and central banks accountable for their actions will ensure that CBDCs are not misused that radically alters:
existing structures of economic power;
institutional arrangements; and
which are essential to maintaining political and economic freedoms which have been the bedrock of western civilisation for centuries.
John Adams is the Chief Economist for As Good As Gold Australia
 https://www.bis.org/about/bisih/topics/cbdc.htm  https://www.cnbc.com/2021/04/19/central-bank-digital-currency-is-the-next-major-financial-disruptor.html  https://www.bis.org/publ/work948.htm  https://www.coindesk.com/cbdcs-time-has-come  https://blogs.imf.org/2021/02/18/public-and-private-money-can-coexist-in-the-digital-age/  https://www.investopedia.com/terms/l/legal-tender.asp
 https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp  https://www.forbes.com/sites/frankvangansbeke/2021/06/27/why-central-bank-digital-currencies-cbdc-now-and-what-could-they-mean-for-climate-change-12/?sh=1008b43124a8  https://www.cnbc.com/2021/04/19/central-bank-digital-currency-is-the-next-major-financial-disruptor.html  See footnote 8.  See footnote 8
 https://www.brookings.edu/blog/up-front/2020/07/23/design-choices-for-central-bank-digital-currency/  See footnote 11.  See the following October 2020 publication by the Australian Strategic Policy Institute (ASPI): https://www.aspi.org.au/report/flipside-chinas-central-bank-digital-currency
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