Even though 86% of the world’s central banks think about the risks and benefits of issuing a central bank digital currency (CBDC), much of the analysis is still theoretical or untested. This is a good thing since there are a lot of potentially unstable risks and other things that central bankers have to consider when they think about joining the space race for digital currencies. Of course, a space race is going on for the future of money and payments, but the natural choice is not whether central banks should become retail-level technology companies, which is what launching a CBDC would mean. Instead, the honest debate is about how to let a growing and more competitive private sector thrive by giving payments and money much-needed competition and choices in the future.
Here are ten crucial risks and things to think about that are often left out of the CBDC debate and should be carefully considered as central banks weigh the pros and cons of digitizing their national currencies.
1. Technology risks and obsolescence:
Starting a CBDC would put a lot of technology risks on the public sector and, in the end, on taxpayers, who would have to pay for fast-changing technologies that are often still in the testing phase. For example, blockchains are now in their third generation, and the technologies of public, open-source financial infrastructure are changing quickly. Consumers, markets, and the government will benefit if this change in how value moves on the internet, like all the others that have come before it, stays a free market activity with public sector oversight.Embed from Getty Images
2. Cyber threats and single points of failure:
A CBDC would have to be centralized, making the many cyber vulnerabilities even worse and making it easier for hackers to attack the economy and the central banks (recall Equifax, Solar Winds, and the Colonial gas pipeline as three examples). It is best to use public blockchains and a free market to move value on the internet to take advantage of the cyber-resilience that comes with distributed systems. Just as the failure of a single bank lowers confidence in banking as a whole, a CBDC could potentially pass this risk on to central banks, making strategic risk-sharing structures and operational “air gaps” between financial system participants useless.Embed from Getty Images
3. Privacy and consumer protection:
A CBDC could be a problem for consumer privacy and protections, especially if given out at stores or by a government that wasn’t very good (remember, there’s a thin line between democracy and anarchy). But, on the other hand, what would stop people from using a CBDC as a weapon against other people or blocking legal transactions when they fall out of favor? To the right lawful, the use of money (a public good to which everyone has the same right of access) and how it is saved, sent, spent, and secured should be as free as possible while making sure that bad actors get the most punishment possible.Embed from Getty Images
Systemic risk and instability:
A CBDC could cause a “flight to quality” in the domestic market, which would upset the two-tiered banking system that central banks are supposed to protect. The banking system and the economy could be seriously hurt by the possible systemic effects of a CBDC. For example, an increase in the speed of money could cause ripple effects that hurt other parts of the economy. The model shown by privately issued digital currencies with a real “air gap” between reference assets (like cash, cash equivalents, and high-quality assets inside the banking system) and tokenized assets on public blockchains doesn’t create any new money and protects and keeps the two-tiered banking system in place. The transmission of monetary policy is also kept, which is very important.Embed from Getty Images
5. Vendor risk and technology capture.
For a CBDC to exist, someone has to sell central banks some new technology. This shows the often-overlooked operational risk of supply chain and vendor risk, not to mention the sneaky possibility of buyers’ remorse or technology becoming obsolete. To protect the public’s right to know where their money comes from and keep an eye on it, central banks don’t have to become retail banks or, even worse, technology service providers with substantial data stores that can be used to make the “honeypot” databases that hackers flock to.Embed from Getty Images
6. What can’t be done with digital twins –
CBDCs can be thought of as having many different shapes and sizes. The most likely outcome is a wholesale version, which could make bank-to-bank relationships more efficient but would leave improvements at the retail and market level to “trickle down” effects. However, as with the present status of digital currencies, e-money, and mobile money breakthroughs, true financial inclusion and innovation advantages depend on strong free market competition and innovation with exponential technologies. Many of these can be thought of as digital public goods, which benefit from open source standards that encourage competition and quick prototyping, as well as from the work of thousands of developers and cybersecurity experts (who use bug bounties to improve resilience) who work together to make things more stable.Embed from Getty Images
7. Decentralization is the point.
For a CBDC to work at all, at least as it is currently envisioned, it must run on blockchain rails. From a technological, operational, and governing point of view, the problem is that decentralization and distribution are the keys to blockchains. So, a CBDC issued and managed by a central authority would probably use closed-loop systems or “fake blockchains,” which would copy the cyber and other potential vulnerabilities that distributed systems were made to protect against.Embed from Getty Images
8. Regulate the activity, not the technology.
Most regulators and banks agree that financial activity, not technology, needs to be regulated. Even though the U.S. and other countries don’t have an industrial policy on how to use exponential technologies like blockchain, AI, and quantum computing, among others, there is a tendency among economists to say that the U.S. and other countries should come up with one.
Regulators want to ban cryptocurrencies and payment systems based on the blockchain. Yet, strangely, these technologies may be the most significant improvement to financial inclusion, innovation, and honesty in the last 50 years. Moreover, since everyone can see the internet’s public financial ledgers could exponentially improve financial crime compliance and security.Embed from Getty Images
9. Interference with free markets
Through the creative-destructive process, an economy that is strong and competitive can grow. In the first ten years of cryptocurrencies, digital assets, and public blockchains (now in their third generation), entrepreneurs have built a $2 trillion market. This journey has been full of risks, failures, lessons learned, and, most importantly, a better understanding by regulators of how to use these foundational innovations responsibly. These risks, as well as those in this article, should stay in the free market. The key is to support and use activity-based, technology-neutral rules and, most importantly, to regulate the economic behavior of digital assets instead of taking a “catch-all” approach. In other words, not all crypto is the same. If it acts like a security, it’s likely security. Suppose it works like a currency or payment system. In that case, the benefits of “digital legal tender” or conformity with well-laid money transmission, e-money, financial markets infrastructure, and prudential rules should be given.Embed from Getty Images
10. Complex systems fail in complicated ways.
There’s no doubt that the public sector needs to keep coming up with new ideas and improving its digital transformation plan. However, trying to keep up with the central bank Joneses and jumping on the CBDC bandwagon puts more risks on the public sector, which is already struggling with upgrading core infrastructure, than the potential benefits of a CBDC warrant. A risk management saying says that when complex systems fail, they do so in complicated ways. Moreover, transitioning a rapidly changing blockchain-based business model to the public sector for something as fundamentally important as money and monetary oversight ignores the fact that most value-added money in circulation today (M2) benefits from solid banking, payments, and technology landscape, all of which operate under the watchful eye and global coordination of central banks, who are in charge of the macroprudential framework.
With this in mind, central banks will have to decide whether or not it is wise to digitize their fiat currencies. As with every other change in how money moves, since people stopped hauling and trading goods and started using more formalized units of account and mediums of exchange, the way money moves has become a public-private issue.