CBDCs: Do they pose a threat to Cryptos?

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The pandemic accelerated the world’s race toward digitalization and changed how people spend money. Post-pandemic, as cash becomes more redundant each day and the demand for digital assets increases simultaneously, central banks worldwide are faced with the prospect of a parallel monetary system beyond their realm of control. Cryptocurrencies’ explosive growth and mainstream adoption have given rise to a distinct sector in the financial economy that can no longer be ignored.

Governments and central banks around the world are acting with increasing urgency and exploring the possibilities of Central Bank Digital Currencies (CBDCs). Cash — the only form of central bank money available to the public — has gotten its digital kin in the form of CBDCs. So are we heading towards a mixed economy of public and private finance in the digital sphere? Or do CBDCs pose an actual threat to cryptocurrencies? Before we answer this, let’s first wrap our heads around the concept of CBDCs and how central banks worldwide are working on CBDCs to capture the first-mover advantage?

What are CBDCs?

In layman’s terms, CBDCs are digital currencies issued and backed by central banks. Central banks present them as the alternative to cryptocurrencies and stablecoins. As per Atlantic Council, 10 countries have launched their CBDCs (Nigeria, Bahamas, etc.), 15 have initiated a CBDC pilot project (Russia, China, Saudi Arabia, etc.), and more than 50 countries are at an advanced exploration stage (Australia, Canada, Brazil, etc.).

All in all, 105 countries representing 95% of the world GDP are exploring the case for a CBDC!

Weforum succinctly puts forth the motive behind the development of CBDCs as “revitalizing and expanding access to payments infrastructure, facilitating cross-border payments, and maintaining sovereign currency control.”

Yet several concerns such as privacy and state surveillance, lack of infrastructure and cybersecurity, etc., continue to persist and raise a question mark on the feasibility of CBDCs in the decentralized future of the digital world.

Do CBDCs pose a risk to the cryptocurrency ecosystem?

CBDCs are virtual currencies centralized in nature and dependent upon the trust accorded by banks and governments. Built with the utopian motives of promoting financial inclusion, facilitating faster and cheaper payments and cross-border transactions, and strengthening economic integration worldwide, CBDCs appear to be the panacea for the financial systems around the world.

Whether CBDCs pose a risk for cryptocurrencies is a matter of discussion. The so-called battle of supremacy between the CBDCs and cryptocurrencies is more a result of the scepticism and negative outlook of the banks and institutions for cryptocurrencies.

Cryptocurrencies, being decentralized digital currencies, accord financial sovereignty and greater control to the users over their money. Central banks, as the prime issuers of fiat money, most consider this a possible threat to their monopolized powers of issuing money as much and as many times as they want to finance their deficit or fund their motives. As such, in an attempt to control the narrative, maintain their powers unquestionably, and address the problem of the rising adoption of cryptocurrencies, central banks are considering developing or implementing CBDCs.

China and Nigeria banned cryptocurrencies before pilot testing or launching their CBDCs in their respective jurisdictions. Such events are bound to raise fear of a possible threat to cryptocurrencies which seek to nullify the role of central banks and institutions. However, in actuality, CBDCs replicate physical cash in the digital realm and have nothing more in common with cryptocurrencies except that both are digital money, and both will vie for their share of the userbase in the future. Our traditional mindsets and regulatory compulsions may also force us to opt for CBDCs instead of private cryptocurrencies.

But CBDCs pose no immediate threat to cryptocurrencies for a number of reasons. Let’s recapitulate:

  • CBDCs are digital equivalents of their fiat counterparts, are centralized, and their supply is controlled by the central banks. Cryptocurrencies, on the other hand, present an alternative mode of payment away from the prying eyes of the state. The supply of most cryptocurrencies is either fixed or programmed to be deflationary.
  • Cryptocurrencies are at a more advanced stage of development than CBDCs, still grappling with infrastructural and cybersecurity issues. Cryptocurrencies deploy the available infrastructure of the network of computers to preserve a decentralized database of transaction history and records, while CBDCs will still be prone to single points of failure.
  • Cryptocurrencies aren’t just a good store of value; they can be securities, assets, or tokenized shares of a company, while CBDCs will be meant only for retail monetary transactions. Cryptocurrencies also allow holders to earn passive income or enjoy platform utilities and perks. Use cases for cryptocurrencies and other kinds of digital assets are immense and beyond the scope of a CBDC.
  • CBDCs are still under evolution and finding answers to issues such as interoperability and cross-border payments. Some CBDC bridge initiatives like the Dunbar project have come up, but these aren’t enough to tackle the issues at a global level. Cryptos, in contrast, is borderless, and many crypto platforms such as Chainlink and Polkadot have come up with interoperable cross-chain solutions.
  • Privacy is the greatest concern for CBDCs. Instead of financially including the masses, the state can use CBDCs as a tool for mass surveillance first and then can use the information to deny certain people inclusion in the financial economy.

Other than these, CBDCs could be a systematic threat to banks. For instance, citizens could withdraw excessive money from the bank at once to purchase CBDCs, which could trigger a run on banks as they wouldn’t be left with enough balance to lend. This situation may cause interest rates to rise shockingly. Like cryptocurrencies and stablecoins, CBDCs, too, require a comprehensive regulatory framework concerning privacy, consumer protection, and stringent AML/ATF/KYC standards.

All in all, CBDCs, once operational successfully, could act as a bridge between fiat and cryptos. Via crypto trading and other blockchain-focused ventures, CBDCs can find new use cases, and countries too can convert billions of dollars worth of trading volumes onto their CBDC payment systems. The upcoming era of web3 will have to find its balance between CBDCs, stablecoins, and cryptos — between centralization and decentralization — to present itself as transformational for the masses.

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Dr Vin Menon

Dr Vin Menon

A blockchain enthusiast and entrepreneur’s musings on the next big revolution since the Internet.