Central Bank Digital Currency: A Primer

It should be clear that from the point of view of the central bank, the issuer of fiat money, digital currency has some advantages over physical cash. For one thing, it truly is costless to produce: while the costs of producing physical cash are negligible, they are there and may especially become evident when new physical cash has to be distributed fast (e.g., to avoid a run on a bank). Digital currency, on the other hand, can not only be created instantly, it can also instantly be distributed to the persons the central bankers want. This is so since there are two models for holding and using CBDC: either directly with the central bank in a “digital wallet” or on account with an intermediary designated by the central bank. In either case, the central bank can quickly and costlessly direct the flow of new digital currency to whomever it wants.

The Difference from Physical Cash

While both CBDC and physical cash are parts of the supply of fiat money, there are some notable differences between the two. This is understood by central bankers, since, as I noted in my previous article on the topic, they recognize the need for investing digital currency with legal tender privileges. Otherwise, they fear, people might refuse to accept it in exchange. The key differences between the two types of fiat money are: costs to the user, privacy, and extent of control by the central bank. Let us examine each in turn.

Costs to the user: physical cash is virtually costless to hold for the general public, even in substantial amounts. It is true that at some point one might want to invest in additional safety measures in order to protect one’s cash, such as investing in a safe or renting a safety deposit box in a bank (although these are not so safe anymore). Digital currency, on the other hand, means that people will have to invest in and learn how to use whatever software and electronic devices are required to handle it. This might be a challenge to many who are not especially tech-savvy, and a significant burden to stores who will have to invest in new machines in order to process digital payments. It also imposes burdens in the form of new risks. To the old risks of simple robbery are added the new risks of cyberattacks that might drain a person’s digital wallet. While central banks may be able to piggyback on the technological developments in the field of cryptoassets, we should not dismiss the reality of this risk, nor of the discomfort, it may cause people who are not digital natives.

Privacy: the most private way of engaging in commerce, the only one that leaves no paper trail, is still paying in physical cash. Bitcoin and other cryptocurrencies cannot compete here, although sophisticated techniques may bring them close. In any case, when it comes to CBDC there can be no question of privacy: as the ECB explicitly stated in their recent report on the issue,3 it will be necessary to make it possible to access every single transaction—all in the name of combating money laundering and terrorism, of course. Whatever the merit of such concerns (spoiler alert: abysmal), the clear outcome will be to make all transactions transparent to the central bank and to whomever the bank chooses to share the information with.

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