CBDC vs Crypto: Divining the Future of Digital Payments

With the emergence of cryptocurrencies in 2009, the financial industry has experienced major disruption. This invention acted as a catalyst for many subsequent innovations, which came about by building on the revolutionary blockchain technology, or by reacting to it. A prime example for this phenomenon are Central Bank Digital Currencies (CBDCs). As opposed to cryptos, CBDCs are considered to be fiat money; government issued currency that is not backed by gold or other physical commodities. Effectively, CBDCs are a digital form of cash, which operate with the backing of the full faith and credit of government. In practice, this should materialise as each person having a government-licensed payment application on their phone.

At first sight, CBDCs do not seem too futuristic. What is really the difference between CBDCs and mobile payment apps such as Revolut and Venmo from a user’s perspective? The key advantage and selling point of these existing services is the reduced or non-existent international transfer fees and commissions for converting money. Thus, CBDCs hardly offer a financial incentive to drive user adoption, as the only remaining form of cost cutting would be free-of-charge account maintenance. What is the point of Central Bank Digital Currencies then?

Those who are sceptical of the CBDC project would argue that this invention hardly offers anything for citizens, but represents the interests of another party instead, i.e. the government. These critics would be quick to point to the world’s most advanced Central Bank Digital Currency, China’s “Digital Currency Electronic Payment”, expected to launch in February with the Winter Olympics. This new Chinese payment system clearly fits the paradigm of the Chinese Communist Party’s complete control of the economy even to the point of intrusion into people’s private lives. Given the willingness of the Chinese government to exert control over the personal choices of its citizens with its up-and-coming Social Credit System, China’s CBDC will be an instrument that facilitates this system by allowing the government to track all transfers made within China. Although these concerns are certainly not unfounded, especially in the case of China, leaving the discussion at that would certainly do an injustice to CBDCs.

One of the strongest arguments in favour of CBDCs is that they will allow governments greater leeway for conducting fiscal and monetary policies. A fitting theoretical example of this would be putting an expiry date on government stimulus checks. With this policy, and the help of CBDCs, central banks could increase aggregate demand almost instantaneously, enabling them to counteract economic shocks much more quickly than they have been able to in the past by lowering short term interest rates or buying government bonds. The potential usefulness of perishable stimulus checks is perfectly demonstrated by the current pandemic. The fears of inflation due to expansionist monetary and fiscal measures could be alleviated, while the response time lag to the emergence of a new wave of infection could be drastically shortened, cushioning the economic impacts of sudden lockdowns.

In addition, CBDCs offer great potential for developing countries, where the share of people with access to a bank account is low. Currently, approximately 1.7 billion people do not have access to a bank account, however, of those, half a billion have access to the internet. Therefore, CBDCs might be the best way to include hundreds of millions of new people into the digital payment ecosystem, in places where the banking infrastructure is underdeveloped. To illustrate how crucial this step is, and how far governments are willing to go to attain this goal, we should have a look at India. In 2016, Narendra Modi, Prime Minister of India, announced a major demonetisation policy, withdrawing recognition of 500 and 1,000 rupee notes, which represented 87% of the total cash in circulation at the time. In response to this abrupt announcement, people flocked to banks to deposit their cash saving, which the customer service systems were unable to handle. As a result, the economy partially shut down, and the ensuing civil unrest cost several lives, forcing the government to revoke its policy. Transitioning an economy to a digital payment system can be a tremendous challenge for governments in developing countries, and in this context CBDCs can be helpful instrument.

When discussing the future of financial technology, the two most often mentioned trends are cryptocurrencies and CBDCs, the two of which are often considered to be rivals. Interestingly, however, both of them represent extremities. A widespread embrace of crypto would mean the nearly total anonymity and decentralisation of payment systems, depriving central banks of their most effective policy tools. On the other hand, a wide-ranging uptake of CBDCs would expose all of our personal transfer data to the government, and go a long way towards obliterating individual privacy. Which one of these threats proves more dangerous is yet to be determined, and so the future of digital payments is likely to be “both-and” rather than “either-or”.

Bence Borbély is a Hungarian first-year History and Politics student at the University of Cambridge whose professional fields of interest are management consultancy, public policy-making, politics and international relations.

Image: Pixabay

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