CBDC: Pros and Cons

  /  4 minutes read

From barter to the fiat, money and the monetary system evolved overcoming the flaws of its predecessor. Today fiat money is used world wide, issued by central banks of nations. There are 2 types of base money.

1. Overnight deposits with the central bank, currently available only to banks, specific non-bank financial firms, and some official sector depositors;

2. Banknotes, being universally accessible but arguably of limited efficiency and relying on old technology.

CBDC (Central Bank Digital Currency) is supposed to be next and 3rd base money which has some of the benefits of cryptocurrencies (programmable money, smart contracts, increased transparency/trust) without the downsides (downsides for government: anonymity and lack of control).

Let’s understand these terms one by one.

Pros for the Government ::

Programmable Money : Programmable money is designed with in-built rules that constrain the user. These rules could mean that money expires after a fixed date, or the value goes down by certain % if it lies idle in your account or its use is restricted to a certain set of goods.

For eg. A portion of salary will be given in CBDC and that can be used only to pay for EMIs/Accommodation/Fuel etc. OR $100 in your account will become $99 after an year.

Smart Contracts : Smart contracts are a set of rules that executes a transaction when predefined conditions are met. In short, they automate the execution of an agreement without any intermediary. Using Distributed Ledger Technology, Central Bank can architect any smart contract into the system to enforce governance or regulatory requirements OR permit borrowing and lending via smart contracts to enable qualified parties to issue digital assets backed by real-world assets, such as real estate and stocks—using them as collateral to secure loans in CBDCs— something that could bring enormous liquidity into the global economy.

Better Surveillance : With a programmable money, directly under control of Central Bank, based on Distributed Ledger Technology, hosted on private blockchain, Central Bank can monitor every single penny of the CBDC. This effective tool can prevent illicit use of money in money laundering, terrorism financing and illegal hoarding of money.

Strengthen Monetary Policies : CBDC allows Central Bank to overcome situations like ZLB (Zero Lower Bound) using Negative Interest Rate policy which can not be applied with that ease to the fiat money since it is not programmable. It also allows easy distribution of helicopter money when needed. CBDC could also get a larger seignorage income to the state.

Cons for Public ::

End of Privacy : A CBDC would mean ultimate death of privacy where central bank will hold all the power on public’s money. Right now, paper money is protecting that privacy but imagine a future where Central Banks and other govt institutes knows about every penny in your account, from its inception to the infinity, can program that, can freeze that. That sort of power will end whatever little democracy this world has left. The decentralized future which fueled the inception of crypto currencies, would be a lost cause as central banks will hold too much power.

Disintermediation of Banks : Introducing a CBDC could result in a wider presence of central banks in financial systems. This, in turn, could mean a greater role for central banks in allocating economic resources, which could entail overall economic losses should such entities be less efficient than the private sector in allocating resources. It could move central banks into uncharted territory and could also lead to greater political interference. Deposits in Banks are not same as deposits with Central Bank as they are protected only upto a certain sum (Rs. 5,00,000 only in case of Fixed Deposits in Indian Banks). CBDC being issued by Central Bank, people might flock towards CBDC in large scale and it might disintegrate the entire banking sector as we know it.
In the Budget 2022, Finance Minister of India had announced that Reserve Bank of India will be issuing Digital Rupee on the blockchain. It is yet to be seen how, when and what framework is used by RBI for Digital Rupee.

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