Central Bank Digital Currency: The Basics

Lately there has been a lot of talk aboutCentral Bank Digital Currency (CBDC) as central banks around the world have been actively discussing the topic. Some of the issues with CBDC have already been discussed (see, for example, here and here), and I will not dwell on them. The purpose of this article is to answer a simple question: what is a CBDC? How are they different from cash, demand deposits and cryptocurrencies?

What it is not

Let's start with what CBDC is definitely notare: this is not a new kind of cryptocurrency, similar to bitcoin. While central banks are discussing issuing CBDCs in the form of a token, as well as using distributed ledger technology (DLT), this does not mean that central banks intend to allow people to exchange and store them unsupervised, let alone give up centralized control over the supply. this money. DLT and tokenization is only a matter of technology that will be used in the introduction and distribution of digital currency; this does not mean that central banks have adopted any of the ideas behind the Bitcoin phenomenon.

Some central banks seem to believethat the existence of bitcoins and other cryptocurrencies and the rise in prices for them indicates that there is a demand for digital currency, and therefore they must start producing it. They don't seem to understand that the demand for bitcoin - like the demand for gold - is the demand for something that is outside the control of central banks and governments.

It is also important to note that, despite whatAs central banks themselves think, CBDC is not a central bank liability in the same way that cash is. Today, in a purely formal sense, being an item on the right side of a central bank's balance sheet, both cash and CBDC are considered liabilities. However, by definition, liability is the obligation to deliver goods (usually money) to the party to whom the obligation arose (see Investopedia). So holders of central bank liabilities, in theory, have a claim on the central bank, but what exactly are they claiming? The correct answer here is, of course, nothing, and therefore neither cash nor CBDC can be said to be a liability. That central banks record cash as liabilities is merely a relic of a bygone era when central bank notes were indeed substitutes for money in the Misesian sense1 and banks were indeed obliged to hand over money (i.e. gold) when presented with banknote for redemption.

(Note that central bank reservesare correctly listed as a liability, as banks that hold reserves at the central bank do have a claim on the central bank, namely a claim to receive cash.)

What is it

CBDC is (or should be) digitalequivalent to physical cash. Just as, say, four quarters are equivalent to a dollar bill, one dollar in digital currency will be equivalent to one dollar in cash. This is simply a new technological expression of the same paper money. Recall that fiat money, as Mises described it2, is “money which contains elements that give it a special legal status,” i.e. these things are technologically no different from other things, except for special marks indicating that they have a special legal status. The implication of this is that technologically dissimilar items—metal coins, paper notes, and digital assets—are part of the fiat money supply if they bear the marks of their legal status.

It should be clear that from the point of view of the centrala bank issuing fiat money, digital currency has some advantages over physical money. First, its production is really cost-free: although the costs of producing physical money are insignificant, they exist and in some conditions can be significant, for example, when new physical money must be quickly distributed in order to avoid massive withdrawal of money from the bank. On the other hand, digital currency can not only be created instantly, but can also be instantly distributed among the recipients desired by central banks. There are two models for storing and using CBDCs: either directly by the central bank in a “digital wallet” or in an account with an intermediary appointed by the central bank. In any case, the central bank can quickly and inexpensively channel the flow of new digital currency to whoever needs it.

Difference from cash

Although both CBDC and cash are part offiat money offerings, there are some notable differences between them. Central bankers understand this because, as I noted in my previous article on this topic, they recognize the need to give digital currency legal tender privileges. Otherwise, they fear that people may refuse to accept the money. The key differences between these two types of fiat money are costs to the user, privacy, and the degree of control by the central bank. Let's look at each in turn.

Costs for the user:Storing cash for the general public requires virtually no cost, even in significant amounts. It is true that at some point someone may want to invest in additional security measures to protect their money, such as investing in a safe deposit box or renting a safe deposit box from a bank (although this is no longer as secure). Digital currency, on the other hand, means that people will have to invest in the software and electronic devices needed to operate it and learn how to use it. This could be a problem for many who are not particularly tech-savvy, and a major burden for stores who will have to invest in new machines to process digital payments. This also introduces a burden in the form of new risks. In addition to the old risks of simple robbery, there are new risks of cyber attacks that can empty a person’s digital wallet. Although centralbanks can take advantage of existingtechnological developments in the field of cryptoassets, we must not discount the reality of this risk, nor the discomfort that it can cause for people who are not experts in the digital world.

Confidentiality:The only way to engage in transactions that does not leave a paper trail is to pay in cash. Bitcoin and other cryptocurrencies cannot compete here, although various sophisticated methods can bring them closer to cash. In any case, when it comes to CBDC, there can be no question of privacy: as the ECB explicitly stated in its recent report on the subject3, it will be necessary to make access to every single transaction possible - all in the name, of course, of anti-money laundering money and terrorism. Whatever the credibility of such concerns, the obvious outcome will be to ensure that all transactions are transparent to the central bank and to those with whom the bank chooses to share information.

Central bank control:since physical cash is wholly provided by the central bank, one might think that it has effective control over their supply. However, it is not. It is true that the central bank can increase the supply at its discretion, but it is quite difficult for it to control the distribution and ownership of physical cash. He also cannot easily reduce the supply of physical cash. Consequently, people can, if they so choose, keep a significant portion of their wealth in the form of cash, and there is essentially nothing the central bank can do about it. Or rather, whatever action he can take is very costly and blind; that is, they cannot target directly those persons whose cash balances are considered excessive. With digital currency, the central bank will have both the power and the knowledge needed to control what each person or company owns. Since the generally accepted goal of central banks is to increase nominal spending, they want to have a digital currency in order to be able to impose all kinds of restrictions on the storage of money to achieve this goal. The ECB, for example, is open about limiting the amount a person can hold, limiting the time a person can hold a certain amount of money, and imposing negative interest rates on amounts that the bank considers excessive. All of this would be nearly impossible if people were using physical money instead of digital currency.

CBDC and bank created money (demand deposits)

It is also important to clearly distinguish between CBDC and substitutesmoney issued by commercial banks. Unlike digital currency, these fiduciary funds represent real obligations, that is, the owner of a demand deposit can demand payment in cash. We don't need to go deep into banking theory here; suffice it to note that the ability to redeem in cash imposes a restriction on the issuance of fiduciary funds, which are not available in the production of fiat money by the central bank.

Banks are usually willing to pay interest on depositson demand, because they invest most of the money people have in their accounts in the process of credit expansion or credit creation. On the other hand, a CBDC held in a digital wallet can no more serve as the basis for credit expansion than physical cash held outside banks. In our current environment of low, zero, or even negative interest rates on demand deposits, central bankers fear that no interest rate CBDC will lead people to simply cash out their demand deposits in digital currency. Since central bankers know only one policy - "stimulating" the economy by lowering interest rates, which they do by flooding credit markets with cheap money, this possibility obviously gives them serious concern. Hence, they absolutely need to be able to charge negative interest rates on people's digital wallets in order to maintain the credit system. Not so much out of love for private banks and investors (although given the careers of Greenspan and Bernanke after the Fed, this might be an important consideration for some), but simply so that they can continue to pursue policies that are in line with their inflationary dogmas (and the interests of their political masters).

Conclusion

I hope it is clear from this brief overview thatare digital currencies offered by central banks. In a word, this is the last step in the evolution of fiat money: money is completely under the control of the issuing government. While the language and some of the technology may be borrowed from the world of cryptocurrencies, don't be fooled. Bitcoin is an attempt to store wealth outside the reach of government; CBDCs are designed to thwart this goal. If, following Rothbard4, we interpret history as a struggle between freedom and power, between a free society and the domination of the state, we can say that a central bank digital currency is simply the latest weapon in the arsenal of the state in its quest to completely dominate society.

Of course, since economic doctrines,which central bankers and governments are guided by are nothing more than a web of misconceptions, the consequences of the introduction of a digital currency are likely to be very different from what is expected. But if 2020 has taught us anything, it is that there are no limits on what states will do in pursuit of increasing their power.

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