CBDCs: Why it’s not a good idea for the future of crypto

Digital currencies have undoubtedly revolutionised the financial sector. Not only are its transactions faster and cheaper, but they can also reach those who don’t have access to traditional banks. Seeing how far more efficient digital currencies are has pushed traditional financial institutions to innovate and adapt. 

KEY TAKEAWAYS:

• CBDCs are a digital national currency issued and regulated by the central bank.
• CBDCs give governments financial control. This allows them to freeze assets, set negative interest rates, and employ programmable spending.
• CBDCs take away the core principles that make crypto great such as privacy and decentralisation.

One of the responses to the advent of digital currencies is Central Bank Digital Currencies (CBDC). Although it has its benefits, there are also many CBDC risks. Learn more about the dangers of CBDC and how will CBDC affect crypto with this guide:

What are Central Bank Digital Currencies (CBDCs)?

Before learning why is CBDC bad for crypto, it is important to know what is CBDC in crypto. CBDCs are digital forms of a country's fiat currency issued by the central bank. Unlike crypto, these have a fixed value equivalent to traditional fiat currencies. 

It is comparable to paper dollars in the sense that it is a liability of the Federal Reserve. However, it does not offer either the privacy protections or the finality that cash provides.

Here is a brief overview of CBDCs and their purposes:

• They promote financial inclusion by giving access to secure and convenient digital payment systems.
• CBDCs encourage stability as they reduce risks associated with crypto and ensure the backing and regulation of a government.
• They offer a secure means of exchanging digital currency, mitigating the volatility often associated with crypto.
• CBDCs improve the transparency of financial transactions. This makes it easier to track and combat illegal activities such as money laundering.

When you compare the benefits of CBDCs and existing technologies, CBDCs do not offer anything unique. They do, however, pose some serious risks. One risk of CBDC is it threatens the few financial privacy protections.

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Threat to decentralisation

One of the fundamental principles behind crypto is decentralisation. Most of the established coins like Bitcoin (BTC) and Ethereum (ETH) rely on blockchain technology similar to the CBDC blockchain. This eliminates the need for intermediaries like central banks. 

CBDC, in comparison, is centralised by nature. As mentioned, it is controlled and issued by central banks giving them financial control. Introducing CBDCs could undermine the decentralised nature of crypto, disregarding the core principles that attracted users to them in the first place.

CBDCs give central banks financial control

Another potential risk that comes with the concept of CBDCs is giving central banks significant control over the financial system. This allows them to regulate and track transactions with ease. 

While there may be some pros when it comes to combating illegal activities, it raises concerns about potential abuse of power. Governments can use CBDCs to do the following:

Freezing of assets

One of the most effective ways to lock someone out of society is by freezing their financial resources. With CBDCs, the government can easily freeze assets as it creates a direct line between citizens and the authorities.

Programmable spending

A CBDC’s programming capabilities can prohibit what users can buy with their digital cash. This makes it easier for governments to employ rules and limits. 

Negative interest rates

A CBDC crypto gives the government power to set negative interest rates. As a result, people would lose money. This is a possible strategy to stop people from spending.

Lack of privacy

Privacy is one of the most crucial benefits that has attracted millions of users to crypto. Bitcoin, for instance, offers pseudonymity. This allows users to transact without revealing their identities. 

Just like regular banks, CBDCs comply with anti-money laundering (AML) and counter-terrorism financing (CFT) regulations. This means verifying users’ identities is crucial to help prevent illegal activity which gives central banks access to a user’s financial data. 

Comes with systematic risks

In many cases, crypto has been a target of hackers and thieves. Considering the core concept of a CBDC is similar to crypto, it is likely to attract the same attention. Cyberattacks and the like will lead to disruptions in the economy affecting stability. 

Disruption of existing systems

Crypto has become a popular alternative to traditional financial systems. It offers users better accessibility and inclusivity. The introduction of CBDCs has the potential to disrupt the crypto landscape. 

There may be entities that may gravitate towards the legitimacy and backing by governments CBDCs have. This would lead to a decline in crypto adoption and use of private coins.

Affects integration and division

The financial landscape is diverse as countries have different approaches when dealing with crypto. If CBDCs are adopted worldwide, this can lead to more competition and division. 

Each country can create its own digital money which can lead to many incompatible systems. This makes it harder for different systems to work together, hinders cross-border transactions, and the potential for a unified global financial system.

The future of the crypto landscape and CBDC

Juda Agung, assistant governor at the Central Bank of Indonesia stated, ‘A CBDC would be one of the tools to fight crypto’. However, how true is this? Although its various features would undermine crypto, many would likely reject the idea of a CBDC. 

It's the very same features (threat to privacy, loss of control, and disruptions) that would cause people to reject its concept. With this, central banks have to be cautious if they want people to accept it. Considering this, it is unlikely for a CBDC to influence the crypto landscape in the following years. 

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