CBDC vs cryptocurrency: The debate heats up

Mainsteam central bank digital currencies seem inevitable. How will that impact cryptocurrencies?

Digital yuan coin against a bitcoin fading away. Black back ground – Photo: Alamy                                 
The digital yuan faces little competition, given China’s antagonism towards crypto – Photo: Alamy
                                

Contents

Fiat by any other name

To the uninitiated, the technologies behind CBDC – central bank digital currencies – and cryptocurrency might sound similar. They are both digital currencies, after all. But to conflate the two is vastly misleading. Even if CBDCs adopt distributed ledger and blockchain aspects at the design level, they will in no way provide utility in the decentralised finance (DeFi) or Web 3.0 spaces.

A CBDC is simply digital fiat. Since most fiat transactions are already digital in nature, “it’s hard to see how these are really very different than the money we have today," according to Kent Barton, tokenomics lead at ShapeShiftDAO.

Barton warns of the “illusion of choice”. CBDCs might appear to be the gateway to digital currencies when in reality “they’re just a different flavour of fiat. CBDCs do not solve any of the fundamental problems of traditional fiat and only serve to further entrench the interests of central banks.”

A working CBDC would share none of the trustless, permissionless or decentralised principles that crypto is founded on. Some fear the exact opposite. Crypto trader Scott Melker, the self-styled “Wolf of All Streets”, said: “CBDCs are a central banker's wet dream, and are completely different from crypto assets. They lack the ideals that cryptocurrencies were founded on and are nothing more than a government tool to extend power and control over the currency. CBDCs strip away privacy, personal sovereignty, and decentralisation.”

Some wonder if the central banks are simply playing catch-up with the crypto narrative, thus conflating two wildly different technologies. That is an opinion shared by Mark Basa, director at HOKK Finance. Basa said: “The next generation may grow up entirely on the blockchain. That means the first account they’ll ever open may just be a crypto wallet with a decentralised currency. I think the banks know that and this is their way to stop the currencies from falling into blockchain.”

But CBDCs could succeed in one aspect where bitcoin has failed. Given bitcoin’s harsh gas fees, the cryptocurrency is effectively useless as a form of value transfer, domestic or internationally. On the other hand, CBDCs could reduce frictions in cross-border payments, depending on appropriate design choices, according to a report by the Bank for International Settlements.

CBDCs: Hidden intentions?

Despite serving different purposes, some believe the CBDC vs crypto debate should be looked at in the context of reeling in the unbanked populace.

The central banks could very well point to the Terra Labs disaster and wider crypto market volatility with an I-told-you-so grin on their faces as a way of pushing the CBDC agenda. Whether stung investors take note is a matter of speculation, but “many have fled already in the recent market correction,” said Barton, adding: “Others may move to CBDCs when available, since some of these users may not understand the differences between cryptocurrency and what governments are proposing with their digital alternatives.”

While crypto pessimism varies from government to government – ranging from China’s outright ban on transactions to El Salvador making bitcoin legal tender, with the US hovering somewhere in the middle – crypto regulation is a near-universal trend. Controversies surrounding Tether in 2021 and Terra Labs’ recent death spiral have only kicked this trend up a few gears.

Thus some are positioning CBDCs into the wider regulatory conversation, as governments seek to wrest at least a bit of control over the digital-asset economy. Dion Guillaume, global head of PR and communication at Gate.io, said: “The biggest motive I see for governments to enact a CBDC is to provide stability, control growth, and influence inflation through the country's central bank, rather than relying on digital currencies with little to no oversight.”

But try as they might, the benefits of CBDCs will undoubtedly fall on the deaf ears of many crypto natives, who, according to Basa, “won’t buy into it and will probably dive deep, further away from CBDCs.” Despite encroaching regulation, DeFi and decentralised exchanges will still allow ways of circumventing perceived government overreach.

The issue of privacy

Privacy is a primary concern when discussing the difference between CBDC and cryptocurrency technologies. 

Guillaume said: “With crypto, governments and regulators have an issue with them running an almost parallel economy with no proper government supervision. CBDCs give them oversight over digital payments.”

Diving into the Federal Reserve’s Money and Payments: The U.S. Dollar in the Age of Digital Transformation research paper from January 2022 produces the following: “Protecting consumer privacy is critical. Any CBDC would need to strike an appropriate balance, however, between safeguarding the privacy rights of consumers and affording the transparency necessary to deter criminal activity.”

The paper also outlines what it calls an “intermediated model” between the Federal Reserve and the private sector (that is, commercial banks and non-bank financial services providers). Since the Federal Reserve does not facilitate individual bank accounts, it would retain liability of the CBDC while engaging the “use of the private sector’s existing privacy and identity-management frameworks”.

The UK House of Commons economic affairs committee’s paper Central bank digital currencies: A solution in search of a problem? flagged privacy as one of its key concerns. “How can a CBDC ensure strong privacy safeguards while also meeting financial compliance rules? Which organisations will be able to access sensitive CBDC payments data, and for what purpose will that data be used?” the paper asked.

No crypto enthusiast is likely to sacrifice the privacy afforded by bitcoin in return for the stability afforded by CBDCs. Whether newcomers to the financial system can be swayed is another story.

Public appetite

Jae Yang, head of non-custodial crypto exchange at the software company Tacen, recently submitted a testimony to the Wyoming legislature regarding the state’s interest in CBDC technology. In Yang's view, “The public appetite for CBDCs, particularly among regulators and institutional investors, is growing by the day amid increasing pressure for a sensible and responsible regulatory framework.”

recent poll of the British public into a UK digital  “Britcoin” was largely negative, despite the clever name. Of the 25,000 polled by POLITICO and Redfield & Wilton Strategies, 30% thought a CBDC would be more harmful than beneficial to the UK, against 24% with the opposing viewpoint. The majority remained unsure. An ongoing public consultation in the European Union has so far yielded largely negative feedback, citing concerns about privacy, security and the elimination of cash.

The US Federal Reserve completed a public consultation in May 2022, and while specific data is yet to be collated, all submitted commentary is publicly available. It is hard to find a positive word to say among the thousands of replies. Cynicism over the Federal Reserve’s intentions seems to be a motivating factor, often veering into the conspiratorial realm. One response read: “The only thing the Fed should be ‘considering’ is whether they want to contribute to Freedom or Tyranny. For Freedom: the free market decides what money is. For Tyranny: CBDC.” Another respondent wrote:  “A totalitarian takeover of the entire finacial [sic] system would be unavoidable.”

Positive responses tended to focus on international competitiveness. “if we do not get on-board with this, we will be v left behind. We need this in order to maintain the dollar being the world's most important currency,” read one. “Why aren’t we the leaders in this endeavor? We have the strongest economy in the world, we should be the leader in CBDC not determining what we do based on what other countries are doing,” read another.

In comparison, a global survey conducted in Q1 2022 by Bitstamp discovered that more than three quarters of retail consumer investors expect crypto to go mainstream in 10 years, and more than half would buy goods online with crypto.

CBDC vs cryptocurrency: Final thoughts

Cryptocurrency has the benefit of longevity behind it, and is probably better understood than CBDCs, which  may be why public opinion seems considerably more positive at this stage for crypto compared to CBDCs.

All the same, there is a feeling that CBDCs are an inevitability. In Yang’s opinion: “Between President Biden’s crypto executive order in March and most recently the Terra/Luna crash, the crypto industry has been under increased regulatory scrutiny. In my view, it’s only a matter of time before a CBDC is passed into law, given the central role they can play in the crypto ecosystem.”

China is on a clear path to full CBDC implementation while in the West, not only do governments seem fixated on the subject, but the global payments system SWIFT is going all-in on the technology. What is less certain is what impact this will have on the cryptocurrency market.

Crypto has taken a battering recently, but it seems unlikely that crypto natives will be swayed by the potential benefits of CBDCs, given their privacy risks and general lack of utility in the DeFi and Web 3.0 spaces. But for newcomers entering the financial system for the first time, deciding between a CBDC or cryptocurrency could be harder.

Can the crypto economy and CBDCs coexist? According to Guillaume, “It depends on the policies [the central banks] choose. Are they OK with running CBDCs side-by-side with crypto, or are they going to squash crypto to boost CBDC utility?” With central bank digital currencies likely to be a major talking point in the years ahead, we will have to wait and see.

FAQs

The CBDC vs cryptocurrency discussion is misleading. For all intents and purposes, CBDCs are simply digital versions of existing fiat currencies, thus directly influenced by monetary policy and inflation/deflation. They lack the trustless, decentralised aspects of cryptocurrency.

Unlikely, since they serve different purposes, although CBDCs will undoubtedly have an impact on the cryptocurrency sector. To what extent depends on the policies between jurisdictions. Governments with a pessimistic attitude to crypto may very well use CBDCs as a way of reducing the influence of stablecoins.

CBDCs are more stable than cryptocurrency, since they are fiat, but cryptocurrency has the advantages of being decentralised, trustless and private. The CBDC vs crypto debate will likely become louder in the years ahead.

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