Uncovering the Benefits and Risks of Central Bank Digital Currencies: An In-Depth Analysis

The cryptocurrency industry constantly evolves, with new trends and developments rapidly emerging. While some of these trends, such as DeFi and NFTs, have the potential to drive innovation and provide users with new opportunities, one growing trend in the space signals cause for concern as it goes against the fundamental principles behind cryptocurrencies and the decentralized finance movement.

Enter CBDCs:

Big Brother’s weapon of choice to suppress your financial freedoms and curb your access to a pseudonymous and decentralized finance system. 

Central bank digital currencies (CBDC) have been gaining attention as a growing number of countries worldwide are exploring the potential of launching their own digital currencies. According to the Atlantic Council, over 20 countries will take significant steps toward piloting CBDCs in 2023, with over 100 countries in some stage of CBDC research, development, or implementation.

CBDCs are digital currencies issued and regulated by a central bank or monetary authority, tokenized on the blockchain or a digital ledger, and pegged to the value of the country's fiat currency.

They are considered a way to increase transaction efficiency, reduce the cost of banking services, promote accessibility, and potentially reduce the risk of money laundering and other financial crimes. While CBDCs could offer a range of advantages, such as improved efficacy and control, individuals must consider several drawbacks.

Understanding CBDCs

Central Bank Digital Currencies are a digital representation of a country's fiat currency issued and backed by the central bank.

With more countries exploring the possibilities of CBDCs,  it's crucial to understand their implementation.

Firstly, it is essential to note that CBDCs are not a panacea for all financial problems. They have risks and challenges that countries must evaluate before adopting them.

Second, the adoption of CBDCs must be carefully planned and implemented, meaning that countries must conduct thorough research and develop appropriate regulations to ensure that the benefits of CBDCs are maximized while minimizing potential risks. Intrinsically,  this will further centralize the financial system and increase power for central authorities.

Third, countries must ensure their citizens are well-informed and prepared to use CBDCs, provide clear guidance on using the currency, and educate citizens on the risks and benefits of using digital currencies. Introducing CBDCs would require significant investment and resources, potentially outweighing their benefits, particularly for countries with well-established financial systems.

The primary motivation behind CBDCs is to promote digital money instead of physical cash, as the demand for paper currency has decreased. This is mainly due to the advancements and advantages of digital finance and payment systems and the COVID pandemic, which accelerated the shift away from cash. Central banks and monetary authorities are exploring implementing digital currencies to tackle the challenges of storage, safety, limitations in large transactions, and complications of cross-border transactions associated with using cash.

Central banks are also attempting to address the public's desire for digital currencies, seen in the growing popularity of cryptocurrency, to purportedly protect retail investors from the inherent risks of unregulated assets such as volatility and exploits. Despite some potential benefits, the drawbacks of CBDCs outweigh them.

Risks of centralized control over digital currency

CBDCs present several risks, including security issues, potentially adverse effects on financial stability, and significant privacy concerns.

The introduction of CBDCs raises several concerns about the invasion of privacy, with the government or central bank at the helm of these digital currencies. CBDCs threaten citizens' privacy, as the central authority can monitor and track all transactions, allowing them to surveil individuals' purchases and spending activities. Such scrutiny could expose intimate details about people's values, priorities, and lifestyles, undermining their privacy and civil liberties. The advent of CBDCs could signal the death knell for cash and the rise of the all-seeing eye over our every spending move. A cashless society could mean more surveillance and less privacy, making reality feel like an Orwellian nightmare.

Implementing CBDCs could exacerbate economic inequality. Government control over CBDC issuance likely leads to the continued prioritization of certain groups accessing financial services. For instance, governments show favoritism to their voter base through economic incentives or support. Likewise, the potential weaponization of CBDCs to financially inhibit and limit the spending of individuals and groups who do not align with the ruling party is a concern for a democratic society. This weaponization of CBDCs to suppress opposition would lead to the erosion of democratic values and the gradual descent into an authoritarian state.

Additionally, CBDCs pose a threat to savers as central banks could introduce negative interest rates on CBDCs. Landing a severe blow to anyone trying to save money, as instead of earning interest, they would be charged for holding CBDCs in their accounts. While this may stimulate economic growth in the short term, it could also lead to inflation and have long-term negative consequences for the economy, and infringes on individuals' financial freedoms.

The pandemic and inflation crisis has highlighted a crucial lesson: those in power fail to realize that we cannot print our way out of problems. CBDCs may seem like a solution, with their ability to circumvent traditional obstacles such as transaction speeds and storage costs. However, with their potential for limitless money creation, CBDCs could accelerate the already rampant issue of hyperinflation and send the economy into a meltdown. 

Critically, CBDCs place DeFi as a direct competitor in digital currencies. As CBDCs become more widely implemented, they will likely attempt to displace decentralized cryptocurrencies and platforms. The emergence of CBDCs is expected to significantly impact the regulation of cryptocurrencies as governments work to establish their dominance in the digital economy.

Final thoughts

CBDCs, despite their promises of increased economic inclusion, faster payment speeds, and reduced transaction costs, pose a significant threat to our privacy and financial freedom.  

It is essential to weigh the trade-offs between centralization and decentralization as the world embraces digital assets. While CBDCs may offer more stability and control for monetary authorities and governments, DeFi allows for a level of innovation and sovereignty stifled by the centralized nature of CBDCs. The ability for anyone to participate in financial services without the need for an intermediary is a crucial aspect of DeFi that CBDCs cannot match. 

From the perspective of someone who values financial freedom, I firmly believe that CBDCs are an unnecessary and potentially dangerous answer to the financial industry’s problems. DeFi offers a more secure and private alternative that empowers individuals to control their finances. Ultimately, it is clear that decentralized finance is the only viable option for the future of freer finance, and it is a core reason why I decided to start building Glitch in the first place.