Central Bank Digital Currencies (CBDCs) have been one of the hottest topics in the world of blockchain lately– and for good reason. The financial services industry has been reaping the benefits of blockchain technology for several years, from improving the efficiency of outdated financial frameworks to improving the liquidity and viability of more niche asset classes, like green electricity options. It was only a matter of time before central banks sought to capitalize on blockchain’s benefits in the form of digital currency. 

The benefits of CBDCs are clear, especially when it comes to international finance and transfers. The current international financial system is underpinned by code from SWIFT, a private company with a monopoly on the framework for cross-border payments, remittances, settlement, and clearing. Yet SWIFT code, written in the 1970s, is far beyond repair. Aside from obvious concerns around security and the integrity of data, the transfer and exchange processes are extremely slow and cumbersome, and in dire need of updating. Until the arrival of blockchain, though, no viable alternative had emerged. 

Hardwired for security, efficiency, transparency, traceability, and scalability, blockchain is already laden with essential traits for digital currency. The benefits of the technology for regulators and central banks reach far beyond speed and efficiency. With CBDCs, it becomes easier to implement new monetary policies, while blockchain’s traceability and transparency could bring about the end to issues of counterparty risk and even international money laundering and tax evasion. Given the benefits, it's no surprise that in every region of the world, central banks have begun consultations and pilots–  China is trialing the digital Yuan, Sweden the E-krona, Nigeria the eNaira, and so on. 

While there exist pilot projects in the work, the future of CBDCs is still uncertain and gives rise to fundamental questions about where this burgeoning technology will lead. Aside from questions around what CBDCs will eventually look like, there are crucial concerns around the challenges of implementing them, data privacy, and whether they are in fact a better long-term solution than traditional cryptocurrency. 

Challenges with implementation

Like any emerging technology, it’s unclear what CBDCs will ultimately look like. There are two primary predictions about where the technology will go. The first predicts CBDCs to be an infrastructure tool– a background process used only by central banks and international monetary organizations, and essentially a one-to-one replacement for the outdated SWIFT framework. The second predicts CBDCs will replace all currency, replacing national or supranational currencies such as the US Dollar or Euro with new, entirely digital entities. Naturally, the second route would follow the first, so you could argue the initial infrastructure will be a stepping-stone for the latter. 

As an administrative tool, CBDCs would barely impact citizens’ daily lives, and while using them this way would be complicated initially, it pales in comparison to the difficulties of entirely replacing traditional currency. Even if implementation by banks is seamless and uniform, like the adoption of Europe’s PSD2 regulations, it would be a major learning curve for everyday consumers. There is a huge gap between being capable of using a mobile banking app and understanding how to keep secure custody of digital assets such as digital currencies. 

This leads to the question of how far a widespread implementation could actually reach. Even in economically developed nations, there are large areas with limited or no internet or mobile phone signal. Earlier this year, the Pew Research Centre found that 7% of Americans don’t use the internet. When you look at less economically developed nations, this figure skyrockets– the World Bank estimates that only 29% of Sub-Saharan Africans use the internet. There are already concerns with the unbanked, and widespread implementation of CBDCs could exacerbate this problem. That said, in an increasingly digitized world, the problem of providing internet access (let alone affordable access) isn’t unique to digital currencies, and the emergence of them – whether in the form of CBDCs or cryptocurrencies – could kick-start us into thinking of solutions faster. 

Concerns around privacy

Many crypto proponents shun the notion of CBDCs on the question of privacy alone. When Satoshi Nakamoto published the whitepaper, early adopters were drawn to the principle of anonymity and the ethos of decentralization away from the authority of national and international monetary organizations. While abuse of anonymity with cryptocurrency remains a problem – claims that it can be used for black market purchases are not unfounded – there are many who argue this misuse is a small price to pay for financial privacy. 

While it’s shortsighted to say the technology underlying cryptocurrencies cannot be used in centralized financial systems, CBDCs do fundamentally contradict the ethos of crypto and reveal a risk around privacy that is very real and should be taken into serious consideration. A CBDC founded on the blockchain is transparent and would theoretically permit authorities such as government agencies or police services to tap into its financial data and reveal information about its citizens. The same arguments that have raged for the past decade around phone tapping and state-sanctioned hacking apply here.  

With CBDCs, there’s also a risk of things like social credit systems being implemented. We’re already seeing concerns about the digital Yuan being used in China to bolster its social credit system. Akram Keram from the National Endowment for Democracy argues in the Washington Post that with “digital yuan, the CCP [Chinese Communist Party] will have direct control over and access to the financial lives of individuals, without the need to strong-arm intermediary financial entities.” While banks and financial institutions do already share financial data with governments, this begs the question of whether a centralized digital currency is in fact the best long-term solution. 

CBDC vs. cryptocurrency

In recent years we’ve witnessed a lot of state resistance to cryptocurrency. In 2020, the UK’s financial regulator, the Financial Conduct Authority, banned the sale of crypto derivatives to retail consumers– a move some argue was only made because the FCA doesn’t have the remit to ban cryptocurrency itself. 

El Salvador became a trailblazer in 2021 by making Bitcoin legal tender. Though Bitcoin receives criticism that it is too volatile to function as the sole currency for a state economy, this move was a major departure from the international focus on developing centralized digital currencies as the alternative to emerging cryptocurrencies. 

It’s worth noting here that the notion of Bitcoin (and other cryptocurrencies) being an investment before a currency is relatively new and cemented primarily by the emergence of investment-first instruments like NFTs. There is still a strong vein running through the crypto community that the token should be used for currency first, especially among those who value decentralization over convenience. 

It’s still unclear whether El Salvador is an anomaly or pioneer when it comes to cryptocurrency acceptance, and whether its move to make Bitcoin legal tender will open the door to similar moves by other countries, or if they will stick to developing bespoke CBDCs. By extension, it’s also unclear whether people will buy into a new CBDC-driven economy or turn to decentralized cryptocurrencies to preserve their privacy. Records suggest that average consumers are willing to trade privacy for safety or convenience, but if they’re ever denied a loan because a credit rating agency has decided they spend too much money on coffee or taxis– something which doesn’t seem out of the question with CBDCs– their views may change rapidly.