CBDCs, short for Central Bank Digital Currencies, are digital forms of currency that are issued and regulated by central banks. They aim to combine the advantages of digital technology with the stability of traditional fiat currencies.
Unlike Bitcoin or Mintlayer’s ML tokens, which are decentralized and not backed by any government or central authority, CBDCs are created and controlled by central banks. These digital currencies are secure, transparent, and accessible to individuals and businesses while working in the framework of existing banking systems.
Even though CBDCs are centralized they retain some properties of cryptocurrency like preventing double spend, requiring validators, and the underlying technology.
CBDCs can be used for various purposes, such as making payments, storing value, and conducting financial transactions in a digital environment. The development and adoption of CBDCs are being explored by central banks worldwide.
Types of CBDCs
The planned design of CBDCs follow three models. These are direct, indirect, and hybrid.
Direct CBDC: In a direct CBDC, the government’s central bank interfaces directly with end users. In this scenario, the central bank will take on roles that they have traditionally delegated to commercial banks. This model removes intermediaries, but dramatically increases the role of the central bank and requires real-time communication. The user currency interacts directly with the central bank’s ledger, which would have to be designed to handle a large amount of transactions.
Indirect CBDC: In an indirect CBDC, the government’s central bank only supports interface with other banks. This model maintains traditional finance infrastructure, may be easier to integrate, and allows deferred communication to the central bank. Commercial banks would make daily settlements with the central bank, decreasing the load on the primary ledger.
Hybrid CBDC: In a hybrid CBDC, user’s assets are directly recorded on the central bank’s ledger, but additional value is added through commercial banks and payment processors.
Mintlayer is suited for all three use cases. It’s especially useful for indirect and hybrid models. Commercial banks can use Mintlayer’s special implementation of the Lightning Network and Mintlayer’s sidechain to add functionality while reducing the load on the primary blockchain.
Potential Benefits of CBDCs
CBDCs offer the potential to enhance financial inclusion by providing an accessible digital payment system to the unbanked.
They also play a role in modernizing the financial system. By leveraging the advancements in technology, these digital currencies can streamline payment processes, reduce transaction costs, and enhance the speed of transactions. Governments can also streamline their operations by integrating digital applications for tax reporting and payment.
This can benefit citizens by providing a more efficient and convenient means of conducting transactions.
CBDCs can address concerns related to privacy and security. With proper regulations and safeguards in place, CBDCs can reduce the risks associated with counterfeit currency, fraud, and unauthorized transactions.
Using CBDCs can enable better traceability and transparency. CBDCs will help combat money laundering and illicit financial activities.
CBDCs provide central banks with a tool to strengthen monetary policy. These digital currencies can offer more precise control over the money supply, allowing central banks to manage economic stability, inflation, and interest rates.
Disadvantages of CBDCs
A major concern citizens have for CBDCs is the possible compromise of their privacy. Digital currencies could have overt or covert reporting mechanisms to the government that controls them. Mundane transactions could trigger red flags that invite extra scrutiny and government control.
If your government suspects you of misreporting financial data or misusing their currency, they could freeze all of your assets held in their CBDC. Your friends and family could be scrutinized and attacked as well–as a means to coerce your cooperation.
CBDCs would be susceptible to cyber attacks. They might offer a large attack surface for cyber criminals if there is added functionality and compatibility.
Fraud is a primary concern for any country that wants to transition their population from fiat currency to a digital currency. Chainanalysis found investors lost $14 billion to cryptocurrency scammers in 2021. The FBI reported Americans lost $10 billion to online fraud in 2022 in the US alone, up from $6.9 billion in 2021.
The average citizen may not be sophisticated enough to secure their own assets digitally. Older adults and young people are particularly vulnerable to digital fraud.
CBDCs centralize control in the hands of the government that issues them. Governments and government employees are fallible. Even if the actual CBDC is secure, the ledger containing sensitive information will likely be copied, shared, and stored improperly by government employees.
Governments already collect a substantial amount of data on their citizens via census taking, and tax filings. CBDCs will increase the amount of data surveillance a government can engage in.
Some skeptics believe that the future could look like a dystopian science fiction novel where governments combine their CBDCs with a social credit scoring system. Citizens will get discounts for complying with government demands and reporting their neighbors. Citizens will face penalties if they do not comply with government suggestions. This may seem far-fetched, but we witnessed governments quickly ramp up surveillance and coercion during the COVID pandemic.
Countries Engaged in CBDC Research
Digital Currency Electronic Payment (DCEP), China: The People’s Bank of China has been working on the DCEP project for several years. This is arguably the most advanced CBDC project.
e-Krona, Sweden: Sweden’s Riksbank has been studying the feasibility of the e-Krona, especially as the country rapidly moves towards being a cashless society.
Sand Dollar, Bahamas: The Central Bank of The Bahamas has advanced its plans for the “Sand Dollar,” a digital version of the Bahamian dollar. This project was in a pilot phase.
Digital Euro, European Union: The European Central Bank (ECB) has started the digital Euro project, which is in its research and design phase.
Britcoin, UK: The Bank of England, together with HM Treasury, has established a taskforce to coordinate the exploration of a potential UK CBDC, sometimes referred to as “Britcoin.”
Digital Dollar, USA: The Federal Reserve is researching a digital version of the US Dollar, but the project is still in its early stages.
CBDC, South Korea: The Bank of Korea has launched a pilot program for a central bank digital currency.
Digital Yen, Japan: The Bank of Japan started conducting experiments on issuing a CBDC.
mCBDC Bridge, Hong Kong-Thailand-China-UAE: A joint project by multiple central banks to develop a cross-border CBDC.
CBDCs In Practice
The first country to consider CBDCs was China in 2014. China’s DCEP (Digital Currency Electronic Payment) features an NFC based payment option that doesn’t require an Internet connection. This makes it a plausible replacement for cash because DCEP can be traded anywhere in the world.
According to statistics from the World Bank, 1.7 billion adults around the world use cash because they don’t have bank accounts. However, two-thirds of this population own a mobile phone, which can be used to make monetary transactions.
As China continues their “Belt and Road Initiative‘’ to expand trade routes throughout Europe and Africa, they needed a currency that could be used where there is no Internet connection. Their CBDC, the DCEP, would bypass existing financial infrastructures and allow unbanked to pay for both in-person and online purchases.
China hopes to have countries along their proposed “Silk Road” impose the DCEP on their people.
The U.S. on the other hand, has been less enthusiastic about CBDCs. Most U.S. lawmakers believe that they already have a robust digital payment landscape. Jerome Powell held the opinion that most of the challenges CBDCs aim to solve do not apply to the U.S.
China also wants to move away from existing banking infrastructure such as SWIFT, which they believe is heavily monitored by the U.S. government. There is evidence that SWIFT allows the U.S. government to spy on users.
CBDCs are an offensive strategy by some countries to usurp the US Dollar as the world’s reserve currency. In this paradigm, China wants to present a CBDC with many advantages, and the US wants to develop a CBDC that is interoperable with their existing fiat.
Bitcoin as an Alternative
CBDCs maintain the government’s power over monetary policy. Bitcoin is a borderless digital currency that gives power to its users.
While the world leaders spend their time digitizing fiat, countries in South America, Africa, and Southeast Asia are adopting Bitcoin as their preferred digital currency.
Leaders have welcomed Bitcoin as a savior in countries suffering from inflation and a lack of trust in their domestic fiat. Traditionally, these countries would have brought in U.S. dollars to stabilize their markets and allow their citizens to buy necessities. Now, Bitcoin does the same without ceding control of their monetary policy to a foreign country.
We have witnessed countries like El Salvador make Bitcoin an official currency. Other countries like Nigeria have seen dramatic adoption of Bitcoin. 33.4 million Nigerians have either owned or traded cryptocurrencies—that’s a 35% adoption rate among people between the ages of 18 and 60.
Bitcoin Reaching Institutions With Mintlayer
There is no scenario where changing the national currency to Bitcoin is attractive to large governments like the U.S. and China. However, it may be advantageous to make their CBDC as interoperable with Bitcoin as possible since it is leading adoption in the rest of the world.
This is where Mintlayer comes in. Countries can use the open source Mintlayer protocol to build out a robust currency system that handles hundreds of uses, but is still directly tradeable with Bitcoin via atomic swaps.
Countries can even use Mintlayer to issue their own CBDCs that are interoperable with Bitcoin. A decentralized system would ensure government transparency and improve equality. A CBDC built with Mintlayer would also open up investment and services to individuals that already use Bitcoin.
With smaller countries moving to Bitcoin in the future, the cumulative liquidity available will be immense.
Bitcoin adoption by the world’s largest governments is unlikely. Economic power is closely related to their control over monetary policy and how much of that policy they can export to other nations.
For mid-sized and smaller countries, Bitcoin can be an attractive alternative. It allows countries to adopt an existing digital currency that already has support systems without contributing to the monopoly of a major world power.
Mintlayer is the perfect platform for countries that use Bitcoin to build decentralized applications for a wide range of government services. We have developed novel ways to offer tokenization of government services, smart contract capability, and payments that offer advantages over existing infrastructure.