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The era of central bank digital currency (CBDC) is coming? Interview with dr Tomasz Michalak

Central bank digital currencies not necessarily need to replace existing forms of money, may operate not instead but next to other instruments, be an additional payment option. However in black scenario, the governments might want to supervise and, if they feel it is necessary, block or delete the wallet of every user

25 August 2022

What is the difference between cryptocurrency and central bank digital currency (CBDC)?

TM: There are significant differences, although they are not necessarily immediately visible to the consumers. From the point of view of virtual wallet, digital currencies managed by banks or countries may be confusingly similar to cryptocurrency. However, in essence, they are not, because currencies issued and controlled by central banks or other institutions are based on assumptions that are contrary to the values and goals of cryptocurrency supporters.

The essence of the idea of cryptocurrencies is that they are “dispersed”. It means, that information on every transaction is recorded in blockchain being infrastructure owned and controlled to certain point by all users. This enables the functioning of the system of decentralized finance without the so-called “trusted third party” in the form of a bank, financial supervision, etc. This is the goal of the change (called “revolution” by the supporters) brought by development of cryptocurrencies: creating digital store of value, which may be owned or exchanged without one centralized managing institution. Central bank digital currency, similarly to traditional currencies, as the name implies, is issued and controlled by central bank. This is the key difference, which has pros and cons, depending on the point of view.

Do CBDC use blockchain technology or wider, decentralized computing registers?

TM: Blockchain technology or other types of digital registers lie at the root of digital currencies that are currently designed and tested by the countries. Governments and central banks research this subject, because to them introduction of the new form of currency has many advantages. For example, if transactions are conducted in peer-to-peer model, payment infrastructure offered by CBDC is more resilient to cyber incidents than payments in centralized model. Additionally, in such system costs of transaction may be lower, and the possibility of exchanging information and agreeing the details of transactions between contractors increases.

Where did central banks’ interest in digital currencies come from?

TM: Governments have been interested in digital currencies for years. Recently, in October 2021, Nigeria has introduced digital Nair and since then the number of persons using electronic payments through it has been steadily increasing. Another example of the trendsetting country is China, which also in recent years passed from the research stage to the so far cautious, experimental and local implementation stage. In case of this country it is probably related to popularity of cryptocurrencies among its citizens – or, wider, in the countries, which we would not describe as liberal democracies. In the opinion of many inhabitants of these countries, cryptocurrencies are an attractive alternative to saving and investing in their own currency. Additionally, in case of China with the prominent level of control of social and economic life, the introduction of the digital Yuan may provide the rulers with additional tools for conducting macroeconomic policy, as well as for tighter control over wallets, paying taxes and purchasing decisions of citizens.

The governments have been interested in digital currencies for years. Recently, in October 2021, Nigeria has introduced digital Nair and since then the number of persons using electronic payments through it has been steadily increasing (…) The problem is, that new possibilities also create opportunities for new forms of wrongdoings. A rational and beneficial for societies and economies financial policy requires the guardians of the financial system to be prudent and independent.

What would change if, for example, Poland introduced a digital zloty from the next year?

TM: The new ways of conducting macroeconomic policy by the government and the central bank would emerge. As of today, both institutions may influence key macroeconomic variables such as supply and demand only to some extent. Due to the programmable nature of CBDC, the government and the central bank would have an incomparably more flexible tool for conducting macroeconomic policy. They could, for example, shape the composition and distribution of demand, i.e. support chosen ways of spending or investing money by citizens.

Example form the recent past: covid financial aid could be precisely aimed to the sectors that really need it. The funds could be programmed, so that they could only be used to pay wages to employees or pay off liabilities to other companies. However, they could not be used to buy luxury goods, which is said to have been the case. I do not have exact data on the ways of using covid aid by Polish companies, however e.g. in 2020 the Lamborghini brand noted a historic record of orders in Poland. If digital zloty were to work, this type of situation could be effectively avoided.
Additionally, a digital zloty could have a specific expiry date. This would significantly increase, for example, the ability to conduct macroeconomic policy by the Ministry of Finance. The risk of “overdue” funds in itself would force consumers to make purchases and investments, and not, for example, to put off expenses and save, which limits the effectiveness of macroeconomic policy. Moreover, public institutions responsible for the financial system could, manoeuvre between deflation and inflation in Poland more easily. Such tools could be of considerable importance in the situation we found ourselves in after Russia’s attack on Ukraine

Many people criticize CBDC. What are the best arguments for and against the introduction of CBDC? What may decide about the adoption of such a solution?

TM: From the technical point of view CBDC has many advantages, what is the most important argument for implementation of this legal tender. Central bank digital currencies not necessarily need to replace existing forms of money. Digital central currency may operate not instead but next to other instruments, be an additional payment option.

The problem is that new possibilities also create opportunities for new forms of wrongdoings. A rational and beneficial for societies and economies financial policy requires the guardians of the financial system to be prudent and independent, e.g. from political pressure.

There may be also doubts raised by the methods and procedures in which financial innovations are introduced. We can imagine a situation where CBDC would suddenly totally replace cash. It is easy to imagine, that such action would not only discriminate against people unfamiliar with modern technologies (e.g. smartphones, applications, electronic accounts, etc.), but would also exponentially increase the ability to control the citizens.

Similar concerns apply to privacy and security of citizens’ wallets. In the world of CBDC, the governing entities decide on whether surveillance will apply to everyone, or only to people whose financial operations actually raise doubts (e.g. due to terrorist threats, “money laundering” or tax fraud). In black scenario, the governments might want to supervise and, if they feel it is necessary, block or delete the wallet of every user. Such a “switch” is a potentially powerful tool, the use of which should be strictly regulated not only from the perspective of citizens’ rights, but also the economic system as a whole. This, in turn, requires the development and testing of new theories as well as many years of macroeconomic research and analysis.

What can we expect on this topic in the coming months and years?

TM: CBDC experiment has already begun. Luckily, at least from the perspective of such countries as Poland, we are not the research subject. Today, all eyes of the parties interested in the future of currencies and monetary policy should be on countries like Nigeria or China. This is where in real time we can observe how does CBDS act in real economy, how do they affect the market and social life. Let us hope, that before we introduce such solutions ourselves, we will draw conclusions from the experiences of others beforehand.

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