Central bank digital currencies: Risks, not rewards

Worryingly, about 130 national governments (representing 95% of global GDP, including all G7 members) are exploring the adoption of Central Bank Digital Currencies (CBDCs). CBDCs will provide no material, tangible benefit to people whilst risking an economic crisis, hurting commercial banks, and invading our financial privacy. This is assuming CBDCs are adopted by populations, which has been shown not to be the case.  

CBDCs are a digital form of a sovereign fiat currency, backed and held by the Central Bank rather than private entities. They are designed to enhance financial efficiency.  

With the introduction of financial applications such as cryptocurrencies, private bank money, and stablecoins, there is arguably a need to maintain the ‘singleness’ of money, ensuring that £1 remains £1. According to the Bank of England (BoE), a well-functioning monetary system relies on both public and private forms of money being exchangeable one-for-one. The BoE believe that “singleness supports both monetary and financial stability and the effective and efficient functioning of the real economy.”  

Ecuador was one of the earliest countries to introduce a CBDC in 2014, but due to limited adoption and operational issues, it scrapped the scheme in 2018

A significant benefit of CBDCs is that they provide competition for private payment systems, reducing market concentration and challenging the market dominance of VISA and Mastercard. It may reduce fees at the margin, but it is unlikely to dislodge their duopoly, with their main competitive advantage being international payments. CBDCs are national in scope and therefore cannot replace this mechanism.   

CBDCs act as a safe asset, one not at risk of commercial banks failing to manage deposits. However, this benefit ironically comes with significant risk. The BoE has modelled that 20% of deposits would move to CBDC wallets, potentially causing a credit crunch. The widespread adoption of CBDCs means deposits will leave commercial banks and be transferred to the central bank. Therefore, commercial banks would have less funding for lending, leading to more expensive credit, and tighter lending criteria. The BoE recognises the importance of commercial banks in creating new money, and basic economic theory would argue that reduced lending will reduce consumption and investment.   

However, this situation is unlikely to happen. Firstly, CBDCs have a 0% interest rate, which means only some deposits (mostly from current accounts) may move, still leaving commercial banks with significant deposits from savers. Furthermore, we have seen the failures of CBDC adoption in Nigeria, where only 1.5% of wallets are active on any given week, and less than 1% of the bank accounts in the country have wallets. This isn’t the only CBDC that has struggled to gain traction.  

The Bahamian Sand Dollar is struggling, and accounts for only 0.16% of all currency in circulation in the Bahamas. Meanwhile, the Jamaican CBDC drowns at 0.11% despite incentive bonuses for the first 100,000 people to sign up, education campaigns, and merchant outreach. Ecuador was one of the earliest countries to introduce a CBDC in 2014, but due to limited adoption and operational issues, it scrapped the scheme in 2018. These aren’t just cherry-picked examples; they are among the few countries to have adopted a CBDC. 

I think it’s relatively safe to say that whilst a Credit Crunch is an intuitive theory, it’s unlikely that a CBDC would be adopted enough to have any tangible impact on commercial banks.  

CBDCs will provide negligible financial benefits, and yet they carry significant social risks. The Central Bank will oversee all transactions using CBDCs, allowing it to track where, when, and how people spend money. This gives the government unprecedented surveillance powers over our everyday lives. From a financial privacy perspective, this is not only worrying, but also dangerous.  

The concentration of significant payment data in the hands of central banks provides a strong incentive for cyberattacks.

I personally would rather keep my financial transactions private; there is no need for the government to collect data on my purchases. What is even more dangerous is the potential security concerns. The concentration of significant payment data in the hands of central banks provides a strong incentive for cyberattacks. People’s personal data and extensive payment history are like moths to a flame to hackers. Furthermore, many CBDC designs integrate with commercial bank accounts and payment apps, meaning that if hackers exploit a vulnerability, there would be cascading failures across the banking and payment systems. Any successful attack would destroy public trust and confidence in CBDCs.  

Due to this significant operational and systemic risk, the system will require extensive cybersecurity measures, which are likely to be expensive. However, most countries exploring and experimenting are focusing on policy goals, with little consideration paid to cyber resilience.   

In effect, governments are exploring a policy that will have little benefit to citizens but create immense risk, all while costing people their financial privacy. If the benefits were sizeable and adoption rates were high, the debate could shift slightly, though I would still worry about their implementation. CBDCs are an example of high risk, low reward, and I recommend governments allow other countries to try and fail before taking the leap themselves.