The problem with governments and programmable currency
January 10th, 2022
Assorted euro notes laid out in an overlapping pile
Assorted euro notes laid out in an overlapping pile

Photo by Ibrahim Boran on Unsplash

2022 looks set to be the year of Central Bank Digital Currencies (CBDCs). Despite their convenience and cost savings, we should be wary of the consequences.

Just as China led the way in the issuance of paper money, it is once again taking the lead in the next phase in financial evolution: state-backed digital currency. In the time since the mining of the Bitcoin genesis block thirteen years ago, central banks have been researching how to adapt the technology to their own purposes: the Bank of England was thinking about this back in 2016.

As we start 2022, scores of countries are researching the idea, while others such as Sweden have already launched pilot projects. The Bank of England confirmed last year that it is working on a digital pound — which the media promptly dubbed BritCoin. Cambodia and the Bahamas have also powered ahead with their own schemes. However, China’s Digital Currency/Electronic Payments programme, which allows citizens to spend e-CNY (digital yuan) with a mobile wallet approved by the People’s Bank of China (PBOC), is the one that economists and technologists are watching most closely.

During a series of pilots in regions such as Suzhou and Shenzhen, billions of dollars’ worth of digital yuan have been spent by consumers, with prominent foreign brands such as Starbucks and McDonalds also participating.

Why is this different from the digital money we already use?

Unless you are one of the one billion unbanked people in the world, you may be wondering what all the fuss is about. We already transact almost exclusively digitally in many countries. The pandemic has accelerated the trend away from cash, and many people — especially those in urban centres — may go for weeks without using notes or coins for transactions. Sweden may become the first cashless society as early as next year.

However, there is one crucial difference between the digital payments we make now and the ones we will make with CBDCs. When someone in London, New York or Paris pays for a coffee with a card, phone or watch, the payment may be denominated in pounds, dollars or euros but it is being routed via a payment network to and from a commercial private bank. For the purposes of this explanation, fintechs such as Revolut — technically an e-money institution with a banking licence in the UK — are included in the category of ‘bank’.

While this system appears to work smoothly, this process is built on cumbersome legacy technology, created over decades and upgraded many times. Banks have to settle payments with each other, and running different systems across many different companies and networks results in much unnecessary cost and friction, even at a domestic level.

These problems are amplified, of course, for international payments, where transactions can take days or even weeks to be settled.

Additionally, banks provide payment services in the expectation that they will make a profit, and in many countries, fees are levied on basic checking accounts. This means that the poorest people in the world, who cannot be upsold sophisticated financial products, are often unable to access banking services.

In a pre-digital age, this caused many inequities but people could generally get by without banking services just because they had always done so, even if this left them at the mercy of wire services that charged extortionate fees. For local payments, a patchwork of solutions has evolved to remedy this problem, including the use of mobile money such as mPesa in parts of Africa.

It is this gap that CBDCs aim to fill. A mobile wallet released by a central bank may look very like a Google Pay wallet, or a Monzo or Revolut app, but the difference is that the payment can be routed directly via a computer network run by a central bank, most likely using a blockchain-like architecture on which transaction data are stored in an immutable ledger held on a cluster of servers to which only bank officials have access.

What does this mean for consumers?

It is entirely possible that on a day-to-day basis, not much will change for end users. The pilots in China have shown that people have quickly got used to using mobile wallets containing digital yuan. The denomination of the currency is the same, and the user experience of making and receiving payments is sufficiently similar to any other digital wallet, such as AliPay.

However, the superficial similarities mask one fundamental difference: the central bank — and by extension, the government — now has a real-time view of exactly what everyone is spending their money on.

This is a concern because the ability to make anonymous transactions is important in an ethical, functioning society — not in the sense of money laundering or tax evasion, which can be prevented in other ways, but in the sense of giving us the freedom to transact legally in a way that does not expose our data. For example, take the man cited here who said that he never uses his card to pay in state-run shops selling alcohol because he does not want the bank to know how much he spends on wine. In an authoritarian society, you would probably not want the owner of your transaction data — the government — to know that you had bought certain books, rented certain films or visited certain people.

Officials at the People’s Bank of China have spoken of “controlled anonymity” in an attempt to reassure those worried about this giant data grab, but once technology has made something possible, it is hard to imagine governments resisting this particular honeypot.

How can money have an expiry date? The problem with programmable money

The issues with CBDCs run far deeper than simply handing over a wealth of personal data to governments, to be strip-mined at their will. The technical architecture that is being used for most CBDCs enables smart-contract functionality, whether this is used or not. In simple terms, this means that money can be programmed so it can only be spent on specific items.

The initial intention may not be for these state-issued currencies to be programmable, but endowing them with programmable properties opens up a whole new world of possibilities for finance departments and behavioural economists.

For example, both China and Canada are experimenting with expiry dates for their digital cash. This is something that rarely happens with physical cash: normally, if the notes or coins become deprecated (as happened with the UK’s move to pound coins from pound notes), there is a long period where old money can be exchanged for new, with the same face value.

Digital cash that expires is the ultimate Keynesian tool for directly expanding or contracting the money supply — in other words, it can be used to penalise those who prefer to save their cash rather than spend or invest it. If a central bank decides that the economy needs a temporary boost, they can decide to issue tax rebates or bonus payments that have to be spent on consumer items within a certain period: use it or lose it.

When programmable money is combined with other data layers such as health information or social credit systems, this property becomes even more dystopian. Imagine taxation rates on alcohol or unhealthy food that rise incrementally once you exceed your weekly allowance, or a thousand other ‘nudge’ techniques designed by behavioural economists with the best of intentions but the worst of outcomes.

This is not to say that CBDCs will inevitably be used in this way, but once the technology is in place and if there is no other way of paying for goods and services other than via payment rails administered by governments, it will be too late to do anything about it.

What are the alternatives?

CBDCs can never be seen as a one-stop solution. Fintechs, decentralized currency networks and stablecoin projects are all working on solutions to streamline payment systems and bring useful new features and functionality to the way we transact. A payment solution that is beneficial for everyone is more likely to be a loosely coupled, interconnecting network of decentralized payment systems, private payment solutions and central bank infrastructure rather than a monolithic entity controlled by one organisation.

Lowering costs and broadening access to digital payments are important improvements, but central banks should resist the temptation to overstep their remit and do more than simply pay lip service to anonymous transactions.

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