The Central Bank Digital Currency(CBDC) is the Government’s attempt to create an equivalent Bitcoin except for this time it would be a centralized currency just like existing fiat currencies. Therefore, the major question would be which currency would likely come out on top, if the CBDC is finally launched, and what are the likely dynamics that would be at play?
Cryptocurrency really became a thing in 2009 after the most popular Crypto, Bitcoin, was made open source. Since then, Bitcoin’s adoption has grown massively in spite of various obstacles especially opposition from the government and mainstream investors, the opposition or resistance from the government majorly stems from the decentralized nature of cryptocurrencies with the digital currencies running on decentralized structures and Blockchain technology thus bypassing any centralized financial institution including the Central banks owned by the government.
Despite the varying resistance from the government including various forms of bans in various countries, Bitcoin has grown massively in barely 10 years, with Forbes reporting in 2019 that Bitcoin was now averaging 350,000 transactions per day at around 15,000 transactions every hour which is approximately 4 transactions per second.
Such massive numbers by a digital currency not yet generally recognized by the government as a legal tender is quite massive. The position of cryptocurrencies like Bitcoin as digital currencies also means they are also well suited to the increasingly digitized world, with the ability to make cross border payments, speculations or transactions from the convenience of your phone amongst other intrinsic benefits, seemingly appealing to a lot of people, especially the millennials.
Hence, when the news that the government of certain countries and other major financial institutions are actively testing the possibility of a digital currency to rival Bitcoin, it didn’t really come as a surprise as Bitcoin especially has hinted that a digital currency can actually work.
The Central Bank Digital Currency(CBDC), as most have reported it would be likely called, is the Government’s attempt to create an equivalent Bitcoin except this time it would be a centralized currency just like existing fiat currencies.
Therefore, the major question would be which currency would likely come out on top, if the CBDC is finally launched and what are the likely dynamics that would be at play? Before I try to answer these questions, it’s imperative to give a brief explanation of what the CBDC would most likely look like, its likely position as a digital currency and most importantly the similarities and differences between the currency and existing decentralized digital currencies like Bitcoin.
CBDC, a response to Bitcoin?
Although the central Bank Digital currency is not yet officially in use in any country in the world, many Central Banks have launched pilot programs in order to determine the efficiency or viability of the potential CBDC, the Bank of England was reportedly the first to initiate the proposal of a Central Bank Digital Currency in which the Central Banks of other notable countries like China, Sweden, Singapore, Canada, Uruguay and others are also reportedly looking into the possibility of launching their own CBDC.
The proposed Central Bank Digital Currency will likely leverage on a database run by the central bank, the government, or approved private-sector entities like conventional banks (Banks have always operated with a partnership with the government and its financial regulators). Each CBDC unit will act as a secure digital instrument equivalent to a paper bill and can be used as a mode of payment, a store of value, and an official unit of account. Like a paper-based currency note that carries a unique serial number, each CBDC unit will also be distinguishable to prevent imitation.
Since it will be a part of the money supply controlled by the central bank, it will work alongside other forms of regulated money, like coins, bills, notes, and bonds. The central database would keep a record of the amount of money held by every entity, such as people and corporations, it will however also have appropriate privacy and cryptographic protections which is in a bid for it to bring together the convenience and security that is attributed to cryptocurrencies and also the regulated and reserved-backed money circulation of the traditional banking system.
Therefore, it is obvious that the proposed Central Bank Digital Currency is inspired by the obvious successes of cryptocurrencies and the reputation these digital currencies have garnered in short a short period which is a big compliment to these cryptocurrencies
but also a clear sign that these digital currencies and their unregulated and decentralized industry is a threat to the more regulated and centralized form of the government’s financial system, hence, it is only intuitive to expect that the CBDC will try to dominate the digital currency space and most likely replace cryptocurrencies like Bitcoin.
They (CBDC and Cryptocurrencies) share certain similarities; firstly, they are both digital currencies with the CBDC to be implemented in such a way that money transfers and payments could be made in real-time, directly from the payer to the payee although all currencies will have unique serial numbers as already stated.
Secondly, they would also be built with cryptographic technologies that will ensure data privacy as already being experienced with Bitcoin and cryptocurrencies generally with both forms of digital currencies to be built via Blockchain. However, the differences between the potential CBDC and cryptocurrency might be the defining factor on whether CBDC would be able to outrightly replace cryptocurrencies; I will engage the dynamics and consequences of these differences and the likely edge they might give each form of digital currency over the other.
Centralization vs Decentralization
The issue of decentralization or centralization is not just a difference between cryptocurrency and CBDC, it is in fact the defining factor between their separate use case and adoption. Cryptocurrency is built on a decentralized structure by leveraging Blockchain technology meaning the currency is not regulated by any central body like the central bank regulates fiat currencies and would regulate the CBDC.
The implication of this major difference is that in the case of decentralization for cryptocurrencies, people have autonomy and feel independent of any financial body and in cases where a major decision is to be made there must be a concession amongst the majority of the Bitcoin community members, for example, the decision to mine above the 21million Bitcoin cap would only be accepted if 51% if the Bitcoin community agrees to it by using a hard ‘fork’.
This sort of ‘Financial Democracy and autonomy’ that Cryptocurrencies like Bitcoin give the people cannot be said to exist in any form of a centralized financial system the government puts in place even if it ensures data privacy similar to cryptocurrencies. People love to feel independent and know that they have equal input regarding decisions that affect them, and the behavioural effect and significance of that feeling must not be underestimated.
Besides, there have been situations where such level of decentralization and privacy that cryptocurrency has, has been reportedly useful; in the recent and popular #ENDSARS protest by Nigerian youths, it was falsely reported that funds for sponsoring the protests that were received by a unique link via a Fintech Platform, Flutter wave, was frozen by the Central Bank of Nigeria and that the bank accounts of protesters who reportedly funded and donated to the Protests were also frozen by the country’s Central Bank, however, during the protest, a Bitcoin wallet was quickly created in response to the move by the government to stifle the protest and thus bypassing any form of a centralized financial body. The #ENDSARS example is a perfect example of how decentralization and its benefit are a very important factor when comparing CBDC and Cryptocurrency.
Forex Trading and Currency Devaluation
The CBDC will be a part of the money supply controlled by the central bank, it will work alongside other forms of regulated money, like coins, bills, notes, and bonds CBDC will act as a digital representation of a country’s fiat currency, hence, it will be backed by a suitable amount of monetary reserves like gold or foreign currency reserves.
The implication of this is that the CBDC will be a stable digital currency and will be subjected to the same market forces governing the popular paper fiat currencies thus making it way less volatile than cryptocurrencies like Bitcoin. Bitcoin’s volatility remains one of its biggest criticisms from mainstream investors and some financial experts, its volatility has made it to be mostly used as a currency for speculation, trading or ‘gambling’ as legendary Investor, Warren Buffet, once described the popular cryptocurrency. Fiat currency on the other hand, although used for forex trading, is more stable and its trading is seen more as a financial art or form of recognized financial activity with a lot of people to have reportedly made it big via forex trading.
However, despite the volatility of Bitcoin, its volatility has been on the upside, to put it in proper context, if you had bought 1$ worth of Bitcoin in 2009, it would be worth more than $4million today!
Hence, despite the unstably of Bitcoin, it has massively increased in value as more and more people continue to become Bitcoin holders.
The value of fiat currency is another factor that comes under this analysis; in developing economies like most African countries, the fiat currencies of such countries are considerably weaker in comparison to standard international currencies like the Dollar, hence, there has been a reported increase in the adoption of Bitcoin by Africans (especially the millennials and tech-literate generation) because it helps them to a very large extent to bypass the negative effect of their weaker currencies as some of them are able to make international transactions for large amounts of goods using Bitcoin.
The advantage of Bitcoin over fiat currency devaluation cannot be underestimated because of the money it saves citizens of countries with weaker currencies, and as already stated, the CBDC will work alongside other forms of regulated money, like coins, bills, notes, and bonds and act as a digital representation of a country’s fiat currency which means it will also be backed by a suitable amount of monetary reserves like gold or foreign currency reserves, therefore, the CBDC will also be subjected to the same currency devaluation that bills or notes are subjected to which means that there would be no difference on the upside for a Nigerian trader who has been on the receiving end of the Naira notes on the international market. Hence, despite the advantage of privacy, stability and seamless digital transactions that the CBDC can guarantee, it would still be subject to the normal forces that all fiat assets go through and that means that people would have to make a certain trade-off if they are to choose only one between cryptocurrencies or CBDC, and knowing humans we would all most likely want to take advantage of both platforms if possible.
Despite the few frauds scares here and there, security remains one of the biggest selling points of cryptocurrency advocates because of the cryptocurrencies being built on the highly secure Blockchain technology, however, the presence of a fiat digital currency like CBDC being built on the same secure technology, means that that unique selling point might not be as unique again.
Also, with the central database system and unique serial numbers that every CBDC would have, it means that the CBDC would be more secure than cryptocurrencies like Bitcoin and would still have the privacy feature(Cryptography) that Bitcoin also has.
Hence, the CBDC would be more secure and the crypto fraud cases would be nearly impossible due to the CBDC central database system and tracking mechanisms that would be strictly implemented by the Central Banks of the countries that adopt the fiat digital currency.
The ‘Money’ Status
Despite Bitcoin and other cryptocurrencies being allowed in some countries, it is not recognized as a legal tender and obviously does not have the state-recognized status as money (obviously, if it does it would most likely have to be fiat). The behavioural significance of the ‘money’ status that the CBDC would have and Bitcoin won’t have is quite important; the goal of Bitcoin is that more and more people continue to adopt it in every day to day transactions and there has been progressed in that regards with some major companies already accepting payments in Bitcoin but still the potential availability of a similar digital currency but with a recognized ‘money status’ can become problematic because the CBDC will definitely have the advantage of becoming a habitual asset compared to Cryptocurrencies which are still pushing for more everyday lifestyle application.
Therefore, of all the major differences and cases I have used to engage the potential battle that might ensue from these two forms of digital currencies, this is the most hypothetical and intriguing one because as the CBDC is still not yet launched officially, Bitcoin might just have enough time to penetrate into every aspect of human lives and finally achieve its everyday application goal as we can already see more advances in that regards with recent news of the Financial giant platform, PayPal, introducing a feature that allows transactions in Bitcoin on its platform while there is evidence that Africa is fast becoming a hub for more practical use of Bitcoin asides speculation or trading or on the other hand it lags behind and the CBDC being approved by the government becomes an everyday aspect of all citizens and thus a part of their everyday lifestyle.
Watch this Space
If Bitcoin and cryptocurrency weren’t doing well, then it is highly unlikely that the government and Central Bank would be considering digital currencies, then it means amongst other reasons, the government is a little bit threatened by the progress of Cryptocurrencies.
However, the government remains a powerful entity and as much as Bitcoin has managed to survive despite some pushbacks, the emergence of a supposed alternative can be Bitcoin’s biggest threat.
I have tried to identify some of the dynamics and defining factors in the event of the launch of the CBDC, and I personally think the peculiarity of cryptocurrency means it would most likely still survive as people would always see it as an alternative to Fiat, but that’s just my own view and the possibility of CBDC being the end of cryptocurrencies is also likely, hence; I suggest this is one to look out for: watch this space.
The Biggest Threat to Bitcoin (CBDC) was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.