Cryptocurrencies are increasingly competing with state-issued legal tender. To hamper the advance of Bitcoin, central banks are developing digital legal tender. An old acquaintance from economic history will be rejoicing a third option.
Central banks will do themselves a tremendous disservice should they attempt to replace physical cash with government-issued digital currencies.
Dozens of central banks around the world are working full-throttle on digital legal tender which is also called the Central Bank Digital Currency (CBDC).
According to the central banks, they primarily want to provide consumers with access to a simple, generally accepted, safe and reliable means of payment.
However, there is an increasing number of voices claiming that CBDCs are being developed to stop the victory march of cryptocurrencies such as Bitcoin as they are increasingly undermining the sovereignty of central banks.
CBDC is envisioned to be as fungible as physical cash yet digital. CBDCs would therefore be digital legal tender that is available in electronic wallets, i.e. on smartphones or on end users’ computers akin to cryptocurrencies. Hence, it is meant to replicate the functionality of cryptocurrencies, yet it will be under the control of central banks and guaranteed by them.
What central banks communicate much less frequently is that CBDCs opens up completely new dimensions of control when it comes to money flows.
Depending on the design of the new money, a central register could henceforth be used to record what each and every citizen does with his or her money. Every single financial transaction could be recorded, every in- and outgoing payment – from cradle to deathbed.
Supplement or replacement of cash?
At present governments and central banks are still steadfastly assuring that CBDCs will not replace traditional cash. Rather, it is said to become complementary to physical cash.
However, it doesn’t take much imagination to envisage how cash could ultimately be displaced by CBDCs. In addition to the cost argument that “cash is expensive,” the arguments against drug and human trafficking, terror financing and tax evasion could be used.
In other words, all the arguments that are already being used against cash today could be used. However, these arguments will gain considerably more weight as soon as an official digital alternative actually exists.
Private data and the state
Human nature will not change with the introduction of a digital euro or US dollar. People will continue to break regulations and commit crimes. They will continue to moonlight and do drugs. At the same time, it would fall short of reality to claim that only criminals will reject the new money.
Even a law-abiding citizen may not necessarily want to share information with the state about how many cigarettes or bottles of alcohol he buys every day, whether she does drugs – even if they are legal, how much he spends on medicine and, if applicable, on which ones, whether she is in medical treatment and why, whether she may even be in psychiatric treatment, that he donates money to a religious community, that she has to pay lawyer’s fees due to legal disputes, that she is a party member, or that he pays alimony for an illegitimate child, etc.
However, the consequences of CBDCs could be much more extreme in countries whose legal systems are less pronounced. Here, the consumer may want to keep from the state their private information.
However, going forward, the state could obtain all of this information from a centrally managed electronic register, the so-called “digital ledger”. What is more, the data retrieval could potentially happen decades after the actual payment was made.
One should also consider people who may suffer hardship through no fault of their own. For instance, someone may need medicine and cannot obtain it through official channels and CBDC payments.
In all of these cases, consumers will seek ways to bypass CBDCs and switch to other means of payment and revert to unofficial markets.
It can therefore be assumed that two currency systems will form in a jurisdiction devoid of physical cash; an official and an unofficial one.
Back to the Future
While these assertions may sound far-fetched at the moment, we have seen them time and again in reality; in the socialist countries of Eastern Europe, in the so-called Eastern Bloc, numerous national currencies exists, be it the GDR mark, the Polish zloty or the Russian ruble, etc.
The working population received their wages in these national currencies and used them for all official payments, from rent to grocery shopping to paying for larger purchases such as a car from domestic production.
However, there was an unofficial currency system based on valuta, i.e. on currencies from the West such as the US Dollar. Numerous goods and commodities were hardly available through official channels or only after enduring a long waiting period.
But almost anything could be bought on the black markets with “hard” Western cash, and it could be acquired promptly.
Central banks striving to replace cash across the board with CBDCs in the future could be confronted with the same phenomenon.
It is conceivable that two currency systems will develop in one jurisdiction; one that is based on official CBDCs and in which many goods and services are available, and one that is based on a non-official parallel currency.
The parallel currency of the future
What would the future of parallel currency be like? It is conceivable that a cryptocurrency could serve as such a common denominator. It should be noted, however, that the vast majority of cryptocurrencies are not anonymous, but merely pseudo-anonymous.
This means that the sender and recipient of the money are oftentimes identifiable. In addition, digital transactions always leave data traces that may reveal the identity of the transacting parties – if not today, then possibly in the future, when the state of technology has advanced sufficiently.
I consider it therefore much more likely that the asset class will re-establish itself as a parallel payment standard that has been the prime payment method for millennia; physical precious metals.
It can be easily transferred and stored without leaving traces. In addition, a ban on physical gold can hardly be enforced in practice, as the experience of the USA in the 1930s has shown.
Conclusion
Should governments and central banks deploy CBDCs to stop the advance of parallel currencies such as Bitcoin, they could achieve exactly the opposite.
Mandatorily restricting consumers to CBDCs could provoke a reactance among them; the citizens could then use a precious metals standard to take back that very space of freedom that was previously taken away from them by the central banks. It is possible, but unlikely, that this could also happen by the means of cryptocurrencies.
Should such an alternative precious metal-based currency system establish itself alongside digital legal tender, it is likely to pose a much greater threat to the sovereignty of central banks than cryptocurrencies.
Ironically, in this way central banks would de-facto reintroduce a gold standard even though they had deliberately abolished it decades ago.
