If you’re a consumer of financial media, you may have heard about Central Bank Digital Currencies or CBDCs. Depending on where you read, you may have even heard the following: In the future, money will not be yours, and Central Bank Digital Currencies are the gateway into totalitarian control by the government.
The nature of government is a balance between privacy and security. All the way on either side of the pendulum is a dystopian hellscape. The natural tendency of government is to take more control, and the people’s natural reaction is to resist it. Democracy keeps tension on both sides of the rope to keep things in balance. While tug-of-war tension manifests itself across our world, there is one topic that frequently pops up in the banking system and investment markets regarding CBDCs, particularly with the new entrance of cryptocurrency technology.
Interestingly, most cryptocurrencies are specifically decentralized, meaning that they are controlled by a network of people and computers, not able to be controlled by a single source. In contrast, a Central Bank Digital Currency (CBDC) is designed to combine the benefits of a fully digital currency while preserving the governmental control afforded by a sovereign currency. Naturally, this has caused many to ask if we need to fix something that may not be broken and what additional powers it may provide the government (take from Citizens).
Admittedly, this topic is more complicated than most we tackle in Contrary to Commentary because CBDCs are in their infancy. We don’t truly KNOW how they can or will be used; we only have informed guesses. We are likely years away from any serious rollout of a CBDC. That being said, it’s important to talk about what the future may look like. To do that, let’s examine the system we have and what likely could be added from the introduction of a CBDC.
The “rails” of the U.S. economic system are largely built on the following systems:
- ACH System (Direct Deposit and Interbank Transfers)
- Fed Wire System
- SWIFT Cross-border currency system
- Payment Networks (Visa, Mastercard, Discover)
- Security (Stock & Bond) Exchanges & Settlement Processes
Of these, several are on the precipice of significant near-term evolution.
In 2023, the “FED NOW” system is scheduled to be rolled out, allowing interbank money movement 24/365. This will no longer keep cash financial transactions constrained to the hours of bank branches. This is a meaningful evolution that stands to bring modern technology (like that we experience now through apps like Zelle, Cash App, and Paypal) to traditional financial transactions like buying a house.
In securities, a handful of years ago (towards the beginning of my tenure with Allen & Company), the settlement period of stock transactions decreased from T+3 to T+2. Today, theirs is a push to move to T+1 or even T+0 (instantaneous).
Despite the evolution in many areas, one area is painfully in need of evolution: Cross Border Currency Transactions. Under the current systems, cross-border payments are costly and slow. Part of this is designed to limit money laundering and other financial crime risks; however, the cost is striking, looking at the numbers.
The U.S. Federal Reserve published a report in January 2022 titled “Money and Payments: The U.S. Dollar in the Age of Digital Transformation,” which detailed the pros and cons of a CBDC. In it, the Fed found that the average fee charged on cross-border currency transactions is a whopping 5.41%! That’s $5,410 on a $100,000 transfer. $54,100 on a $1 Million transfer! While that percentage surely changes with the transaction size, the point is clear that Cross Border is not an efficient system today.
For these reasons, if a CBDC were introduced, I believe it would most likely target the cross-border market rather than the traditional banking system we experience daily.
Additionally, while certain tracking and privacy regulations might be easier for governments to enact with a CBDC, we already have significant surveillance and tracking within the current system.
Those who are concerned with the regulations of the future may also not be fully understanding of how regulated the current system already is. Kicked into over-drive with the expansion of regulations post 9/11, our team experiences a host of compliance and regulatory processes daily. These might include “KYC or Know Your Client protocol,” “Anti-Money Laundering,” or “OFAC Checks.” All are designed to identify bad actors in the Economic System and are present at all U.S. Financial Institutions.
The reality is, generally speaking, the government doesn’t care that you sent your friend $20 for the bill they picked up last night.
What they do and will continue to care about is: Are you paying the taxes you owe based on the current laws? (a big issue with payment apps like Venmo!) And, are you attempting to conceal who you’re sending dollars to or from? If the answer to either of those questions is yes, I expect it will be increasingly difficult not to get caught. However, this is not necessarily different from the trend of the last 20 years. It’s really about enforcing the current rules and regulations that already exist. If the answer to each of these questions is no, then I don’t expect the system, CBDC or no CBDC, to change a whole lot.
One of the reasons I have this confidence is because of our country’s respect for the rule of law. Whatever system we follow or implement still must abide by the current laws, including the protection of civil liberties afforded us by the U.S. Constitution. This doesn’t mean that we as citizens should stop “pulling on the rope” to preserve these liberties, but it means our system is as good or better as any that’s ever been created.
When it matters:
So, given all this background, a very fair question would be: What sort of outcome, new regulation, or law should really get people worried? In my opinion, if laws were passed that make the grey area of financial crimes more subjective rather than objective, it would be one cause for concern. Additionally, if a CBDC were used to centralize all or most banking, thereby centralizing all credit decisions, that would be a massive red flag. The United States is one of the only countries with a large number of different banks (Canada only has about 5), this is a feature, not a bug, and we should protect that as it helps the growth and innovation of the economy and decentralizes power.
Lastly, regarding changing laws, a true worst-case scenario for the financial system would be an evolution into what China has today.
According to various sources, many in China claim that the country has adopted a ‘Social Credit’ system, where because so many things (payments, credit, ride hailing, social media, talk, text, etc..) are all concentrated within a few “super” apps that are also at least indirectly influenced by the government, China can effectively remove someone from society and their life by de-platforming them, all without any due process. In theory, the government wouldn’t even need someone to break the law in order to punish them in this sort of system. Think of it like waking up one day unable to hail an Uber, order delivery pizza, or have Instacart send you groceries, all while being shut out of Instagram, Facebook, Tiktok, and your texting app on your phone—very “1984.”
There’s a reason I personally don’t desire to live in China, and this may be at least part of it, but let me be clear, we are nowhere near that point today in America. Like our forefathers, we should continue pushing for innovation and progress without compromising the rights we hold most dear. This will be a tricky balance as we go forward, but there’s no better place than America to get this balance right.