What CBDC Is (Not) About: Part VI

The Politics of Cash and CBDC

Photo by Jonathan Marchal on Unsplash

Note: This is the sixth –and final – post in a series about central bank digital currencies, or CBDC (you can start with Part 1 here). We briefly explore CBDC's relationship to cash and conclude the series with a proposal to embed the discussion in a proper political process.

Tl;dr: For technical and regulatory reasons, CBDC is unlikely to replicate the properties of physical cash – making it all the more important to preserve the latter. CBDC has begun as a technical discussion; now is the time to acknowledge its political dimension and correspondingly initiate a transparent decision process that involves society at large.

Update (27 October 2020 19:08): I have slightly reworded a sentence about AML regulations in section 2 after receiving valuable feedback from Rohan Grey on Twitter. I have added footnote [2] for further details.

The unique properties of cash

Before concluding our discussion, let's spend a moment thinking about physical cash and how it relates to CBDC. This is a fitting topic given that the declining use of cash has often been cited as the main driver behind CBDC initiatives.

The appeal of cash stems from its specific set of unique properties that are unrivalled by alternative forms of money. [1]

• Risk-free central bank liability: it's the only form of public money that is universally accessible to the public, and thus carries no counterparty risk.

• Bearer nature: the physical nature of cash means that possession and usage do not require managed accounts. Instead, possession equals ownership: cash is resistant to seizure (unless taken away by force).

• Instant P2P settlement: cash is a settlement medium that does not depend on third parties who could interfere with the transaction (e.g. blocking transfers, but also charging fees). Transactions are instantly settled on the spot as the physical tokens change hands: they cannot be reversed (except through the use of force).

• No collective memory: cash transactions are not systematically recorded. Coins and notes do not have a prior history attached to them; they come with a clean slate. That's good for fungibility, and also good for financial privacy as users enjoy relative anonymity.

There are, of course, also caveats. For instance, cash transactions require geographical proximity – your counterparty needs to be in the same physical location. Cash is costly to store and difficult to transport in large quantities. Operating the cash system is expensive, and cash can be subject to counterfeit.

Despite the limitations, cash is king in many parts of the world still. Cash transactions may be declining relative to electronic payments, but absolute usage remains high. Cash thus has a clear value proposition for many consumers and businesses, not in small parts thanks to its unique properties.

Cash in the digital world

Can we replicate these features in the digital world?

In theory, yes; in practice, likely not.

Retail CBDC is often likened to an electronic form of cash. There are, however, various technical and regulatory factors that stand in the way, casting doubts on whether physical cash can ever be appropriately replaced.

From a technical perspective, offline payments would require the use of specific physical devices (e.g. smart cards) and in-built P2P settlement functionality. Selective privacy – or 'controlled anonymity' – could be implemented using a variety of cryptographic techniques, but there is no guarantee that hidden vulnerabilities or potential backdoors would not be exploited.

From a regulatory perspective, the strict anti-money laundering (AML) and combating the financing of terrorism (CFT) regulations in place for digital payments may have to equally apply to electronic cash, for an exemption could provide an unfair competitive advantage over private payment methods. [2]

And from a political perspective, there are a number of vital questions that have yet to be fully addressed: how open and inclusive should public money be? Should crime detection and prevention be prioritised over financial privacy? Should open access to a non-commercial electronic settlement method be a fundamental civil right?

In the end, these are all political considerations that concern the very fabric of society – and the values it holds dear.

CBDC is a deeply political issue

And this brings us to a larger point that seems apt for concluding the series: CBDC has begun as a technical discussion; it should instead be framed as a political issue.

It is no surprise that blockchain-based Bitcoin and Libra sparked off a discussion that concentrated on the technology angle first. I mean, this happens all the time with 'blockchain' – much to my dismay, I should add. [3] However, as we have seen in our scenario analysis, the implications of introducing a CBDC can be manifold – and go largely beyond mere technical considerations. [4]

This requires going back to first principles. CBDC allows us to redesign the monetary system – and all that springs from it – from scratch. It's time to recognise that there is a deeply political dimension to this.

CBDC is an important discussion about fundamental societal issues that cannot be left to central bankers and regulators alone (which is not something they would be very keen on, anyway). Instead, it should be subject to a transparent political process where decisions about design and implementation will be taken based on extensive public consultations with a broad range of stakeholders that represent all parts of society. The final decision should reflect the true will and choice of society as a whole, not only of its most privileged parts.

It seems to me that central bankers are aware of the political significance of CBDC. As the very personification of risk aversion, I have no doubt that they will take the necessary precautions to avoid a disorderly slide into chaos. Even so, they should always bear in mind that reclaiming money creation as a sovereign right can have severe unintended consequences – not only affecting the financial and monetary system, but also the very fabric of society.

Footnotes

[1] These are what I would consider the primary attributes of cash. There are of course a range of other useful characteristics that are particular to cash – offline functionality and immunity against negative interest rates are two that come to mind.

[2] Rohan Grey and Misha Guttentag have pointed out that it’s a common – and dangerous –misconception to believe that current AML regulations exclude the possibility of a truly anonymous e-cash or CBDC token. We can expect AML regulators to aggressively lobby for an extension of their regulatory framework to include e-cash or CBDC, too; such campaigns are political in nature and should be resisted.

[3] Blockchains are socio-technical systems where the 'social' aspect (including governance, rules, enforcement, participation, access, etc.) is much more important than the technical arrangement. You cannot solve social problems with technology alone. Such attempts are destined to failure right away – what a waste of opportunity and resources that is!

[4] We discussed three potential scenarios in previous posts. As with any scenario analysis, these should be taken with a grain of salt: each CBDC will be different as the design will be tailored to the unique local context. I may also have overly leaned towards provocative edge cases; yet extreme scenarios tend to provide a better picture of the full spectrum of possibilities. Practically speaking, I consider Scenario 3 very improbable, with Scenario 1 being the most likely outcome.

Thank you for reading the series; I hope you found it useful. Please do not hesitate to reach out if you have any questions, comments, or feedback.

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