From our blog we have always highlighted the importance and the advantages encompassed in decentralization in terms of freedom, resistance to censorship, privacy, networks stability, safety, etc. But, what happens when a new project lacks decentralization?
In the private sector, to be considered a security by the SEC or to be subject to potential fraud allegations, insider trading, etc. is quite controversial. But while centralization has a negative impact in the private activity, in the public sector it is desired. And desirable at the same time?
As our readers have surely guessed by now, this article is not about projects boosting decentralization and financial freedom; on the contrary, it is about public and centralized initiatives seeking tighter control and transactions traceability. To give you a better idea, let’s explain what a CBDC is (Central Bank Digital Currency).
The main difference with Stablecoins lies on the issuing entity. Whereas CBDCs are issued by Central Banks (the same entities that issue legal tender), stablecoins are issued by private companies with a backing reserve of fiat currency “equal” to the tokens’ circulating supply (or at least so they claim).
Stablecoins’ value is pegged to fiat currency, generally US dollars. In these cases, one “buys risk” of the tokens’ issuing company. That’s why we recommend to make a thorough survey on the solvency of the company involved to avoid headaches such as the Terra Luna crash. In the case of CBDCs one buys the risk and trustworthiness of the issuing country.
Before exploring CBDCs global initiatives that are currently being applied with more or less success, we’d like to focus on an interesting public project (likely to be mass-adopted and developed by the US Federal Reserve): FedNow.
FedNow is a service developed by the Federal Reserve of the United States that enables financial institutions to send and receive money in real time, 24 hours a day, 7 days a week and 365 days a year. The platform represents an improvement allowing to process transactions on holidays, weekends and off-hours. This revolutionary instant payment platform is designed to offer uninterrupted 24/7/365 processing and will feature integrated clearing functionality, enabling financial institutions to deliver end-to-end instant payment services to their customers (for the time being, only inside the United States).
This immediacy will allow the platform to compete with other payment systems such as PayPal or Mercado Pago (strong player in LatAm) and with the different available cryptocurrencies. This fact could affect crypto, mainly those highly appreciated for their transactional value (due to its immediacy). As a result, the FinTech space could be induced to explore innovation to keep developing other uses apart from immediacy (better fees, service quality, new features, etc).
Since it is a governmental project, FedNow is being launched subject to tight regulation and audits. This, all available data are not anonymous nor private. The system is operated by the Government of the United States itself with all “administrator’s rights”, being entitled to real-time information whenever required.
This mega controlled and regulated ecosystem could lead to tighter control of the crypto industry. The Fed, vested with experience in this field, could set up new rules and regulation to approach genuine concerns or to eliminate the competence.
We insist, it is a payment system (not a CBDC) that could pave the way to the digital dollar. You can enter this article from Volantetech connected to this topic. The main difference between a payment system and a CBDC lies on its purpose and function. A payment mechanism does not replace cash nor can serve as cash digital representation but rather streamlines funds transfers inside the United States. A CBDC is a digital form of fiat currency issued by a country’s central bank, backed by its government and regulated as such by the issuing country.
As reported by Forbes, the launching of this new platform can involve legal issues due to the denial of permits and licenses to private companies (banks related to the crypto industry) intended for similar payment mechanisms. Further, the specialized media BeinCrypto comments on the launching of FedNow and the several concerns for the crypto universe. Even though it appears as a new competitor for instant money remittance, it has some deficiencies compared to the decentralized ecosystem in terms of safety, resistance to censorship, privacy and decentralization, among others.
Risks associated to CBDCs
Going back to CBDCs, serious concerns have arisen regarding the potential for privacy risks and inclusion. For example, issuing governments could block funds or, even worse, make funds disappear depending on the accounts’ holders identity and / or affiliation (an individual or group of individuals). The mere fact that the money owned by a specific group of people (such as ethnic minorities, political opponents and/or criminals) could be seized by government authorities reflects the system’s vulnerabilities. Deep analysis is mandatory, since the latter is desirable, while the first two have to be prevented.
In addition, as a digital identity system may be interconnected with central banks’ systems, any government could arbitrarily elect to exclude anybody (with or without judicial authorization). This is similar to a punishment that was, luckily, removed from the positive law many years ago called “civil death” (convicted individuals were deprived from carrying out any legal act in the society).
In Argentina, the losing presidential candidate, Sergio Massa, approached this topic during the presidential debate and talked about the project of launching a digital currency, in line with the agreement signed with the IMF and with his anti-crypto position. This announcement was covered by local traditional media and by international specialized media as well and, apparently, a bill had started to be drafted. Considering this position is contrary to the economic vision of the Elected President, Javier Milei, it is likely to come to nothing (at least for four years).
I’d like to remark that, in a high inflationary environment combined with high money issuance like Argentina, with a negative and unbalanced trade balance, the fact of issuing currency without even the need to print banknotes would have been catastrophic in terms of public expenditure.
Let’s talk about Nigeria, the first country with a functional CBDC. The eNaira is a digital currency issued and regulated by the Central Bank of Nigeria (CBN) aiming “to foster financial inclusion and to become a cashless society.” As a touch of color, Nigeria has a crypto-friendly community, exchange control and restrictions within an inflationary environment similar to Argentina amid a cash shortage.
The eNaira was launched in November 2021 within a modernization scheme of the Nigerian financial system. It is a CBDC backed by the Nigerian government and can be used for any type of transactions. The eNaira empowers individuals and enable them to efficiently transact at little or no cost, anytime, anywhere. Among other benefits compared to cash-transactions, the Nigerian government has reported higher privacy and safety for citizens compared to traditional payment systems.
Government is striving for higher adoption but statistics on usage differ among the different sources.
Given exchange restrictions, it is the second currency with higher circulation in Nigeria.
eNaira current use is considerable and there has been a significant increase since launching. The value of eNaira transactions has reached 47.7 million dollars. To compensate cash shortage, Nigeria has issued more than 10,000 million eNairas.
In spite of the incentives proposed by the government to boost eNaira usage such as rebates applied to certain services, its adoption is still lower than 0.5% of the total population.
Beyond official information, we take advantage from our international alliance Alliott Global Alliance to get a reference provided by a well-known professional from such jurisdiction regarding CBDC real operation. Nkiruka Onigbanjo , accountant and partner at G.E. Osagie & Co. comments as follows: “Nigeria’s eNaira aims to bring more people into the financial system and boost the economy. However, there are some hurdles to overcome, such as getting people to use it, making it work with other payment systems, and keeping it safe. Despite these challenges, I believe the eNaira has the potential to change the way people in Nigeria use money in the long run..”
Other country where CBDCs became a reality is China. As anticipated in this article, China is strongly committed, since a very long time, to develop (and boost) the use of its digital currency. The first step was to limit the competence by banning the use of cryptocurrencies to the whole population (citizens and residents), something quite surprisingly since China had a strong mining activity.
As reported by BeinCrypto, the Digital Yuan climbed up to 250,000 million dollars in transactions, becoming a pioneer in the market. Within a very strict regime (as already covered, Chinese government applies incentives and severe penalties in case of non-compliance), China’s Central Bank continues to take aggressive steps to boost CBDC habitual usage, being a core issue in China financial market.
Other countries that moved onwards towards CBDCs’ development or implementation (with more or less adoption degree) are Bahamas, Jamaica, The Central Bank of Eastern Caribbean, South Africa, Tunisia, Morocco, Kenya, France, South Korea, Canada, Saudi Arabia, Arab Emirates, Ghana and Uruguay. For further information, we share this article as well as Forbes coverage.
Special mention is made to the Digital Euro due to the complex consensus mechanism required to become a reality (even though the euro area led the move, implementation seems somewhat complicated). Some progress has been made in the last years but it is still at a development stage and implementation is still pending in the euro area. The European Central Bank (ECB) has been working in the project in cooperation with the national central banks of the euro area, at least as an alternative to reduce cash use and in favor of digitalization. In spite of the progress made, concerns persist regarding loss of privacy. The ECB launched a public consultation on digital euro with an adverse feedback and has moved forward on the investigation stage.
Another initiative to mention is the project launched by the BRICS members (Brazil, Russia, India, China and South Africa) regarding the development of a common currency for cross-border transactions to be able to compete with the dollar. Beyond economic and geopolitical implications, it could be the first native digital currency. However, it would not be a CBDC because it wouldn’t be backed by any central bank. This aspect is to be defined since the block does not share any currency.
One of CBDCs underlying risks is to be used politically and/or for any type of persecution; so, central banks globally should submit clear evidence approaching this serious concern as well as the cyber security issue. This said, CBDCs do not seem to affect the crypto market for now. In any case, central banks’ supremacy may be threatened by the crypto disruption, leading them to innovate to stay competitive.
Although some projects show progress, the main CBDC use case (and FedNow) remains relegated: the possibility to make instant cross-border transactions in CBDCs among bank accounts worldwide and among individuals or companies located in different countries. This possibility could be a disruptive feature in foreign trade, evolving towards modern mechanisms in customs systems and sworn statements, fostering transparency and traceability.
To conclude, there is an underlying legal issue in addition to technological complications: the CBDC used in all countries involved in such transactions should be considered legal tender. And the only currency that fulfils such requirements today is the US dollar which is intended, as discussed, for a payments system (not a digital currency). It may be too late by the time they want to develop it.