CBDCs: The 21st Century Paradox.

Decentralization. The bedrock of blockchain technology.

Before learning about Bitcoin, I mostly associated the word with politics and systems of government. Blame it on law school.

Satoshi Nakamoto shared their epiphany with the world at a crucial moment. Big Tech was slowly sinking its talons into the global data architecture. Facebook was a four-year-old baby giant. Google and Amazon were vying for supremacy in cloud computing.

In hindsight, decentralization should have caught on much earlier. It was a big-brain principle, yet so simple. Own your data, verify your ownership publicly, and protect your digital assets from abuse.

Fifteen years later, it seems we’re headed for another epiphany. The time is coming when we will have to rethink the idea of “decentralization.” From a practical (and political) standpoint, some compromise is necessary.

So how do we get diplomatic about data ownership?

First, we need to examine the why behind this paradigm shift.

Everything is relative. Nothing is absolute. This might as well be a universal law. It’s the reason why circumstances and context are required to understand the true state of anything.

OK, let’s try a less philosophical approach. How about a crash course in economics and the history of money?

Coins were developed as a way of measuring the value traded in exchange for goods. People agreed on the system because it worked. Then came a Mongolian emperor named Kublai Khan.

This smart fella decided that anybody doing business in his territory would have to pay him—indirectly. He appointed administrators to issue receipts for deposits of coins and items of value. These receipts would be accepted as legal tender all over the land.

The policy was a home run. Merchants got a good deal from Khan. They didn’t have to carry tons of coins and gems at great personal risk. The royal treasury increased its reserve. Central banking was invented.

Fast forward a few centuries. People would deposit physical assets in a bank, which could then issue loans backed by the assets in its care. Gems, precious metals, and even land were examples of such assets.

Over time, banks realized that several assets were volatile in value. They needed a stable peg. So they began issuing loans backed by government bonds. This served as a model for the modern global banking system.

What are the common patterns in these two tales?

1. People developed and adopted popular systems of commerce.

2. These new systems were born of necessity and inconvenience suffered due to the existing systems.

3. Government authorities co-opted these systems into their administrative structure.

4. The result was a hybrid system which proved to be more stable than the original version, paving the way for the next stage of economic growth.

Central bank digital currency. In the words of Will Ferrell, “No one knows what it means, but it’s provocative.” I’ll attempt a loose definition for your sake, though.

A CBDC is any digital token that is issued by a government-authorized financial body. This is a very simple description, so don’t get caught up in the specifics. There are three factors that matter:

1. The token is issued by a sufficiently authorized financial body, usually by statutory mandate.

2. The token is equal in value to an existing fiat currency.

3. The token exists on a permissioned digital ledger.

The last part is very important because private blockchains can get weird.

A token that exists on a private blockchain cannot be truly decentralized, even if the blockchain itself is a decentralized ledger. Basically, someone controls a master key capable of making things very dark, very quickly.

You might be thinking, “What’s the difference between a CBDC and regular crypto?” This diagram should help you visualize the concept quickly.

Let’s take a closer look at the key differences between these two.

1. SUPPLY

CBDCs do not have a supply cap, unlike regular crypto tokens. CBDCs are linked to fiat currency, and central banks can print money at their discretion. Hence, there is no definite limit to how many CBDC tokens can be in circulation. This could result in volatile demand-supply dynamics.

2. CENTRALIZED/PERMISSIONED

Public blockchains use consensus mechanisms. Distributed networks of operators called "nodes” publish and validate changes to the blockchain. Anyone with enough computing or staking capacity can run a node.

Private blockchains, which power CBDCs, involve a system where a central entity chooses who gets to run a node. Participating nodes must obtain permission from the central authority.

This effectively strips away the element of transparency. As a result, CBDC systems are more vulnerable to corruption.

3. MONETARY POLICY

Regular crypto tokens launch with a white paper that explains, among other things, the tokenomics. This signals how the tokens will operate within the financial ecosystem.

Traditional financial institutions adopt a more nuanced approach to monetary policy. They reflect the stance of powerful decision-makers reacting to socio-political factors. Individuals are not privy to these changes, which could leave them blindsided by market movements.

4. LIMITED OWNERSHIP/CENSORSHIP

A permissioned system creates room for the censorship of nodes. Even users can be blacklisted at the discretion of a central administrator.

Government authorities also have unlimited access to user data. This means all transactions can be doxxed and are vulnerable to leaks.

Nodes running on a permissionless blockchain are harder to censor. Privacy concerns are minimal due to the pseudo-anonymous nature of this system. This makes regular crypto tokens more attractive to many users.

Congrats! Now you know why CBDCs are so provocative. Many people would sooner wear clown makeup than they would submit to government-controlled crypto. So where do you choose to draw the line?

The answer to this question is subjective. However, I think we will all be using some form of CBDC within the next couple of decades. So we have to figure out how to navigate this crossroads sooner rather than later.

I believe it’s best to view this concept as a new type of social contract between the government and users (read, “citizens”). A functional system is created where both sides recognize each other’s duties and rights.

These allowances must be made reasonably, considering the needs of each party. For instance, governments worry about pseudonymous financial crimes, taxes, and large-scale fraud. How can CBDCs solve this?

Integrating CBDCs with an existing national database (such as Social Security) would be effective. It would aid anti-money laundering (AML) measures, help with tracking taxes, and enable large-scale fiscal audits.

Users would retain the freedom to use regular crypto tokens. The ability to trade legal tender on the blockchain would enhance user flow. As Reddit proved, onboarding users to a new product through a familiar system is effective.

Crypto users are worried about censorship and privacy. With the rise of surveillance states, CBDCs could be weaponized by governments. Blockchain technology provides options to creatively navigate this issue.

A sensible approach would be to take advantage of CBDC’s utility as legal tender. Use delegated wallets for investing in regular crypto; swap only what you need to make payments, similar to how people use stablecoins today.

Of course, this is easier said than done. Some countries will try to promote CBDCs by making it harder for people to use regular crypto or cash. Others will push retail traders out of the market by creating minimum portfolio thresholds. Policies like this are simply… weird.

The most progressive approach is consulting with blockchain industry experts to formulate CBDC policy. They understand the unique pain points faced by users and can help translate them into legal text.

CBDCs have the potential to stimulate growth in the blockchain industry. Over 95% of the global GDP is represented by countries exploring the system.

In 2023, at least 20 countries will launch a CBDC initiative. They could unlock more use cases for digital tokens in real estate, global commerce, counter-terrorist financing, national welfare programmes, etc.

However, this promise comes with a fair bit of compromise and a healthy dose of caution. They must not be implemented in the absence of a fair regulatory framework. This can only happen after years of iteration.

If history is a decent indicator of future patterns, blockchain technology will evolve the way we think of money. This will lead to a growth spurt in financial innovation and fuel new opportunities for an economic boom.

All it takes is a spark. Depending on how the narrative plays out, CBDCs may light up the blockchain industry or set it ablaze.