How CBDCs will transform the world as we know it

In recent years I have been working with my team on Broxus to develop the infrastructure central banks need to deploy digital versions of their currencies. As we do this work and other projects have made similar efforts, the dialogue around CBDCs has taken on a life of its own, colored by misconceptions about what Central Bank Digital Currencies (CBDCs) are and their purpose.

Essentially, CBDCs are digital versions of a country’s fiat currency pegged at a 1-1 ratio to the original currency. For example, if the US were to release a CBDC, it would be in the form of a digital dollar that is always equal to its fiat counterpart. While CBDCs are related to cryptocurrencies and blockchain technology, there are some key differences.

By definition, CBDCs are recognized digital legal tender. That means that CBDCs, unlike other similar digital assets such as stablecoins, have the same legal weight as fiat currencies. This is important because one of the main drivers of CBDC expansion is the global shift towards cashless societies. As more societies become increasingly cashless, current economic infrastructure struggles to support local and international economies. CBDCs are a possible way to solve these problems.

Much of the disconnect has come from the perception of many regarding cryptocurrencies, and the association that CBDCs have in the public eye with cryptocurrencies. The truth is that while cryptocurrencies remain primarily speculative, CBDCs are something else entirely. Speculation has no role here. CBDCs, if set up correctly, could optimize financial systems that have become obsolete and no longer meet the needs of the world’s most vulnerable demographics from a financial perspective.

While the value of cryptocurrency is often tied to future developments and use cases, the value with CBDCs lies in the here and now. The usefulness of this digital currency is something real, something that addresses shortcomings that are being felt around the world right now. I believe that the framework in which we discuss CBDCs needs to change so that the ongoing efforts to integrate this technology into the fabric of the global economy can bear fruit.

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CBDCs and Universal Basic Income

The social security systems of the 19th and 20th centuries all required the building of an important state agency to redistribute wealth. These bloated governance structures have generally been unable to adequately assist those in the more vulnerable spheres of society. To address this problem, an experiment was conducted in Finland that attempted to provide a universal basic income (UBI) to the generally unemployed. In Finland, instead of using a welfare model, benefits were provided through a direct cash deposit of €560 per month. On the one hand, this provided direct support to those in need and, on the other hand, it reduced the costs of collecting, accounting, and disbursing funds that run high in welfare programs.

The final results of the Finnish experiment are now in, and the findings are intriguing: UBI in Finland led to a modest increase in employment, vastly improved outcomes in material well-being of recipients, and more positive individual and societal feedback.

CBDCs may be in a unique position to improve the performance of Universal Basic Income (UBI) programs. Since most of the pilot projects and prototypes launched for CBDCs target a 0% deposit rate, i.e. a situation where CBDCs are subject to inflation and depreciation, central banks could gain a more effective influence in managing aggregate demand in the economy by collecting taxes and distributing a portion of it to UBI recipients. By issuing currency in digital form, central banks can radically reduce the cost of the state to ensure the circulation of the national currency and social support for the population.

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Reaching the unbanked

In 2021, according to the World Bank Group, 1.4 billion adults still did not have a bank account. That’s a huge portion of the world’s population, and the failure to provide adequate banking services to these people is likely to prolong poverty cycles and put a brake on global economic growth.

This problem is acute in Southeast Asia and a good example of this can be seen in the Philippines, an area we have focused on in our work. Just over half of the adult population in the Philippines has access to banking services. In a healthy economy, small and medium-sized businesses need access to banking services to thrive. With just over half of the population having access to those services, the Philippine economy cannot flourish, leaving the less affluent to bear the brunt.

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Reducing the cost of money transfers

The lack of banking services has led Filipinos to use alternative financial methods and seek employment in other countries. Today, remittances from Filipinos who work abroad and send money home account for 10% of the Philippine GDP or about $70-80 billion. At the same time, the cost of money transfers is about 8-10% of the total amount of the transaction.

Here too, CBDC technology can be effective in improving the situation. As part of our CBDC development work, we have established a partnership between the Everscale network and DA5, one of the leading Western Union authorized direct agents in the Philippines. The blockchain remittance service created by Everscale and DA5 will be the first technology in the Philippines capable of speeding up this process and reducing its costs. As a result, people no longer have to pay such high fees for their transactions once the service is launched.

The first phase of the partnership will see the launch of Everscale’s new stablecoin, which will be pegged to the Philippine peso. After the stablecoin is released, users in the Philippines will be able to immediately exchange fiat for its digital counterpart at low industry rates. But this is just a stablecoin; if the Philippines were to launch a CBDC, it would benefit all sectors of the economy.

The privacy debate

A common argument against CBDCs is their lack of privacy. However, this is only partially true: it can be shown that more centralized systems can provide more privacy than decentralized protocols. The poor privacy properties of Ethereum, in which states are built from reused addresses, are well known. In addition, users sometimes use uniquely linked domain names, making their transactions transparent to outside observers.

There is a trade-off in designing decentralized protocols: full on-chain privacy can lead to an inflation problem within the protocol that cannot be tracked – because the recipient and quantities are not known. A sidechain like Liquid easily circumvents this problem: no more bitcoins can be created within the protocol than have been received at the input. In a centralized system, one trusted oracle can be provided that defines the boundaries of the problem.

Centralized solutions based on Chaumian e-cash could use more sophisticated cryptographic methods to hide counterparties and quantities and selectively disclose this information at the request of the parties involved in transactions. In addition, there is no restriction on how privacy-enhancing features can be implemented as they are not tied to decentralized protocols with limited network resources and free space on the blockchain.

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CBDCs as vehicles for real and necessary economic change

The above problems are not going away, and as countries around the world continue to develop, the people affected by them will likely continue to suffer. Governments have simply never had the tools necessary to implement adequate benefit programs for those who need them. Now, however, that opportunity is here.

That’s the real utility on which all efforts to develop CBDCs are based, and that should be central to the discussion of this new technology.