The CBDC Dilemma: Finding the Perfect Balance Between Privacy and Control

Written by Alexander Vasiliev, co-founder and CCO of the global payment network Mercuryo

As the crypto industry matured, stablecoins have become the go-to way for market participants to exchange between “standard” cryptocurrencies and digital assets pegged to fiat currencies. Since anyone can issue a stablecoin, governments worldwide have raised concerns over the potential risks to their national economies.

In fact, a regulatory body led by the US Treasury Department recently urged lawmakers to regulate stablecoin issuers in a similar way as banks and evaluate whether fiat-pegged digital assets pose a systematic risk to the nation’s payment system.

Fortunately for governments, they can leverage a powerful tool to compete with stablecoins and cryptocurrencies in conquering the financial industry. This tool is central bank digital currencies (CBDCs) that function as the digital version of a national currency and offer most of the benefits of crypto but with state control and issuance.

Despite their potential, while seven nations have already launched their CBDCs and China has become a leader among major economies, the US is treading carefully with central bank digital currencies, with two Fed governors citing more risks than actual advantages.

But what are these risks, and how can the state handle them?

Government Control: the Most Significant Caveat of CBDCs

Unlike crypto, CBDCs offer increased payments efficiency via a centralized network in which the central bank is responsible for issuing coins and overseeing transactions. Ironically, while this is what makes these digital assets a no-brainer for the state, it is also what poses the most significant risk for the economy.

Contrary to cash, CBDCs can be easily tracked as the data related to the identities of their owners and their respective transactions are recorded on the blockchain or another form of a distributed ledger. Since it controls the network, it’s up to each nation’s central bank to determine how closely it wants to monitor citizens.

Of course, a certain level of transaction monitoring is crucial for the state to tackle financial crime, for which CBDCs provide just the perfect tool. On the other hand, the more limits and controls the state uses for its digital national currency, the less privacy and financial freedom people will have.

Suppose the central bank fails to find a good balance between privacy and control. In that case, too much surveillance will discourage citizens from utilizing the CBDC, and make them turn to private cryptocurrencies instead to hide their personal finances from the prying eyes of the government.

However, if too much control isgiven to citizens, it could lead to increased risks of money laundering and terrorism financing. Moreover, such a case can also cause negative consequences for the economy, such as more convenient bank runs in the case of a crisis.

Finding the Perfect Balance Between Privacy and Control Is the Key to Success

Offering too much control for citizens and drastically limiting their financial freedom are both bad choices for governments that will likely lead to grave consequences in terms of CBDC adoption.

For that reason and for benefits to outweigh risks, the state must find the perfect balance between privacy and government monitoring. While this is the toughest part of the job, achieving this task will pave the way for the success of a nation’s CBDC.

After that, the state can focus on other aspects of central bank digital currencies, such as establishing a robust regulatory framework around digital national currency and choosing a network infrastructure that is highly scalable and offers cutting-edge security. The latter is essential to ensure stability, reliable uptime, as well as stay resilient against external and internal threats.

Excelling in all these areas will lead to a CBDC implementation where the benefits significantly outweigh the potential risks and downsides. For example, citizens won’t mind complying with some reasonable KYC and AML measures if they can access instantaneous and inexpensive cross-border transactions as part of a payment scheme backed by the central bank.

Furthermore, CBDCs can effectively solve the issue of the unbanked, which concerns 1.7 billion people globally, according to the Global Findex Database.

At the same time, while state-issued digital assets can be programmed in a similar fashion as cryptocurrencies to build layers of functionalities on top of them, they offer increased flexibility for central banks in terms of designing and executing monetary policies.

Combine all this with more efficient taxation and crackdowns against financial crime, and it becomes clear why central bank digital currencies are such powerful tools for the state.

CBDCs: Powerful Financial Tools That Come With Increased Risks

With all their advantages, central bank digital currencies have a great potential to disrupt the international payments ecosystem and create a completely new age of finance.

However, CBDCs are complex assets that come with new risks that, if neglected, can cause negative consequences for a nation’s economy and financial stability.

While 87 nations representing over 90% of the world’s population actively explore CBDCs, they have to tread carefully. For that reason, it will take some time until we see significant progress in this field.

Featured image via Unsplash

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