China’s e-CNY, how CBDCs are different from Venmo money, and impact on privacy (!)
Originally published on Substack: https://irregularmail.substack.com/p/cbdcs-are-they-really-going-to-change
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Here’s how I think about crypto vs stablecoins vs fiat:
Crypto is unicorn money. Fiat is horse money. And stablecoins are unicorn money wearing a horse costume: you can do all sorts of crypto/DeFi things with them, but they present as a store of value that is stable relative to horse money.
Here’s how I think “Central Bank Digital Currencies” (“CBDCs”) fit into the montage:
CBDCs are horse money, with a very narrow set of unicorn superpowers. What on earth do I mean?
CBDCs appear to be a competitor to the borderless, touchscreen-mediated forms of money we call cryptocurrencies.
For those of us in crypto, there is an inherent excitement when we imagine the institutions around us embracing the open, progressive values that define crypto.
But are we sure this is what is happening, that central banks are embracing a more fluid, open financial system? I think not. What follows is why I think this way.
Case study: China’s e-CNY
China is the first major economy to openly embrace and promote what the world refers to as a CBDC. As of early 2020, the People’s Bank of China (“PBOC”) had filed 84 patents related to digital currency. The PBOC’s Digital Currency Research Institute was set up as early as 2016, when governments in the US and Europe were still years away from revolting against Facebook’s announcement of the Libra cryptocurrency in 2019 (now renamed Diem).
In April 2020, China’s “e-CNY” pilot program went live in four cities in China. More than a year on, as of July 2021, it has 21 million registered accounts, which have transacted an average of 3 times/account, for US$75/transaction.
On 15 July 2021, the PBOC published their 15-page whitepaper on e-CNY.
Some key takeaways, some of which are implied rather than explicit:
- Power balance
China’s positioning with e-CNY is to build a financial ecosystem that wrestles back some control from major tech companies like Alibaba and Tencent.
In China, Alibaba’s Alipay and Tencent’s WeChat pay dominate payments in China. Mobile payments account for 59% of payments in 2019. Cash accounts for only 16%, and cards account for 23%. Increasingly, control over financial transactions is being ceded over from governments and the banks they supervise, to tech behemoths and tycoons that control them.
2. e-CNY is explicitly “digital fiat currency.” Nothing more
It is a “substitute for cash in circulation (M0).” It is not intended to have overly fanciful features, nor does it espouse values like decentralization and immutability.
This means that it is unlikely to be integrated into the crypto ecosystem as we know it1. Well, if you’ve been reading the news at all in the last 3 months, it’s obvious that crypto is a no-go in China, between banning bitcoin mining and cracking down on exchanges.
In fact, the paper states, “cryptocurrencies such as Bitcoin… lack of intrinsic value, acute price fluctuations, low trading efficiencies, and huge energy consumption… speculative… risks to financial security and social stability… money-laundering and other illegal economic activities.
Yep. The vitriol is real. Anything resembling or enabling crypto is a no.
There is, however, one potentially interesting feature:
3. Programmable money
A grand total of two sentences make a reference to programmability.
Smart contracts are promised, enabling “self-executing payments according to predefined conditions.”
This does sound exciting. The e-CNY could perhaps interact with the world of stablecoins (far) down the road — of course, only indirectly.
I’m very curious about how this plays out. Could e-CNY disintermediate payment flows in the same way crypto can, with direct and instant settlement, but without being a pain in the neck for regulators? Who are the intermediaries who would fight this?
Financial services providers often act as rent-seeking intermediaries that substitute for trust between counterparties — how are they going to fight direct settlement… or profit from it?
There are several other points of interest in the whitepaper, such as considerations on privacy, and the PBOC’s eventual goal of using a corporate version of e-CNY to internalize the RMB through smoother, non-USD denominated cross-border payments. I recommend skimming the whitepaper.
How are CBDCs different from the dollars in your internet banking account, or your Venmo account?
I researched CBDCs more generally, ahead of speaking on a crypto community call recently. Governments on both hemispheres are contemplating CBDCs of their own. PWC had a nice summary of CBDC efforts around the world.
Most of these CBDC efforts sound like just digital money, in the fashion of e-CNY.
What makes these CBDCs different from any digital form of spendable credit, whether it’s on Venmo or your banking app?
To me, the salient differences lie in two major factors.
First, CBDCs are issued by the government.
This means that there is zero counterparty risk.
If your bank goes bankrupt, your deposits are only protected up to the FDIC limit, or the equivalent for wherever you bank your money (sounds unlikely, but some of us have acute memories of the Great Financial Crisis / the Great Recession of 2008).
If there is a serious security or cybersecurity incident at Coinbase, all your stablecoins are gone in a poof.
If your stablecoin issuer faces a crisis, your stablecoins are safe in your hardware wallet, but they may be worth cents on a dollar (USDT, anyone?).
If you hold a CBDC instead, you are protected from all these scenarios.
Second, settlement can be direct and instantaneous.
When I pay a merchant with PayPal or my credit card, it will be a day or more until they see my funds in their bank account. Funds have to flow through a national or global settlement network, through a sometimes labyrinthine network of intermediaries. The amount of administration overhead this kind of payment flow creates can be migraine-causing.
Of course, there is value to such a payment flow; it ensures a high degree of interoperability and commercial/regulatory assurances. But most of this overhead is unnecessary for the average payment. If one could make payments with CBDCs, customers and vendors could settle payments instantaneously, cheaply, and significantly reduce working capital needs.
What kind of impact will CBDCs have on stablecoins?
In the short term, given that CBDCs generally look more like digital fiat rather than a fundamentally different form of currency, I don’t think the impact will be great. DeFi users will continue to interact in degen ways enabled only by the crypto community.
I think the greater impact in the long term will be the cannibalization of a significant proportion of future stablecoin users.
The people that would want to hold stablecoins primarily for their ease of use, borderless-ness and programmability, now have a government-backed alternative.
Unless you have certain anti-authority beliefs, the choice feels obvious?
What kind of impact will CBDCs have on… the world?
The most interesting impact from an economic perspective appears to be the disintermediation of banks in the monetary system.
Banks serve an important role in managing the economy through the fractional reserve system, allowing the central bank to push certain levers in order to boost or rein in the economy. Unless banks find a way to be relevant in a paradigm where direct settlement becomes possible and even preferred, interest rate policy may be at risk as a policy tool. Arguably, as the government deficits around the world deteriorate interminably, this is a good thing — but what secondary and tertiary effects this may have is hard to tell. This is the wild card. Currently most governments’ solution to the wild card is to limit the amount of CBDCs in circulation, but how long can that hold?
The scariest impact from a sociological perspective is the loss in privacy.
When you start transacting on the electronic systems that CBDCs live in, it will become close to impossible to conduct truly anonymous, private transactions. Some transactions should be private because they are embarrassing. Some because they allow people with different beliefs than yours to hurt your career. Some because they support social movements that may be important and just, but as yet unpopular — from universal suffrage to gay rights, the 1800s and 1900s provide many examples of how the majority often sacrifices the rights of the minority. And can you imagine running resistance movements in World War II if all financial transactions were traceable?
Different governments treat the privacy question differently, but it is unlikely that they will value privacy more than the ability to manage crime (whether they should or not is a separate topic of discussion).
TL;DR: I am not optimistic about what CBDCs mean for privacy.
Is it * possible * for CBDCs to respect your personal privacy and freedom?
There are promising proposals on how CBDC systems can allow for privacy. Five credible designs have been proposed in 2021 alone, including one by the OG cypherpunk David Chaum (in 1989, Chaum created Digicash, a precursor to Bitcoin).
The proposals have different levels of privacy. Some create anonymity for the sender, some also for the receiver, and some only shield the amount.
Comparison of proposals for privacy-enabled CBDCs:
However, I am skeptical that central banks will voluntarily go through the tremendous effort required to make privacy-respecting CBDCs work. For central banks to be thus motivated, citizens need to make strong appeals to politicians.
CBDCs should not be a foregone conclusion
At the end of June, the Fed Vice Chair for Supervision, Randal Quarles, proposed in a speech that CBDCs may not be the right thing to do.
These are the problems he highlights with creating a CBDC (paraphrased):
- first, the fact that banks and banking deposits are central to the financial economy and that CBDCs would disrupt this system;
- second, it would create a tremendous, irresistible honeypot dynamic for cybercriminals; and
- third, it would present serious privacy dilemmas.
He speaks positively but cautiously of USD stablecoins, saying that they could support the ongoing role of the USD in the global economy, while avoiding the problems that arise from a CBDC.
I’m not confident that governments around the world will be as enlightened as Randal Quarles appears to be. That being said, I don’t think the CBDC ship has sailed entirely — most governments’ CBDC efforts are still in early stages of development. With enough civic participation, the future can be co-written with citizens.
Parting shot
Facebook’s Libra announcement in 2019 is widely believed to be the spark that accelerated CBDC efforts around the world. It’s ironic, given Facebook’s history of privacy violations, that they may have inspired further potential privacy violations in the form of CBDCs.
The title asks, “Are CBDCs really going to change our lives?” I suspect the answer is yes, but not in the way we expected.
They aren’t going to feel very different from the digital money we already interact with today… but they could have extreme impacts on our freedoms.
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