Do crypto holders need to fear the digital dollar?

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Through cen­tral bank­ing, the U.S. gov­ern­ment has already demon­strat­ed it has access to infin­i­ty mon­ey print­ing. If it launch­es a CBDC – cen­tral bank dig­i­tal cur­ren­cy – what would that mean for the val­ue of cryp­to assets?

Why Would a Digital Dollar Be Useful?

Have you ever won­dered why you can make bank trans­fers via your bank­ing app, but not out­side of bank­ing hours, includ­ing week­ends? After all, the mobile app – and the inter­net – are work­ing 24/7 just the same. To under­stand this is to under­stand the key dif­fer­ence between an elec­tron­ic dol­lar (the dol­lar you access through your bank’s app) and a dig­i­tal one (a CBDC). This helps us under­stand why the dig­i­tal dol­lar would even be need­ed in the first place.

The bank­ing app may have dig­i­tized your cash deposits, but the rela­tion­ship between the Fed­er­al Reserve and com­mer­cial banks still works the same:

  • The Fed set­tles inter­bank pay­ments, free of risk, thus ensur­ing liq­uid­i­ty and finan­cial stability.
  • By pro­vid­ing accounts to com­mer­cial banks, such accounts serve as mon­e­tary bridges between the Fed and the public
  • The cash under com­mer­cial bank con­trol can be issued as elec­tron­ic funds, but the banks are oblig­at­ed to redeem USD in a 1:1 ratio.

In oth­er words, the mon­ey issued by com­mer­cial banks to the pub­lic could be viewed as a kind of sta­ble­coin, pegged to the Fed’s dol­lar. The mon­e­tary sys­tem derives its cred­i­bil­i­ty from this fixed exchange rate. More­over, deposit insur­ance and reg­u­la­to­ry over­sight make sure that the Fed mon­ey and com­mer­cial bank mon­ey is interchangeable.

How­ev­er, because of all the inter­me­di­aries involved in the process, there is a lot of fric­tion involved. Case in point, the ACH (Auto­mat­ed Clear­ing House) Net­work can’t set­tle pay­ments over the week­end because the Fed­er­al Reserve doesn’t work.

There­fore, despite busi­ness­es being able to accept pay­ments 24/7 through soft­ware such as Wave, your mobile app doesn’t have 24/7 access to elec­tron­ic fund transfers.

What Other Issues Would the Digital Dollar Solve?

Hav­ing bank­ing hours in this age of glob­al inter­con­nec­tiv­i­ty and 24/7 online ser­vices is obvi­ous­ly out­dat­ed. The dig­i­tal dol­lar would elim­i­nate this tra­di­tion entirely.

Like­wise, because there would be no need for so many inter­me­di­aries, both domes­tic and inter­na­tion­al pay­ments would be set­tled faster and at low­er fees. Per­haps most impor­tant­ly, one would not even need a bank account to access dig­i­tal dol­lars, but mere­ly a mobile app wallet.

Last­ly, the dig­i­tal dol­lar would become the most pow­er­ful mon­e­tary weapon ever envi­sioned against both mon­ey-laun­der­ing and tax eva­sion. The rea­son is sim­ple; all trans­ac­tions would be trace­able at any point in time.

How Would the Digital Dollar Work?

Accord­ing to BIS (Bank for Inter­na­tion­al Set­tle­ments), 86% of the world’s cen­tral banks are look­ing into CBD­Cs. Yet, Chi­na is the only nation that has already test­ed it. China’s dig­i­tal yuan (e‑CNY) has so far been used in over 1.32 mil­lion pay­ment sce­nar­ios, account­ing for $5.4 bil­lion in trans­ac­tion volume.

With­out a doubt, major cen­tral banks are close­ly observ­ing how e‑CNY per­forms, includ­ing the Fed, so it is very use­ful to take a deep­er dive into how it works. First of all, e‑CNY appears to be based on DLT (dis­trib­uted ledger tech­nol­o­gy), not blockchain per se. The dif­fer­ence between DLT and blockchain is that the lat­ter cre­ates cryp­to­graph­i­cal­ly linked data blocks, mak­ing the record immutable.

In con­trast, DLT doesn’t have to rely on this method, but it does use mul­ti­ple data nodes (com­put­ers on a net­work). Sim­ply stat­ed, blockchain is just a type of DLT. In the case of the dig­i­tal yuan, the People’s Bank of Chi­na (PBoC) opt­ed for a per­mis­sioned DLT-based cur­ren­cy issued as M0 mon­ey sup­ply.

Image credit: Deutsche Bank
Image cred­it: Deutsche Bank

This means that the PBoC will hold direct lia­bil­i­ty over e‑CNY issuance. For exam­ple, in the Unit­ed States, the Fed dif­fer­en­ti­ates between M1, M2, and M3 mon­ey sup­ply, each one for a dif­fer­ent sec­tor of the econ­o­my. This effi­cien­cy of hav­ing an M0 mon­ey sup­ply makes it a risk-free system.

Next, an e‑CNY dig­i­tal wal­let is not con­sid­ered a bank account because only a mobile phone num­ber is required. Option­al­ly, the PBoC opt­ed to make e‑CNY as M0 dig­i­tal cash, from being able to accrue inter­est. And last­ly, com­mer­cial banks are in charge of with­draw­ing e‑CNY and con­vert­ing it into deposits.

In a nut­shell, dig­i­tal yuan, or e‑CNY, is an account-based hybrid dig­i­tal cash.

Will the Digital Dollar Use the Same CBDC Structure?

As you can tell, a CBDC can be tweaked in many ways. This is its main strength – pro­gram­ma­bil­i­ty. How­ev­er, the main dif­fer­ence is one between account-based and tokenized:

  • Account-based – A FedAc­counts approach would allow retail cus­tomers to access the Fed’s M0 mon­ey sup­ply instead of com­mer­cial banks. The FedAc­counts con­cept was pro­posed by pro­fes­sor Mor­gan Ricks of Van­der­bilt Law school.
  • Tok­enized Dol­lar – Pro­posed by the for­mer U.S. Com­mod­i­ty Futures Trad­ing Com­mis­sion (CFTC) Chairs, J. Christo­pher Gian­car­lo and Daniel Gorfine, the Dig­i­tal Dol­lar Project would resem­ble a dig­i­tal form of phys­i­cal cash. It would be dis­trib­uted through com­mer­cial banks and oper­ate along­side com­mer­cial bank mon­ey and phys­i­cal cash.

Unfor­tu­nate­ly, CBDC’s pro­gram­ma­bil­i­ty is a dou­ble-edged sword, poten­tial­ly impos­ing severe down­sides such as:

  • Loss of pri­va­cy – the cen­tral bank would be able to track all trans­ac­tions unless specif­i­cal­ly devel­oped not to do so.
  • The cen­tral bank could de-plat­form busi­ness­es or indi­vid­u­als, effec­tive­ly freez­ing their funds.
  • The cen­tral bank could impose neg­a­tive inter­est rates.
  • The cen­tral bank could impose expiry dates on a cer­tain amount of CBDC to trig­ger spending.

Last­ly, because a CBDC would effec­tive­ly cre­ate a cen­tral­ized spend­ing data­base, the cen­tral bank could make CBDC unavail­able for the pur­chase of cer­tain products.

If not tread­ed care­ful­ly, imple­ment­ing the dig­i­tal dol­lar could become a road to mind-bog­gling total­i­tar­i­an­ism in which every aspect of mon­e­tary life could in some way be sur­veilled, sanc­tioned, direct­ed, or cur­tailed. This leaves us with the most impor­tant ques­tion, how would CBD­Cs affect cryptocurrencies?

The Digital Dollar vs. Cryptocurrencies

When it comes down to it, the crit­i­cal dif­fer­ence between dig­i­tal fiat cur­ren­cies and cryp­tocur­ren­cies is per­mis­sion type. Bit­coin, like thou­sands of oth­er alt­coins, uses a per­mis­sion­less blockchain net­work. Mean­ing, any­one with a com­put­er and inter­net access can become a part of the net­work as either a val­ida­tor or a min­er to secure it.

From this, it fol­lows that a per­mis­sion­less blockchain leads to decen­tral­iza­tion and a trust­less sys­tem. In stark con­trast, a CBDC would rely on cen­tral­ized trust. The pub­lic would be far removed from it, effec­tive­ly rent­ing dig­i­tal mon­ey and count­ing on the good­will of top controllers.

Most impor­tant­ly, unlike Bit­coin which is lim­it­ed to 21 mil­lion, a CBDC would be infla­tion­ary. This alone would pre­vent it from gain­ing val­ue over time. In fact, quite the oppo­site would hap­pen, just as it is hap­pen­ing now with soar­ing infla­tion rates across the globe, fur­ther dri­ving peo­ple toward defla­tion­ary cryp­tocur­ren­cies like Bitcoin.

In turn, the most like­ly out­come of the dig­i­tal dol­lar launch would be two-fold:

  1. Break­ing down the psy­cho­log­i­cal bar­ri­er of view­ing dig­i­tal assets as ‘shady code that has no val­ue’. After all, if the U.S. gov­ern­ment does launch a CBDC, it would bring legit­i­ma­cy to oth­er dig­i­tal assets as well.
  2. CBDC would enter into close prox­im­i­ty with cryp­tocur­ren­cies. To illus­trate, VISA has already devel­oped a Uni­ver­sal Pay­ment Chan­nel (UPC) for cross-blockchain exchange. It would then take a few steps to exit one dig­i­tal ecosys­tem and enter another.

Case in point, when peo­ple dis­cov­er that some decen­tral­ized finance (DeFi) pro­to­cols far out­per­form the stock mar­ket, “high yield” bank­ing accounts at 0.50% APY will not look so attrac­tive when faced with some of DeFi’s 6x – 20x gains.

Michael Son­nen­shein, the CEO of Grayscale which accounts for $43 bil­lion AUM, shared this assess­ment in a recent inter­view with ETF Edge:

“I think it all trends towards the dig­i­ti­za­tion of mon­ey and some­thing that investors and just your aver­age per­son … who may not be in the invest­ment mar­ket can glom onto as well.”

One could even argue that the very exis­tence of Bit­coin, recent­ly cross­ing a $1 tril­lion mar­ket cap, is keep­ing CBDC devel­op­ment con­strained so it doesn’t spook the pub­lic with its sur­veil­lance fea­tures. In fact, the Pres­i­dent of the U.S. Mon­ey Reserve, Philip N. Diehl, advo­cat­ed for just such an approach – cre­at­ing an anony­mous dig­i­tal dol­lar so its util­i­ty would be equal to phys­i­cal banknotes.

Guest post by Shane Neagle from The Tokenist

Shane has been an active sup­port­er of the move­ment towards decen­tral­ized finance since 2015. He has writ­ten hun­dreds of arti­cles relat­ed to devel­op­ments sur­round­ing dig­i­tal secu­ri­ties — the inte­gra­tion of tra­di­tion­al finan­cial secu­ri­ties and dis­trib­uted ledger tech­nol­o­gy (DLT). He remains fas­ci­nat­ed by the grow­ing impact tech­nol­o­gy has on eco­nom­ics — and every­day life.

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