No. 1 rule for central bank digital currencies: Do no harm

Central banks around the globe have decided to compete with private cryptocurrencies and each other in the race to issue central bank digital currencies. These efforts are important, but policymakers should give equal attention to the financial stability risks that may be linked to CBDCs.

Digital money has been in use for some time in traditional payments systems under assumed names. In payments and monetary control systems, banks and the Fed make digital transfers of value all the time to clear and settle obligations between and among each other. Direct payroll deposits as well as debit card, Zelle and Venmo payments all operate as functional equivalents of digital dollars for consumers. But the deployment of a token or account-based digital dollar that directly links retail users and the Fed creates a kaleidoscope of complicated monetary, policy and stability issues that require a careful balancing of the related benefits, costs and risks.

CBDCs have become a sort of financial Rorschach tests. Everyone sees something different when they look at them. They represent modernization, efficiencies and cost savings to some while others focus on the advantages — real or imagined — of real-time global payments transfers. There are hopes that it will better serve low-income and unbanked citizens. On the other hand, China views it as a fail-safe means of surveilling its own population and at the same time defanging U.S. dollar diplomacy and sanctions.

An April 7 Bank Policy Institute report authored by President and CEO Greg Baer summarizes a number of important financial issues, noting that a CBDC could provide the Fed with an even more direct role in setting retail interest rates, transform the flow of consumer funds that banks rely on to make consumer and business loans, and impact the risk profile of U.S. banks and therefore the U.S. economy. The report provides an excellent cost-benefit analysis of the many issues raised by CBDCs and deserves a close reading.

Since the Fed is actively engaged in studying the feasibility of a digital dollar, let’s focus on three critical issues that a CBDC would raise in the United States.

First, CBDCs will centralize and concentrate economic power in the hands of governments, which could potentially allow them to surveil each and every financial transaction. This may be an incentive for China, which is using technology to monitor and control the behavior of its citizens. But the implications of such government-controlled databases will likely invite pushback in the United States.

Second, CBDCs will alter the current banking and payments models by eliminating some if not all of the financial intermediaries involved. Whether it be checks, ATM transactions, automated clearinghouse transfers or credit cards, most retail payments systems today use a processing model that includes validation and transmittal by the payor’s, payee’s and system provider’s banks. All share in the flow of revenue. CBCDs will rearrange these models and even CBDCs reliant on bank-issued wallets will transform payments markets in fundamental ways.

Third and most importantly, governments must be sure that CBDCs do not increase the risk of a digital heist of the nation’s currency? Before becoming intoxicated with technological happy talk and deploying CBDCs, they must consider the their future vulnerability.

For example, today’s public-private key cryptography may be an insignificant challenge for the next generation of quantum-enabled computers, bringing us closer to the “quantum apocalypse” described by scientists. The National Security Agency intends to develop quantum-resistant algorithms by 2024, but the efficacy of those is unknown.

A quantum computer with 4099 perfectly stable qubits could reportedly break RSA-2048 encryption in just 10 seconds instead of the 300 trillion years required today. While such quantum computers do not yet exist, they are on the way. A future where malicious fanatics, terrorists and criminal cartels can get their hands on such powerful cyberattack technologies relatively inexpensively must be averted.

Each day, we cede more of the economic underpinnings of the country to technology in the name of innovation and quality-of-life enhancements. That is generally a positive thing. But to the extent that policymakers become mesmerized by innovation and fail to fully appreciate the attendant vulnerabilities, ultimately, they will facilitate the dark side of technology.

Congress and the public must fully analyze the fundamental issues raised by a government-sponsored digital currency. The Fed is rightly taking a deliberate pace and considering a wide spectrum of challenges to U.S. monetary and fiscal policies, including those posed by replication, mutilation, hacking, theft and alteration of CBDCs. But not every nation appears to be as cautious or has the same to lose from wiring its central bank.

No CBDC should be launched just because it can be. We must first understand the answers to the hard questions, because in many cases the answers may change the way we live. The geopolitical implications of CBDCs raise the stakes significantly, making them perhaps one of the more important existential challenges that we may face.