Security Notes: CBDCs: Hit the Pause Key

Central banks around the world are gripped by an uncharacteristic frenzy. Almost every central bank is at least setting up “commissions” to look into the alluring—yet jarring—prospect of redefining their national currencies. A few countries simply embraced Bitcoin, straight. The second-biggest economy in the world, China, is actively experimenting with a digital yuan. President Biden has issued a directive to explore cryptocurrency, and the European Union is dead serious about the prospect of crypto.

This effort at currency redefinition is a big deal. Liquidity, stability, and employment are all at stake. And unintended consequences lay in wait.

From society’s point of view, money is a means to (i) ensure social justice, and (ii) give society’s talented members the resources they need to translate their talent into societal benefits. As we witness an unfolding process of transforming national currencies into independent cyber entities we must ensure that these two societal missions are well served.

Central banks need to think, plan, and simulate circumstances where everything is paid for with CBDCs—central bank digital currencies—and then instruct the technology so as to satisfy the planned requirements.

CBDCs will be the first form of money that can benefit from the power of cryptography. Cryptography offers security that no physical vault could rival, and privacy that no heavy curtain can match. And, most remarkably, perhaps, cryptography offers a payor the means to ensure that the money he pays will be used according to the terms agreed upon in the payment contract.

In other words, CBDCs will be tethered money (read more in my book: “Tethered Money”), money linked to well-defined terms. Money will be moved strictly according to the agreed upon computer instructions. Payment devices don’t curry favor; they simply execute transactions.

To work at full power, CBDCs will need a dedicated financial language, universalization, and standardization. The tethered content will be written into the transactable coin, as well as into the accounting ledgers tracking that coin. All that must be part of the future CBDC, and it must be carefully designed. If we rush to define CBDCs, as, say, a payment scheme running on Ethereum, then we will botch this historic opportunity.

Alas, we must note that CBDCs will impact society in two ways: by its very nature and by its payment practice. While the nature of cyber money is now slowly evolving, payment efficiency is a well-understood attribute. Central banks may distinguish the nature of this future money from the practice of moving it about. The latter can be experimented with through the notion of stablecoins. The idea is to issue digital claim checks for the national currency as is, and keep these claim checks with instant redemption ability.

Digital claim checks represent obligations against cash. Hence, they don’t impact liquidity (CBDCs proper will). They can be introduced through commercial issuers that are well regulated by the central bank. Stablecoins like BitMint*LeVeL can be  tethered, can safeguard privacy, and can render phones into  wallets, vaults, and de-facto banks. They fit into an Internet of Things regimen, and easily cross national borders. Once payment in digital form is perfected, the road for full-fledged CBDCs will loom.

A radical transformation similar to what is about to happen has occurred only twice in the 5,000-year history of money. The first instance was the brilliant idea of minting precious metal coins at a fixed standard weight. The second was the replacement of metal with paper. Each of those transformations catapulted society to new heights. We expect nothing less this time around, so we’d better get it right!

—Gideon Samid gideon@bitmint.com