Central Bank Digital Currencies (CBDC) - Risks for Citizens (2024)

Central bank digital currencies (CBDCs) are issued by central banks with their value linked to the country’s official currency. The world is increasingly turning away from cold, hard cash to digital financial transactions.

The emergence of blockchain technology and cryptocurrencies has disrupted the financial services sector. Central banks are taking note of the issuance of government-backed digital currencies. The traditional roles of central banks are supporting financial services within a country and the commercial banking system, setting monetary policy, and issuing currencies.

CBDCs can be likened to stablecoins that are pegged to another currency, commodity, or financial instrument. The goal is to maintain a relatively stable value over time. The difference is that CBDCs are state-issued and operated.

Different Types of CBDCs in Use

Different countries are piloting a variety of approaches with their CBDCs. Some of these approaches include:

• Account-based model – an example is DCash which is being implemented in Eastern Caribbean. DCash allows customers to hold deposit accounts directly with the central bank.
• The e-CNY model relies on private-sector banks to distribute and maintain digital currency accounts for their customers. China used the 2022 Olympic Games to showcase e-CNY as athletes used the currency to make purchases at the games.
• The European Central Bank model entails licensing financial institutions to operate a permissioned node of the blockchain network as a conduit for the distribution of the digital euro.
• Yet another model plans to have fiat currency issued as anonymous fungible tokens to protect users’ privacy. The model appears popular with cryptophiles but is yet to be trialed by central banks.

What Are the Risks Associated with CBDCs for Citizens?

As central banks enthusiastically explore CBDCs, there are challenges to be considered. From the onset, the voluntary adoption will be a big challenge. Conservative-minded and liberty-loving citizens will have an instinctively hostile reaction against CBDCs considering them a direct assault on their freedom.

• The concentration of data in the hands of central banks presents a privacy risk for citizens. Payment data of citizens carried on a single, central database will incentivize cyber-attacks. Additionally, there’s a high systemic risk for individual or generalized surveillance. As it stands, most of our banking activity and transactions are already digitized, automatically monitored, and constantly screened. Digital payments can only make it easier to carry out surveillance and freeze private assets. CBDCs are open to abuse by governments and other parties with access to the data.
• Technological stability and infrastructural issues present yet another challenge for CBDCs. Significant investments in terms of money and time must go into establishing new technology and infrastructure for CBDCs. A robust and secure digital infrastructure is required for CBDCs to function properly. Central banks will have a technical challenge to develop and implement CBCSs calling for new decision-making processes and new talent with adequate experience. The Eastern Caribbean DCash went offline for two months in January 2022 due to technological issues.
• Weak business cases for CBDCs since they may necessitate huge capital allocation and fail to offer the envisioned roles and transaction speeds. More effort and resources are required to develop the infrastructure for digital currencies than can be justified by a meager reward. The central banks of Canada and Singapore have concluded that there isn’t a strong case for digital currency.
• Data privacy and protection issues may prevail especially with poor design choices. Digital payment data reveals sensitive aspects of an individual which may worsen existing data protection and privacy issues. Transaction data may be unlawfully used for credit evaluation and cross-selling purposes. Digital currencies are vulnerable to cyberattacks leading to loss of funds and sensitive information. Central banks must implement robust security measures to address fraud, hacking, and other cybersecurity risks.
• Disintermediation and Possible Bank Runs – CBDCs stand to disrupt the financial system by eliminating the need for intermediaries and traditional banking services. Disintermediation will lead to reduced profitability of banks and financial institutions. Changes to the existing financial system can prove to be challenging for both businesses and people dependent on these services. CBDCs may increase the risk of bank runs since they provide an alternative to bank deposits that are backed by the government. Risk officers and chief financial officers (CFOs) must monitor the impact of CBDCs on bank liquidity and capital requirements in light of potential policy changes.

• Inherent complexity and regulatory issues – CBDCs present regulatory issues since they are highly complex. Regulators and policymakers will find it extremely difficult to fully understand blockchain technology and encryption protocols. Complex systems will fail in complex ways. As it stands, the lack of new regulations and legal frameworks on CBDCs and other digital currencies presents huge challenges. Design choices in deploying CBDCs are dependent on the constituencies to be served. User segments will include private citizens, corporations and companies, and commercial banks and will be served by unique design choices. It will take time to develop and implement new regulations, especially about sensitive data, privacy, and cybersecurity.
• Monetary Policy Implications – changes to monetary policy will happen as central banks work around balancing the impact of CBDCs on money supply and interest rates. Tweaking monetary policy could prove to be a challenge for central banks in a time of economic instability and crisis. Adoption goals must take into account hurdles such as fiscal rights, regulations, and frameworks for enabling commerce. One such case is the roll-out of eNaira in Nigeria whereby the government phased out old Naira notes. With 55% of the population in Nigeria relying on physical cash, the phase-out of old notes proved to be a disaster. A frenzied scramble ensued to exchange old notes before they became worthless. The imposition of limits on withdrawals and debit card restrictions coupled with capital controls made it impossible to send money out of the country. Mismanagement of rollouts and monetary policy could lead to social unrest and other implications.
• A lack of trust by users of CBDCs may arise due to security concerns. Incidents that may lead to the loss of assets or sensitive data will erode the trust of citizens and drive them away from CBDC use. Yet another consideration is the role to be played by central banks and their involvement in the adoption and widespread use of CBDCs.

In conclusion, CBDCs may pose a combination of financial, economic, and human rights risks. These risks become potentially greater if a CBDC is designed poorly or with bad intentions. The future use of CBDCs will improve since blockchain technology is highly secure and transactions are highly compartmentalized spreading risk.

Author: Alessandro Civati