Are Central Bank Digital Currencies oppressive tools of a global elite or merely a management consultancy pipedream sold to ossified institutions desperate to remain relevant in an age of PayPal and Bitcoin? They are certainly never far from the minds of sceptical commentators who have already pronounced their guilty verdicts. The case for the prosecution goes something like this: China has a CBDC system, its purpose is to control the beleaguered population, Western banks are considering CBDCs, ergo, digital tyranny. Case closed.
If anyone is still reading, and I appreciate this does not make me Mr. Popular amongst readers of this site, I beg to appeal that verdict. Not because CBDCs are a good thing, nor because I want to see them introduced and it’s only sceptics that hold them back. As we shall see, their problems are legion. I appeal because we, as sceptics, look like gullible, ignorant reactionaries if we have to appeal to science fiction technology and an A-level economics student can knock down our arguments in two minutes flat. Our credibility is at stake.
CBDCs are accused of allowing ‘them’ to stop you buying more than your quota of unfashionable products: fuel for your car, plane tickets, meat, the usual suspects. As one respected sceptic put it to me recently: “Surely, once CBDC is in place and cash has more or less vanished it will be programmable by the govt, so if it wants to reduce expenditure per capita on fossil fuels it can?” To understand why this is extremely unlikely we need to know something about money, banks and payment systems. Keep going, it is not as dull as it sounds.
CBDCs would be another form of money, issued alongside physical cash. If we look at the U.K. economy there are roughly speaking two forms of money, cash and bank deposits, of which cash is about 4% of the total. Banks hold reserves at the BoE which account for about 18% of the total, but they do not mix with the retail money supply. CBDCs would be a third form of money competing with cash, so if introduced would likely be around 5% of the money in retail circulation. Cash is, and CBDCs would be, issued by the BoE, but the remaining 95% of the money is not. That money is created by commercial banks when they create loans. Quick economics lesson: loans create both an asset for the bank and a liability for the borrower, so overall bank loans do not create wealth, only money. Because the amount of money in circulation is a factor in inflation, central banks believe they can control inflation by controlling the rate at which those loans are created. They do this by varying their minimum price, i.e., the base lending rate. Price goes up, demand goes down, fewer loans, less money, lower inflation. That’s the theory anyway. End of lesson.
If your salary is paid electronically into your bank account and you spend it via debit cards, credit cards, direct debits and anything except withdrawn cash, your economic life will not involve the central bank. Eschewing cash is boycotting the central bank. And at only 5% of the overall money supply, we can already see that CBDCs are not a great starting point for mass control of society. The programmable thing is about setting up regular payments and limiting outflows, of which more later. So far, so boring.
But would your bank and credit card balances somehow magically be converted to CBDCs one fateful day? As anyone who has worked in banking will tell you, nothing in banking happens quickly, so we would certainly get plenty of warning. It would require new legislation for a start, which would in turn need the support of the public plus the build-out of a very significant piece of national IT infrastructure, capable of sustaining at least 30,000 transactions per second and once launched could never be switched off. To compete with cash, CBDC payments need to settle in less than a second, so using existing payment systems that rely on card reader providers doing daily netting would be out and blockchains get nowhere near that transactional throughput. BoE consultation papers talk about trialling something, maybe, towards the end of the decade. As someone who rescues these kinds of project for a living, I can tell you those timelines are wildly optimistic. U.K. retail banks still have not figured out how to replace their 1970s era mainframes. But let’s go with it and assume the legislation and infrastructure are ready. It would then require conversion of your bank deposits to entries on the BoE ledger – let’s go with using existing payment systems, while simultaneously transacting back those balances so that there is no net outflow, which would be a mass withdrawal, or a run on the banks. This would all have to be done without your consent thereby contravening the very laws the BoE and HM Treasury purport to uphold. So no, you will choose to use CBDCs, if any of us live long enough to see them. In case you are tempted, the amount of CBDC you will be able to use is likely to be restricted for the reasons set out above. Without limits, even voluntary withdrawal of funds from bank deposits to digital wallets could be an outflow from the banking system akin to a run on the banks. It is the BoE’s job to avoid bank runs, not precipitate them. Even Andrew Bailey knows that.
For anyone who makes the choice to use CBDCs, their holding will not be exactly cash-like because it will not be anonymous. This is because retail banking legislation demands that banks ‘know their customers’ (KYC) and Anti Money Laundering (AML) laws also require authentication of parties to banking transactions. This is why Bitcoin is the darling of scammers and hackers, it has no tie-in with identity. The BoE wants to reduce fraud in financial markets, not facilitate it. Andrew Bailey knows that too. Any reduction in identity requirements for account opening generally leads to an increase in fraud. For example, while banks want to get children into banking, they cannot reasonably ask them for payslips and utility bills as proof of ID. It is therefore harder to authenticate children. This is why child accounts are preferred by drug dealers and the introduction of child banking accounts has been a factor in the involvement of children in so-called county lines. Talk about unintended consequences.
Having said all of that, the identity aspects of a U.K. CBDC will probably be handled by what the BoE calls Payment Interface Providers (PIPs) and External Service Interface Providers (ESIPs) – private sector firms that provide access to the BoE core ledger. In practice, these will be the very same banks you use today. If you already trust your bank with your transactions, there is no reason to not trust them with CBDCs. The core BoE ledger will not contain any personal data. There are several reasons for this. Because ID in the U.K. is such a mess (see my previous article), relying as it does on proxies such as utility bills and payslips, the BoE is above all that grubby checking of things like that, as will be necessary for KYC and AML compliance when digital wallets are created. That is what the private sector is for. The other reason is risk reduction. They need to build a platform that can run fast enough and then be kept secure from cyber threats. Doing authentication checks at the rate of 30,000 per second would get in the way of the speed requirement with the added dilemma that the industrial strength cryptography needed for security of such critical national infrastructure is computationally expensive. As much processing as possible, including identity management, will be delegated to PIPs, i.e., the banks and card providers that you already trust to process your transactions.
Rather than being an Orwellian identity trove, the proposed designs keep identity well away from the core ledger. But the BoE is proposing to go even further by offering an “alias service” including disposable, single-use identities. These would be designed to be used in retail purchases where the payer elects to withhold their identity from the merchant and any downstream payment processor such as card companies, banks and, yes, central banks. Aliases would not anonymise the payer from the PIP (because of KYC and AML) but we already trust our banks with that data.
The upshot of all this is that the deeper you go into the U.K. CBDC system the less personal data you will find. How a curb-your-petrol-enthusiasm scheme is meant to work in that environment is very far from clear. Perhaps James Delingpole or one of his guests can enlighten us. He did have a guest who claimed to have a blockchain that did a trillion transactions per second. But I digress…
Our CBDC defendant does seem to have a plausible alibi. But what about its accomplice, payment systems? After all, CBDCs are literally not going anywhere without payments. That is what payments are, movements of money. Strictly speaking currencies are separate from payment systems and CBDCs would be no different in that regard. However, the accusation is that payments would be interrupted if authoritarian limits were breached and that requires us to make payments accomplices to the crime. Could payment systems do that? If you pay for your diesel with a card, you are using a payment system. Could it give you the ‘computer says no’ treatment? The problem is that Visa, Mastercard or whichever card schemes you and the merchant use to process your payment do not know what you have purchased. They do not know because they do not need to know. As far as payment is concerned, what you bought is irrelevant. All that matters is that the correct amount is reliably transferred from the payer to the payee. When the till instructs the card machine to initiate a payment it only has to give it the amount, and possibly a transaction code, but no product information. There is nowhere in the payment systems to handle that information. That is why you do not see your shopping list replicated on your credit card statement, only where you shopped. It is also why it can be hard to identify items on your credit card bill, or at least exactly what it was that you bought. This commonly happens with online purchases where the merchant is some blandly named holding company whose name is not related to their products. You can try calling the credit card company, but they cannot help because they do not know what was purchased. The data is just not there. This gives U.K. payment systems an alibi too. They are not much help to Klaus’s evil plans.
This should not surprise anyone who shops at a supermarket. Why do you think they are so keen for you to have a Clubcard or Nectar card? Because without them they know almost nothing about their customers. In the hyper-competitive world of hyper-markets, we are given to understand that data is the key to commercial success. But with only a till and a credit card reader all that HQ knows is that a basket of things left the shop and payment was received for them. They do not know who bought them or whether the buyer is a one-off or has shopped there every day for a decade. If you consistently use the same payment card and do not use cash, they could correlate the transactions, but they still would not know anything about you and whether you are susceptable to their marketing dark arts, or those of the companies whose products they stock. So called loyalty schemes fix that. You tell them all about yourself when you sign-up and then at every purchase you are encouraged to swipe your card which ostensibly ‘earns you points’ but is really about tying your identity to your purchases. If Klaus Schwab really wanted to limit your carbon footprint, he would be better off co-opting or launching a loyalty card, not a CBDC. I must have missed the Delingpod railing against the twin tyrannies of Nectar cards and Clubcards. To keep our conspiracy theory going, if Klaus wanted to stop you buying a burger in Davos, he would first have to rebuild the entire Western payments system. Good luck with that. It is different in China, but we do not live there.
Is identity not the crux of the matter? This is why paying attention to identity systems is important. We need modern identity system to protect us from fraud (please stop using utility bills and your mother’s maiden name) while ensuring that they are preserving our privacy. I’m looking at you, clubcard holders. You need to be in control, self-sovereign in the jargon, rather than giving it up to anyone else. Sceptics would be better concerning themselves with loyalty schemes rather than CBDCs. Granted it is not as sexy, but that is by design. For example, why do you think Nectar points are perceived as so valueless? Because it encourages you to feel you have to put every last purchase through the card to get anything out of it and you presume it is not of value to anyone. And that is exactly what the supermarkets want.
So, to the summing up. CBDCs’ problems are legion. They are technically out of reach; they risk undermining the entire retail banking system and as pretty much everyone wrongly thinks they are a one-way ticket to the gulag the BoE and HM Treasury are going to struggle to get the support they need from MPs to pass the necessary legislation for another generation. If they do ever make an appearance in the U.K. economy, we have little to fear. In the meantime, let’s at least look like we know what we are talking about.