Trade-offs in central bank digital currencies

From the Federal Reserve to Bhutan’s Royal Monetary Authority in the Himalayas, central banks are working on digital currency studies or projects. There are several reasons for this. Most importantly, private cryptocurrencies and so-called stablecoins are rapidly becoming popular rivals to traditional money; Central bank digital currencies (CBDCs) would not only keep governments in the game but could help make payments and monetary policy more efficient and direct.
CBDCs have the potential to destabilise everything from traditional banking to the power of the US dollar — and authorities are wary of too much disruption to global financial stability. There is a tricky trade-off: The more limits and oversight get built into state-backed cryptocoins the less likely they are to be used.
Privacy is part of it: Unlike traditional paper money, CBDCs can be constantly tracked because the identity data of owners and their transactions are kept in the blockchain — the cryptographic form and function of all digital coins. It will be up to central banks whether or how closely they keep tabs on people.
For the US, CBDCs pose a geopolitical concern. The threat doesn’t come from China’s digital yuan taking the dollar’s place as the world’s currency of choice for international trade. It’s from digital currencies’ ability to shortcut the systems for cross-border payments. The Bank for International Settlements — the central bankers’ central bank — touched on this in a study released on September 30.
Right now, if you want to send dollars around the world — which many people and businesses do daily — you need to use an international payments network, like SWIFT. At some point in the process, your money has to pass through an American-licensed settlement bank. This gives the US power beyond its borders because it can demand that banks refuse to handle any dollar payments for foreign banks (or whole countries). That’s how financial sanctions against countries like Iran and Russia, or bad individuals anywhere, are enforced.
Digital currencies, including ones created and controlled by central banks, bypass all of this. CBDCs could easily be sent across borders directly between any users. They could then be locally exchanged into and out of dollars if someone else in the same country owns greenbacks — which many people and banks do.
That’s not a bad outcome for governments around the world that want to lessen US financial influence. That includes European nations, as Josh Younger, an analyst at JPMorgan Chase & Co, noted in the tail-end of a report on CBDCs in May last year. “For high-income countries and the US in particular, [creating a] digital currency is an exercise in geopolitical risk management,” he wrote. That’s one strong motive for the US to develop its own digital currency. It can’t defend its interests if it isn’t in the game and people everywhere use other digital currencies. The same concern holds for almost all other countries. But introducing a CBDC creates threats to ordinary banking and financial stability. CBDCs might make a very good alternative to holding cash in bank deposits.

—Bloomberg