Central Bank Digital Currency: Should You Want It Too?

Over the last five months, we have researched and written about e-CNY (China’s Central Bank Digital Currency or CBDC), from its core technology and product experience, to the key institutional players involved and its long-term strategic implications. During this process, I found myself repeatedly asking this question: if you are a central bank, should you want your own e-CNY?

What felt like a more long-term question just a few weeks ago turned more immediate, in light of SWIFT “canceling” Russia, and Visa and Mastercard doing the same. Among the debit and credit cards issued in Russia, Visa and Mastercard cards accounted for 74% of payment transactions in 2020, according to the Nilson Report. In particular, Visa is often treated as the benchmark and incumbent-to-beat for both fintech startups and CBDC’s. During the Beijing Winter Olympics that just wrapped up, one headline that has been celebrated in many Chinese media outlets is this Fortune article, touting that e-CNY has unseated Visa’s monopoly on payments during an Olympic. (What’s less discussed is that Visa has signed an exclusive license with the International Olympic Committee through 2032, so its so-called “monopoly” is a contractual agreement, and e-CNY’s launch during this Beijing Winter Olympics may have violated that agreement.)

Russia’s unilateral invasion of Ukraine has shown that SWIFT, American companies like Visa and Mastercard, and the US dollar can and will be weaponized during war time. Putting down my peace-loving global citizen hat and putting on my unemotional analyst hat, it’s hard to see any central bank not wanting its own CBDC. Knowing what e-CNY is built to do and can deliver, there are three new-found superpowers that’d be hard for any central bank or financial regulator to resist, regardless of if you are a friend or foe of the US.

Superpower #1: Removing Pure Anonymity

There are only two ways of doing financial transactions that are purely anonymous: paper cash or cryptocurrency on a decentralized finance (DeFi) platform. A full-fledged CBDC can remove both forms of pure anonymity. In the e-CNY case, this is euphemistically called “managed anonymity”.

A few weeks ago, on Valentine’s Day, Mu Changchun, who leads the Digital Currency Research Institute – the internal R&D lab of the People’s Bank of China (PBOC) in charge of developing the e-CNY – invoked this “managed anonymity” notion during an event hosted by the Atlantic Council and UC San Diego. (The recording of the entire event is worth watching, if you are a CBDC nerd like me.)

To Mu’s credit, the privacy and anonymity issue of e-CNY is something he proactively addressed. It’s a question he often gets asked in both China and the West. In a nutshell, “managed anonymity” is the “anonymous” tier of e-CNY’s wallet with these requirements and limitations:

• Requirements: cell phone number
• Verification: in-app
• Account limit: 10,000 RMB (~1500 USD)
• Single transaction limit: 2,000 RMB (~300 USD)

This tier is considered “anonymous”, because you only need a Chinese cell phone number to register. According to China’s latest data privacy laws, there is no data sharing between telcos (where you do need a real name ID to get a cell phone number) and banks. So the “anonymity” is only from the bank's perspective, and only when there is no suspicion that any financial crime is being committed by an “anonymous” wallet. If there is suspicion, the telcos of course can and will share wallet identity data with the PBOC, so financial regulators can “manage” this anonymity.

The heart of this power lies in the ease in which a CBDC enables a central bank or another financial regulatory body to crack down on financial crimes and money laundering, which is what they are supposed to do. By permanently taking away paper cash and operating a digital-only currency issuance infrastructure, tracking transactions and money flow becomes a lot easier.

There are many cryptocurrency maximalists who dislike CBDC for this power of removing pure anonymity, some going as far as calling it “one of the single greatest violations of human rights in history”. My own perspective is not so extreme, shrill, or cynical.

Technology is value neutral and its impact, positive or negative, is determined by the human beings who wield it. There will always be regulators who have the best intentions and thus deserve the best technology to do their job, and ones who abuse the power enabled by the same technology.

Superpower #2: Narrative of Financial Inclusion

Promoting financial inclusion is a common “selling point” of a CBDC. Mu touted financial inclusion as a key benefit of e-CNY in his Atlantic Council event presentation. The US Federal Reserve also mentioned financial inclusion as a potential benefit of a CBDC in its discussion paper released in January on whether the US should have its own.

Inclusion into a financial system, any financial system, goes hand in hand with losing anonymity. Being excluded has many drawbacks, but also avoids any regulation, tracking, or supervision. Thus, increasing financial inclusion and decreasing anonymity can be two sides of the same coin.

I specifically call this power the narrative of financial inclusion, because the cause of financial inclusion has been often reserved for high-minded, idealistic international non-profits or development agencies, not central banks or financial regulators. By building a CBDC, a central bank can finally be a part of this cause and a major player in this powerful, uplifting narrative – an attractive proposition to improve its public perception.

Financial inclusion is not a fake narrative, even in a wealthy country like the US. There are still roughly 7 million people who are “unbanked” as of 2019, according to a survey commissioned by the FDIC. This does not include the larger population of people who are “underbanked”, which has given rise to many fintech startups, like Chime, seeking to address this problem. If implemented with financial inclusion as a true objective, a CBDC can indeed improve access to banking services while lowering costs. Of course, it depends on the institutions and regulators doing the implementation.

In the e-CNY case, its limited pilot is deployed in ten cities plus the Winter Olympics bubble. The Olympics bubble is a special case, but the other ten cities are all fairly wealthy. Even Changsha, probably the least known city to foreigners among the ten, is the provincial capital of Hunan, not some backwater rural village in Gansu.

Thus far, e-CNY’s financial inclusion implementation has fallen short, even as it continues to sing that narrative to drive its adoption and public perception. If the US Federal Reserve ever decides to build its own CBDC one day, it can do the same, even if the implementation still favors New York and LA over rural Mississippi. The same goes for any country’s central bank.

Superpower #3: Accelerating a Multipolar Financial System

Russia getting kicked out of SWIFT has made things crystal clear that USD is one of the key components of a unipolar, America-led world. While SWIFT may feel and function like an international regulator, it is actually a non-profit co-op that is technically independent. The only reason why the US can effectively use it as a sanctioning tool is because half of SWIFT’s payment flows are in USD.

Even though America’s decision to exert this power against Russia may be perfectly justified due to the unlawful nature of its invasion of Ukraine, it will also make every other economy, big or small, think twice about its reliance on the dollar and inch towards a multipolar financial system, if only so everyone has a backup plan.

Adopting a CBDC accelerates the pace towards that multipolar world. In the not too distant future, multiple CBDCs can transact via different cryptocurrency exchanges or cryptocurrencies themselves, since both CBDCs and independent cryptocurrencies, like Ethereum and others, are programmable via smart contracts. SWIFT will become irrelevant.

Stablecoin adoption presents a preview into that future. Right now, the vast majority of stablecoins issued by private tech companies are pegged to USD. But as Circle’s CEO revealed in the same Atlantic Council event where Mu discussed e-CNY, his company intends to issue stablecoins pegged to other fiat currencies later this year. Circle is one of the biggest players in the stablecoin sphere and jointly-issues the popular USD stablecoin, USDC, with Coinbase.

The Federal Reserve realizes the implication of this multipolar financial system too, where the dollar would be less powerful. In its CBDC discussion paper, “Support the Dollar’s International Role” is cited as a potential benefit, alongside financial inclusion.

So whether you want to defensively preserve your currency’s role in the international financial system (USD, Euro, Yen), or offensively grow its influence (RMB, India’s Rupee), or simply have a backup plan in case of future sanctions (Russia’s Ruble, Iran’s Rial), all roads lead to a world of CBDC’s.

The more practical question is whether a central bank will build its own or work with a private tech company, like Circle, to speed up its progress or make up for a lack of talent and expertise. This decision is similar to the “buy vs build” question that every company goes through when adopting a new technology product. This “buy” relationship has been how SWIFT does business with many developing countries, who want to be more integrated with the international financial system, but don’t have the expertise and are fine acquiescing to USD’s dominance. India’s partnership with SWIFT in 2014 is one such example.

That was then, this is now. Given the state of the world, if you are a central bank of any given country in March 2022, should you want a CBDC of your own?

It’s hard to imagine the answer is “no”.