Is it possible to replace cash with digital money? The world's central banks are charging ahead

As governments around the world restructure the financial sector with new infrastructure and digital money, it is time to rethink what is important.

 Central banks' efforts to create new digital currencies must be scrutinized in terms of how they affect people's rights, such as privacy, choice, and access to the economy.

The People's Bank of China pioneered the development of a national central bank digital currency, the digital Yuan, or e-CNY. The investigation began in 2014. Over $5.3 billion in transactions have now been recorded for China's official digital currency. The PBOC recently published an English-language report highlighting the development of the digital Yuan and the central bank's guiding policy principles of inclusiveness, privacy, safety, efficiency, regulatory compliance, and interoperability. These principles are sound when taken individually. At the same time, each has system-level implications for CBDC design.

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Where they conflict, as values and requirements frequently do, trade-offs are made based on "what matters" for the CBDC system's goals and objectives. According to a new G7 report on CBDC guiding principles, it will be necessary to strike a "careful balance" between the principles of privacy and inclusion versus regulatory compliance and private sector business interests.

China's decisions on new national payment infrastructure will have far-reaching consequences even outside the country. Governments and central banks all over the world are grappling with the same issues. Many central banks have followed the PBOC's lead and adopted several of its design decisions.

Some central banks have even argued that they are subject to different, more relaxed standards than other central banks, and that users should simply trust central bankers as they decide which principles to follow and trade-offs to make in developing digital public payment infrastructure. We recently published an analysis of the PBOC report in which we identified two major issues with these approaches.

Is it possible to replace cash with digital money

First, there are issues with retail CBDC, which everyday people would use to buy a coffee, for example. A central bank must decide whether digital currency users can only access their funds through an account provided by a regulated entity, such as a bank.

Allowing access outside of such an account, on the other hand, would preserve the anonymity that has long been enjoyed by those who use and have the option to use cash. The PBOC discusses in its report a proposal for "wallets": a pseudonymous option for "small-value" transactions provided and managed by "authorized operators." The PBOC describes its strategy as "quasi-account-based."

The PBOC's design modifies the relationship between retail consumers and financial custodians, who control and allow the use of money. This is a substantial departure from cash. Users of CBDC designed around PBOC-style wallets would only be able to own and use money with the gatekeeper's permission.

We must question why states are even considering CBDC. This begins with the decline in the use of cash for payments in many countries over the last decade, as consumers shift to debit cards and internet payments via custodial accounts. The motivation has evolved into defending monetary sovereignty against the threat of cryptocurrencies, risks posed by privately issued money such as certain stablecoins issued by large tech companies, and threats posed by other states internationalizing their own digital currency. It has also become a component of states' long-term plans for technological sovereignty.

The full-blooded and robust kind of privacy, in which users are free from being completely profiled by any organization, entity, or individual, is and should be a public good.

Users of cash should not be concerned that their activities will be profiled based on their transactions. However, many cashless payment methods leave a data trail that can be used to build a detailed history of an individual's habits, location, and circumstances. Consumers have the right to conduct low-risk transactions with providers of goods and services without disclosing personally identifiable information that could be used to link them to the transaction.

Profiling is a real risk with dangerous consequences because consumers are unable to verify the trustworthiness of digital payment infrastructure and its operators. Users cannot trust what they cannot verify for themselves, and they should not be forced to do so in the absence of payment alternatives that preserve the properties of cash. This principle must be a policy imperative in the redesign of the new social construct of money, both domestically and internationally.

It is also perfectly possible to regulate transactions without linking them to the consumer's personally identifiable information. It is possible to collect information about the payee for tax and anti-money-laundering/know-your-customer compliance, as well as information about the size, location, and nature of the transaction, while keeping the payer anonymous.

The second issue is that the PBOC believes CBDC is part of the monetary base and thus a direct substitute for cash. This is only partially correct. Indeed, a CBDC, like cash and banknotes, would be the central bank's direct obligations. However, this does not imply that it is a one-to-one substitute for cash.

In fact, people use cash for a variety of reasons. People want to avoid discrimination as well as privacy. Many people don't have bank accounts. Others are hampered by a lack of infrastructure, such as internet access. Some prefer to transact anonymously, while others prefer to be the sole owner and possessor of their assets. In fact, having the option to use a medium of exchange that checks all of those boxes is valuable in and of itself.

Many central banks have a firm policy of ensuring that people living in their jurisdiction have complete and unrestricted access to the economy. That is, presumably, the main purpose of a central bank. Such access includes payment modes and mechanisms such as cash, which entails access to public payment infrastructure and payment instruments with cash-like properties.

The fanciful notion that a CBDC would somehow relieve central banks of the obligation to provide access to cash-like payment instruments, or that a central bank could directly satisfy this policy requirement by issuing a digital currency, is based on viewing CBDC as a perfect substitute for cash, which it is not.

We must be wary of viewing CBDC as a panacea for financial inclusion. A long-term decline in cash would prevent many groups from fully participating in the modern economy, including the poor, the elderly, the disabled, those lacking appropriate technological expertise or infrastructure, members of remote communities, and the unbanked. It would, in particular, jeopardize everyone's right to engage in private economic activity. This is especially true if we mix up "wallets" and "accounts," as the PBOC has.

Under that regime, a digital yuan, dollar, or pound sterling could only be used with the approval of a gatekeeper who could always say no or change the rules, especially if those gatekeepers have business models based on data harvesting and profiling.

One might believe that there is no other way to design a digital currency, and that some sort of balancing act must deliver a set of compromises between compliance, efficiency, inclusivity, safety, business interests, and privacy. No, it does not. Central banks must have the ingenuity and courage to create a CBDC policy that guarantees four key principles: first, accessibility, to ensure that nearly everyone can use it; second, non-discrimination, to ensure that any one person's money is as good as anyone else's; and third, privacy, to ensure that no user fears being profiled based on his or her transactions. Finally, ownership is required to ensure that CBDC can be owned by its bearer, just like cash, and used without fear of being blocked by a third-party actor.

These four fundamental principles serve as constraints for redesigning the social construct of money and replacing the foundations of the financial sector with new national payment systems that have the potential to be democratizing. By ignoring them and focusing on what matters, we forego rights and choices that have long been available to the public. Without them, the new digital economy will fail before it even gets started.

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