In the last few years, Central Bank Digital Currencies (CBDC), have been portrayed in a diverse number of ways. Some cryptocurrency enthusiasts have accused CBDC of being public enemy number one. While banking executives, who have previously criticized crypto coins, have praised them.

So what are central bank digital currencies? To put it simply, Central Bank Digital Currencies are an official digital currency issued by the central bank of a country. It can be part of the money supply or make up the entirety of the money supply. Unlike cryptocurrencies, it will be centralized to a certain extent.

But are CBDCs a good thing and how do they compare with cryptocurrencies? Let’s dig a little deeper to learn more.

The difference between CBDC and cryptocurrency

The aim of cryptocurrency is to provide a secure decentralized currency that can be used as a form of payment for goods and services just like cash or used as a store of value. This decentralization was first achieved thanks to a verification process known as proof of work (POW).

During POW, individuals known as miners use computers to solve mathematical puzzles. Every time a puzzle is completed, the miner will be awarded cryptocurrency for their effort. This verification process is required as it helps to confirm the authenticity of all payments; thus ensuring that the cryptocurrency in question is both usable and also decentralized. An increasingly adopted consensus alternative is proof of stake (POS).

On the other hand, you have a CBDC, which ultimately will be controlled by the government of a country through its central bank. In this regard, it is the exact opposite of cryptocurrencies which are guided by their stakeholders, making them a lot more democratic.

Although it still must be noted that in cryptocurrencies, the individuals with more computational power or larger crypto holdings have a bigger say depending on the verification process. Individuals living in the country where the CBDC originates from could have a bit of influence if their country happens to be a democracy.

However, this impact will or can be limited if the central bankers have a heavy influence over the politicians. Additionally, in an increasing number of countries, central banks are made independent from the rest of the political system.

There is also another side to this comparison. If we are to be objective, it is fair to say that many of the people that own the major cryptocurrencies such as Ethereum and Bitcoin do so for speculative purposes with the hope that the prices will skyrocket.

CBDCs will not have such unstable prices and will therefore be used mostly as a form of payment and a way to store wealth rather than an alternative investment asset.

CBDCs are also going to incorporate blockchain into their infrastructure. However, there are different types of blockchains. CBDC by their use purpose would most likely operate using a private blockchain.

Cryptocurrencies, to the contrary, allow for anyone to read and interact with their public ledger meaning that they use permissionless blockchains, also known as public blockchains.

Are CBDC stablecoins?

A CBDC is not a stablecoin. Instead, it is an actual currency that does not have a fixed exchange rate that is tied to another asset. One could argue that a government can create a CBDC that is tied to gold, but I highly doubt this will happen as a government would want to have the option to inflate or deflate the money supply and this could be done relatively easily with a CBDC. Tying it to gold would make matters more complicated.

At the same time, a CBDC will likely be as stable if not more stable than a stablecoin. It is in the interest of any government to have a stable currency in order to stimulate the right economic conditions. Stablecoins have already been involved in a number of controversies.

An example of this is Tether, the biggest stablecoin by market cap which has been accused of exaggerating its reserves of the US dollar which it claims to be pegged to. Due to this, some will say a CBDC issued by leading economies will be much safer for parking your spare cash if stability is what you are after.

Cryptocurrency purists may beg to differ.

How does CBDC work?

We have already answered the question of what are central bank digital currencies. Next, we are going to take a look at how CBDC work. We must point out that CBDC can vary in the way that they are set up. But they will also have a number of similarities. We will mention both in this section.

In the case of decentralized currencies such as Monero and Litecoin, the users will validate the activity of the digital currency. On the other hand, all of the validation of a CBDC will be conducted by the central bank’s servers and algorithms. There is a possibility that this validation process could also be outsourced to approved private for-profit companies.

The ledger will also be monitorable by a small number of approved departments responsible for the digital currency. Every single unit of the CBDC could also have its own ID which will allow for a greater ability to monitor monetary flow as well as track individual transactions.

Regardless of who is hosting and operating the computational infrastructure for the CBDC, it will be the central bank of the country that will decide circulation volume, who can use the digital fiat currency, and where it can be used.

Pros and Cons of CBDC

It is in no way an understatement to say that CBDCs are highly controversial. Many individuals fear that this will be a step further to the installment of a surveillance state. We are going to objectively lay out the pros as well as the cons of CBDC, and let you decide whether they are a good idea.

Let’s start off with a positive. CBDCs are going to greatly lower transaction costs involved with using this digital currency. The reason why some cryptocurrencies have such high transaction costs compared to the current mainstream payment methods is due to the fact that they are decentralized.

The removal of this decentralized framework by CBDC will eliminate these major costs, thus individuals will be able to retain a higher proportion of their money.

Yet, there will be large initial costs and recurring costs in order to make sure that the CBDC apparatus is continuously reliable. These costs will be paid by the taxpayers due to the CBDC being a legal monopoly. Over time this will make it inefficient and increase the associated costs. It can deplete the savings from the reduced transaction costs.

Another positive, the unbanked and underbanked could also enormously benefit from CBDC. Large groups of people still find it hard to open up a bank account such as the homeless, rehabilitated criminals, and low-income earners.

A CBDC can help limit these issues by allowing the underbanked to conduct digital transactions even if they do not have access to a bank account. Rather than needing to open bank accounts, individuals could just open up CBDC wallets that they will just need to verify their identity in order to use. The ability to track transactions in-depth will act as a safety measure to avoid misuse.

Now to talk about one of the most raised concerns with CBDC, the ability to track and control all individuals as well as companies using that CBDC. With centralization of any kind, there is always the worry that it will be abused.

Authoritarian leaders could use it to silence their critics and political opponents. The other danger of centralization is decision-making. History has proven again and again that a regulated free market should be left alone to make economic decisions. There is a worry that such an unexplored level of centralization can lead to man-made economic debacles.

Anonymity has its advantages but it also has major drawbacks; one of those is confidence if you do not know who you are transacting with and if they are not regulated. Then there will always be this fear in the back of your mind that you could potentially be defrauded. A CBDC makes fraud much harder to pull off which increases trust between consumers and businesses. This should help boost economic growth.

The final disadvantage we are going to cover is cyber attacks. Cyber attacks must be considered as something that may happen. Even decentralized currencies have previously been affected by attacks.

Just one successful cyber attack on a CBDC can lead to billions in losses depending on how long it takes to correct, it can even lead to a worldwide recession if a large economic power has been affected.

Why do banks favor CBDC over cryptocurrency?

Banks have notoriously been against cryptocurrencies, so you may be wondering why do they favor CBDC instead?

Profits are the main driver of every business whether they would like to admit it or not. Decentralized crypto wallets are a direct competitor to banks. Using a government-issued digital currency can allow banks to get one up on the competition allowing them to reclaim market share and continue their existing dominance.

The other aspect of this is stability. Banks make their money by lending the funds that have been deposited by their customers. No bank wants to take deposits of currencies that can potentially lose 50% value at any time. The ensured stability of CBDC will allow for reliable and consistent earnings.

Lobbying is a part of big business that must be mentioned. Spending enough money gives you the opportunity to influence laws that if enacted can give your business or industry a competitive advantage.

Banks are not able to effectively and efficiently lobby the users of a decentralized crypto coin. However, they are very experienced with lobbying governments; something that they have done for hundreds of years.

Bitcoin has been around since January 2009 yet regulation around it and other cryptocurrencies are non-existent in the majority of countries around the world. Doing business using unregulated parts of the economy is understandably incredibly risky for banks.

At any moment, the current government can decide to ban them or place major restrictions on them. When a CBDC is released, there will be a clear regulatory framework for the many experts working at banks to become accustomed to.

Banks also worry about CBDCs, it just happens to be the best of the bad options for them. There is a fear among banks that a CBDC can lead to a number of the services that banks offer which could end up making them (banks) obsolete.

At the end of the day, an overhaul of the financial system and order will not be welcomed full-heartedly by the majority of banks. Disregarding this, it is important for banks and everyday individuals to be acquainted with CBDCs as they will likely be a reality for many of us.

Are central bank digital currencies halal?

Are CBDC halal? Some scholars hold the opinion that currency issued by a government is halal, so, generally speaking, we can say, yes, central bank digital currencies are halal.

However, you will also have scholars that will examine whether the CBDC issued by the government is being used for purposes of dhulm (oppression or injustice). One of the downsides of CBDCs is that since it is very centralized, it can make it very easy for a government to control its people and affect their lives in negative and even harmful ways.

And Allah has made it clear that He forbids oppression.

Final thoughts

I believe that CBDC are inevitable as governments will more than likely utilize digital currency technologies to better monitor and improve efficiency as to how money flows between different government entities, allow for more efficient and better management as to how money is disbursed to different government programs, gain better control of tax collection, better control the inflation and deflation of the currency, and more.

Even though there are numerous positives to a CBDC, still, there is a dark side. The temptation for governments to extend greater control over their people will always be present and utilizing CBDCs to control or influence the decisions of its population will be great because what better way for a government to make its people comply than by controlling their access to money?

And as noted earlier, CBDCs can be used to monitor individual transactions, so laws should be implemented that allow the everyday user of CBDCs to have a basic degree of anonymity and implementing zero-knowledge-proof transactions should be programmed into the wallet of the user. Basically, people should be able to have the same anonymity as when they use cash.

At the same time, with $2.3 trillion in US government transactions being unaccounted for, government transactions should be transparent on the blockchain for its citizens to see how government monies are being utilized.

Government-issued CBDCs should also use hybrid blockchains as this can allow for citizens to monitor the blockchain and possibly offer a higher level of security for the govenrment against cyberattackes.

In the end, CBDCs must be issued in a manner that allows a government to operate efficiently and transparently while also respecting the provicay of its citizens who use it.

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