All posts

What are CBDCs? Do they Compete with Bitcoin?

Ian Leviness
September 22, 2022
10 min

The more that Bitcoin grows, the more important it becomes to truly nail down who its’ competitors are and who they aren’t.

Rising above all others in this respect, due to their sheer media attention and governmental backing are central bank digital currencies or “CDBCs.” To many analysts and pundits of all shapes and sizes, CBDCs are currently considered to be a major, future competitor to Bitcoin. Before taking their opinions at face value, however, it’s important to ask: do the fundamentals of both back up such an assertion?

If you’ve read any of our other, past posts on Bitcoin, then you know that its’ overarching value proposition is its’ viability as digital gold, which is starting to include its’ functionality as a safe haven.

With this in mind, it’s logical to wonder: can CBDCs rival an asset that’s provably scarce, endlessly portable, and decentralized to its’ core?

Read on to find out.

What are CBDCs?

CBDCs, are by definition, digital currencies that are issued and held by the world’s central banks. At this juncture, there’s little to no indication that their supplies will be capped, which means that they’ll be just as inflationary as fiat currencies. Furthermore, the central banks that control them will be able to issue more of them in a time of crisis or reduce their supply in a time of prosperity.

In other words, unlike with Bitcoin, digital scarcity won’t be part of the equation.

How a CBDC Could Work: The Case of Sweden’s E-Krona

Right now, the development of a national CBDC called the “e-krona” is in progress in Sweden. During a presentation with Copenhagen Fintech, Björn Segendorf, who is a senior advisor at the Sveriges Riksbank (the Swedish Central Bank), shared the project’s belief that because most of Sweden’s younger generation has “grown up without cash,” they represent the “logical jump-off point for CBDC usage.” Though the Riksbank seems to want to push the e-krona project through to live usage as quickly as they can, Segendorf made clear that the launch of the e-krona is “at least four years off,” based on the estimate of how long the current Swedish parliament inquiry into the project will take, what recommendations it will yield, and how long it will take everyone involved with the project to account for those recommendations.

All in all, it’s early for Sweden’s CBDC, but even so, certain conclusions can still be drawn about how the e-krona might look when it’s live.

During the same presentation, Segendorf revealed the intended basics of the e-krona’s functionality with the caveat that nearly everything about it may change over time, depending on the results of the Swedish parliament’s inquiry.

Firstly, the e-krona’s development team aims for it to be “accessible 24/7 in real-time.” What this seems to suggest is that even when the banks will be closed, transactions with Sweden’s CBDC will go on, facilitated by something like a dedicated app and its’ corresponding payment rails. Next, Segendorf clarified that the primary usage of the e-krona should be as means of payment between individuals and companies (including the government), such as for paying bills, taxes, etc. With this, he also made clear that it will be “denominated in SEK.” For those of you who may not know, this means that SEK will be used as the e-krona’s reserve currency and consequently, be a key part of its ecosystem.

Following this, Segendorf mentioned that the e-krona is designed to have “offline functionality” and “partial anonymity,” but didn’t really elaborate on what these features will entail. While the first of them is easy to clarify since it refers to the e-krona system having the ability to facilitate payments without any sort of internet/data connection, the latter is harder to pin down. For now, what can reasonably be concluded is that “partial anonymity” may refer to the idea that certain aspects of user behavior will be tracked and others will not. Exactly which aspects end up being tracked depends on more details being released about the e-krona project over time.

On top of everything, the team reportedly doesn’t plan for the e-krona to have any sort of interest rate, which leads to the logical argument that it won’t compete with the world’s other stores of value, i.e., bonds, gold, Bitcoin, etc.

While these won’t be the only features of the e-krona and its corresponding payment ecosystem, they do give you a good overview of where the project stands now. Furthermore, through knowing the basics of the e-krona, you also effectively know the basics of most other CBDCs that are already in progress, since the e-krona team has “an open dialogue with most other countries who are developing similar projects.”

What about potential risks with the e-krona?

The overarching risk of the e-krona and all other CBDCs is that as EuropeanCEO and many other critics continue to point out, “state-operated payment systems could enable governments to track all of their citizens’ purchases.” This would stand in stark contrast to cash, which has always been a relatively anonymous payment mechanism. Critics suggest that to avoid a situation in which the launch of CBDCs leads to the end of all transactional anonymity, governments should consider solutions that allow them to at least maintain the status quo. Truthfully, however, only time and continuous transparency throughout the process of developing CBDCs will illuminate what this means in practice.

On top of privacy considerations, there is the potential risk of a reverse-bank run when CBDCs launch, which refers to people doing away with cash and moving to CBDCs quickly enough to actually crash the bulk of the global financial system. In the same presentation with Segendorf, Morten Spange, who serves as the Chief Monetary Policy Advisor for Denmark’s Central Bank, suggested that capping CBDCs’ supplies may help to alleviate this concern.

To understand how a cap might work, just picture either fewer CBDC units being in existence than cash in circulation, or a maximum number of CBDC units that each household could have, thus preventing a massive swap of all cash to CBDCs in theory.

Is Norway developing a CBDC?

As of late last year, when they last published public information on the subject, the Norwegian Central Bank has had the view that they don’t see a need to develop a CBDC as of yet. Instead, they appear to believe that payment apps will continue to outpace cash but cash will stick around as “a backup payment method when payment apps experience any sort of failure.” Over time, you can expect us to keep you updated on the key developments surrounding Norway and CBDCs but for now, they’re continuing to wait and see how other countries’ CBDC projects pan out.

What about the other Nordic Countries?

Denmark, for example, has reportedly also foregone the development of its’ own dedicated CBDC in favor of a wait and see approach. According to Morten Spange, there are no current plans for a Danish CBDC because they currently don’t see the benefit outweighing the downsides. With this, he also revealed that the Danish Central Bank is “continuously tracking all CBDC work” and that they appear to believe that the greatest opportunity for CBDCs actually doesn’t lie in the Nordics due to the “steep decline in cash payments“ and people being already thoroughly used to alternative payment methods as a result. This is in line with the findings of a 2019 research paper by the International Monetary Fund in which the authors found that “demand for digital currencies will thus be weak in countries where cash use is already low.”

In that same paper, the authors concluded that “for a digital cash(CBDC) to be a success, there has to be an incentive to adopt it,” concluding that one possible example of an incentive that fits this bill is the fact that CBDCS “eliminate the need for ATMs.”

Is this, however, enough of a push on its own? At face value, no, at least not by itself. As the year progresses and CBDCs move further into the spotlight, it’s reasonable to expect that the IMF, and all others mentioned here will provide further clarity to their stances on CBDCs. Since more than 80% of the world’s governments are presently researching the viability of CBDCs, future Norwegian and Danish CBDCs aren’t entirely out of the question.

Are CBDCs meant to compete with Bitcoin?

Judging by all existing evidence, CBDCs are less of a threat to Bitcoin and more of the key example of international governments finally waking up to the fact that fiat currencies won’t work the way they are forever. The system needs to be improved, both to account for the mass digitalisation of all financial services and to account for the rapidly falling usage of cash worldwide.

Per the Bank for International Settlements, the crux of CBDCs’ importance lies in being the next logical iteration of fiat currency, to account for the swiftly accelerating digital age of payments. In a speech published on their website last October, BIS representatives said, “a CBDC would be a kind of digital banknote and, as such, could satisfy more use cases than paper while the issuer, being a central bank, could support liquidity, settlement finality and trust in the value of the currency.” Adding this to everything above yields the conclusion that a CBDC will logically be the same as fiat currency, with the caveats that it will exist in fully-digital form with programmability.

In case you’re not already aware, in this context, programmability refers to the ability to bake in certain conditions into a digital currency. Imagine, for example, KYC/AML compliance being baked into the money itself, meaning that the ownership of CBDCs could be instantly restricted to those who don’t fall onto any sort of international sanctions list. This sort of feature is made possible by the fact that digital currencies are issued from and hosted on blockchains, which allow almost any sort of conditional code to be attached to them, in theory.

With respect to programmability, however, this is only the tip of the iceberg.

In future content, we’ll dive deeper into why programmable money matters, but for now, you understand one possible similarity between Bitcoin and CBDCs. The exact degree of similarity they end up having depended on what the exact features of each CBDC’s digital ledger(blockchain or blockchain-like system) turn out to be when they launch.

On the other hand, CBDCs will definitively be centralized, but this isn’t a strong enough argument on its own to prove they’re meant to compete with Bitcoin. Having watched Bitcoin’s massive rise, especially over the course of 2020, it’s safe to say that the governmental consensus is that Bitcoin is at least being given room to grow as well as serious consideration as a store of value and safe haven. If there’s one metric to track related to the chance of any sort of future competition with CBDCS, it’s Bitcoin’s market cap. The bigger that gets, the less likely competition between Bitcoin and CBDCs will be.

As Raoul Pal put it at Real Vision’s Bitcoin in the Real World event this week, “what we’re seeing is a front-running of its market-cap because, at $1 trillion, it’s a serious asset.” The institutions that are involved in Bitcoin now are the pioneers and the true wave has yet to come, once Bitcoin hits the market cap that the bulk of the investment space is targeting. What this is will vary, based on each institution’s risk model, but suffice it to say for now that most appear to agree that beating gold’s market cap(roughly $10 trillion) would be a sort of paradigm shift to adoption like we’ve never seen before.

Nailing down when this may or may not occur isn’t possible because as you may already know by now, Bitcoin bucks all trends. In the end, as long as it continues to grow, it will continue to cement its place in the eyes of institutions, governments, and retail investors alike.

Keep in Mind: Most Countries Are Reportedly Holding off on CBDC Development

In any case, it’s not even clear that all countries will choose to go the route of CBDCs.

Last week, the BIS released a report that indicates only 1/5 of the world’s central banks have confirmed that they plan to release CBDCs in the next three years. Though the growing influence of COVID-19 on world affairs has sped up the development of existing CBDC projects, it hasn’t yet pushed the number past this point.

Therefore, for now, even if each and every current CBDC project gets approved and launched, only 20% of the world (or less) will run on them and that calculation doesn’t include the United States, since thus far, they’ve taken a similar position to Denmark’s. This is significant because of the US Dollar’s present status as the world’s reserve currency, which in turn, has made it its most powerful currency thus far. As of now, that amounts to just under $45 billion being held internationally to balance all sorts of payments through all sorts of different currency mediums.

CBDCs and Bitcoin could one day co-exist

If there’s one key takeaway from all current developments related to CBDCs and their possible future relationship with Bitcoin, it’s that the duo could easily co-exist over the long term. With Bitcoin growing by the day as a store of value, it is even possible that one day, it will be added to CBDC reserves to help them maintain the value they need. For now, however, it’s too early yet to say if any CBDC projects are taking this possibility into serious consideration.

How can I keep up to date on developments related to CBDCs?

On a global scale, the best sources to follow are the International Monetary Fund (IMF), the Bank of International Settlements(BIS), and the research output of firms like Real Vision and PwC. If you’re a resident of the Nordics, then you might consider following the Swedish Riksbank, Danmarks Nationalbank, the Bank of Finland, and the Norges Bank as well.

This text is intended to inform and is not an investment recommendation.

Ian Leviness
September 22, 2022
10 min
Cookie Consent

By clicking “Accept”, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts. View our Privacy Policy for more information.