Why the Private Sector, and not Governments, Should Drive Digital Money

Why the Private Sector, and not Governments, Should Drive Digital Money

Disclaimer: Your capital is at risk. This is not investment advice.

Central Bank Digital Currencies - Part 3

  • Digital cash will shake up the global economy.
  • The central banks have FOMO. They should take the lead from Switzerland rather than China.
  • The private sector is better placed to design and operate digital money in a free society.

There is a sense of inevitability about digital money, principally because new technology, inspired by crypto, allows it. In part 3, we examine the case for central bank digital currency (CBDC) versus private digital currency (PDC).

A CBDC is digital “cash”, issued by the central bank, as opposed to a bank deposit, which many think to be digital. For a recap, please see part 1, where we investigated what digital currencies are and part 2, where we looked at the discussion, research and pilot schemes around CBDCs within G20 nations.

In this piece, we refer to digital money, which can either be a CBDC (government) or PDC (private sector). Digital currencies utilise blockchain distributed ledger technology to create digital forms of fiat currency.

PDCs already exist in the form of stablecoins, such as Tether and Circle, which are essentially money market funds that utilise crypto infrastructure for global payments. Facebook’s Diem is an example of a PDC under development. In future, expect more PDCs issued by banks, payment and tech companies. This is a land grab.

All fiat money is subject to inflation, and digital money does not change this. Yet, in terms of being able to deliver the fiat equivalent as promised, a CBDC has no risk, in contrast to a PDC, which inevitably does. A PDC will have varying amounts of risk depending on the quality of the asset backing. If a PDC has direct access to a central bank, or equivalent guarantees, it could also be risk-free.

The boom in stablecoins

Starting with Bitcoin in 2009, the crypto industry has flourished. Without the invention of the blockchain, this conversation about digital money, public or private, wouldn’t be happening. The success of stablecoins, the forerunners of PDC, is an unintended consequence of bank intervention within the crypto ecosystem.

As crypto markets thrived, the banks made it increasingly difficult to transfer funds to and from crypto exchanges. In recent years, this has slowed growth as the banks constrained capital inflows. In order to overcome this, the crypto innovators came up with a solution and the stablecoin was born.

This first PDC, Tether USD, is a de facto money market fund wrapped in a digital token that is pegged to the US dollar. It is closely linked to the crypto exchange Bitfinex, which has helped Tether issuance grow to over $100 billion. The integrity of the management and the asset backing has come under scrutiny, which has paved the way for other stablecoins to gain market share, most notably Circle, which has better relationships with regulators.

These US dollar tokens are used for trading crypto assets while bypassing the banks. Stablecoins are the first PDCs we have seen, and their success has caught the attention of the central banks, many of whom are considering their own versions.

These pioneering PDCs have fulfilled a market need and have enabled the crypto space to thrive despite the banks’ best efforts. One of the most remarkable aspects of the crypto evolution has been the ability to overcome obstacles. Access to the free movement of capital was one of the greatest challenges, and PDCs have solved it.

An unintended consequence of regulatory intervention in crypto is that, just as it made it hard for money to enter the space, it has made it hard for it to exit. The result is that crypto has become a self-sustaining ecosystem that is more resilient against external shocks than in years past.

In come the central banks

The central banks and regulators have been watching this growth and perhaps fear it will get out of control. Today, stablecoin usage has grown beyond crypto transactions and enables new applications in remittance and general payments.

With such rapid growth, there is a sense of “FOMO” (fear of missing out), and everyone wants in. If the central banks can launch their own CBDCs, then, the theory goes, there will be no need for stablecoins or other PDCs. That line of thinking is incorrect.

Unlike Tether, where there are serious allegations of wrongdoing and governance concerns, government-backed CBDCs are risk-free because they are simply digital cash. While the high credit quality is noted, the advantages of CBDCs over PDCs pretty much end there. As previously stated, PDCs could be high or low risk depending on the underlying asset quality, so they need not be risky at all.

Designing digital money

There are endless design possibilities for digital money, and to get it right, a clear brief is essential. Some countries see this as a matter of influence, as digital currencies can spread their wings. Digital money is more mobile than bank deposits and has the potential to find its way to any one of the world’s 7.5 billion mobile phones. You don’t need a bank account, just a digital wallet, which can be downloaded for free.

If the Peoples’ Bank of China is doing it, then every other central bank must follow suit, else they lose influence. But do they? It is important for a currency’s liquidity, acceptance, and status that it is widely used, but it doesn’t matter whether its facilitation is public or private.

The majority agree that digital cash offers technological progress with lower costs and improved functionality. It embraces the bustling world of open-source software, where innovation is rife. At one end of the spectrum, the goodies see the potential for the billion-plus people that are currently unbanked. In contrast, the baddies love the data, like the Stasi, which would bring snooping to a whole new level.

There are risks. How embarrassing would it be for a central bank to see their CBDC hacked? Their credibility would never recover. In contrast, if a PDC was hacked, the central bank could heroically come to the rescue.

There has been much written on this subject by central banks, the Bank for International Settlements (BIS), the International Monetary Fund (IMF), the Official Monetary and Financial Forum (OMFIF), news agencies, financial professionals and others. Having absorbed much of this, a number of common themes arise.

Data, privacy, and oversight

The digital world leaves a trail of rich data in its wake. This valuable and personal information would track the movement of money like never before. Tracing funds via bank payments is time-consuming, but with digital money, it is instantaneous.

Who should have access to this highly sensitive information? Government and private agencies would have a field day. It doesn’t have to be this way, as designs could address privacy concerns by limiting the data to an independent agency outside of government, leave it anonymous, or not even collect it at all.

CBDCs are most at risk here because there is an inevitability that government will capture data in some way or another. The temptation for law enforcement and tax collectors is great.

This data would be particularly useful for totalitarian governments to introduce social credit scores and to control where, how, and when people are able to access their money. Surveillance, privacy, and control run against everything a free, liberal, and democratic society should embody.

PDCs have an advantage because they might be subject to regulations that would limit the scope of data usage. Furthermore, consumers would have the choice to use whichever PDC meets their needs. They may opt for less privacy because they enjoy promotions from retailers, or they may prefer more privacy and be left alone.

In a testimony to Congress, Rohan Grey, Assistant Professor of Law at Willamette University, stated:

“Perhaps the most important reason of all to be weary (sic) of claims that transactional anonymity is obsolete and unnecessary is simply that the future is unpredictable and volatile.”

He highlighted how in 2018, President Trump subpoenaed personal data records of Democratic members of Congress, including senior members of the House Intelligence Committee, as part of a hunt for leakers. Similarly, the payment processor Venmo began blocking donations made by individuals to Palestinian aid organisations on the grounds that it constituted support for terrorist activities.

The difference between a terrorist and a freedom fighter is a matter of opinion. In the case of payments, who decides? Some businesses, often legitimate in the eyes of the law, face clampdown by payment processors. Monetary censorship is a growing problem.

Issuance, land grabs and interoperability

Many central banks are considering and even testing their CBDC, but with luck, they will come to realise that, just as they leave the commercial banks to service the economy, they will leave digital money to the private sector as well.

The banks won’t stand by and watch trillions of newly created dollars sit outside of their control. They will want in. The tech companies, with their huge networks and deep pockets, will also deem it to be their turf. The payment companies will also fight for their share, while the more youthful and experimental companies from the crypto sector will benefit from already being two steps ahead. There will be an almighty fight as the PDC could be one of the largest land grabs of the 21st century.

Who gets to issue a PDC? Which regulator oversees a euro PDC when it is transacting in Japan? Can a US bank issue a yen token? Will JP Morgan’s Swiss Franc PDC be exchangeable for a UBS PDC, or one issued by MasterCard? Interoperability between platforms is another consideration, as perfectly legitimate digital dollars won’t be of much use if they aren’t widely fungible.

The problem with tech is that literally anything is possible, especially if it is left to the private sector. In contrast, with CBDCs, progress will move at a snail’s pace.

Security, scale and innovation

Another problem with tech is that there’s always a bug. What are the technology risks, and how can they be managed? A world full of competing PDCs would pose less systemic risk than a single state controlled CBDC.

Governments are not renowned for completing cutting edge tech projects on time and on budget. Some CBDCs will turn out to be an embarrassment on a national level. Designing digital money, which works seamlessly, is not an easy task.

A prudent central banker would be advised to watch from afar and blame the PDC when it goes wrong. Instead of taking the blame, they get to be the hero that saves the day with the tried and tested bailout.

The private sector will be more nimble, innovative and able to adapt to change. There will be many PDCs to choose from, and the winners should be decided by the market.

Monetary policy, interest, and bonds

One question is whether digital money should be interest bearing? Cash isn’t and never has been, probably because the tech didn’t allow it. Yet back in the day, bearer bonds did receive interest. Both were pieces of paper, with cash being designed to transact while bonds were a store of value. In a digital world, both could receive interest, despite not being particularly relevant in the developed world, where interest rates are currently zero. That could change.

In discussion papers, the banks are wary of interest-bearing cash because it has the potential to see deposits flee. It is not in their interest. But other financial institutions are excited by the prospects for digital money as it allows for instantaneous global transactions, with near to instant settlement times. This will lead to huge changes in the current financial system.

To turn digital cash into a digital bond, you just alter the code. You can set coupons, payment schedules and the redemption date, and whatever other feature you care to choose. This would reduce costs for the bond market, and it seems inevitable the market heads this way in time. This would be a simple implementation for the private sector, and governments should probably follow suit with their bonds once they are sure it all works smoothly.

Yet, democratically elected governments should not get involved in CBDCs because it would give them even more power than they already have. If they wanted to stimulate the economy, they could press buttons and send money to the people faster than the helicopters ever could. They could also go a step further. Instead of paying interest, they could impose negative interest rates and take it away. If you don’t spend it soon, you’ll lose it. Want exchange controls? Easy, just press that button.

The CBDC provides policy makers with even more tools to implement exotic monetary policy. That sounds fun for central bankers, but do they really need more power in a free society? Most of us see the right to print money as good enough.

Maybe some governments want these additional powers? In which case, they should fess up and outline their plans. There is a feeling of statism by stealth, and all paths lead back to money creation. Money is power and, by having more of it, means the state keeps on growing.


In researching this series, we noticed how people who haven’t spent much time thinking about CBDCs tend to view them in a positive light. Embrace digital and the progress that goes with it. Yet, the more they take the time to think things through, the more concerned they become. They soon realise that a free society should give CBDCs a wide berth.

The digital future, the lower costs and other benefits can be better delivered by the private sector. Yet, most of us would like some regulatory reassurance that the PDC on our phone is abiding by a common set of standards and interoperability while defending our liberties.