By Ben Rininger.
CBDC is not a well-defined term. It is used to refer to a number of concepts. However, it is envisioned by most to be a new form of central bank money […] [a mix of] new and already existing forms of central bank money makes it challenging to precisely define what a CBDC is. In fact, for purposes of analyzing what may change, it is easier to define a CBDC by highlighting what it is not: a CBDC is a digital form of central bank money that is different from balances in traditional reserve or settlement accounts
-The Bank for International Settlements
Background on Money: Demand Deposits, Physical Cash, and CBDC
“The process by which banks create money is so simple that the mind is repelled.”
-John Kenneth Galbraith, American Economist
Money can be said to be a tool, a tool being a word with many definitions. But the definition we will go with here is a “means to an end”—the chief end of money being the facilitating of exchange. How said exchange takes shape depends greatly on what form money takes, and on who controls and directs the creation and flow of money in a society.
Central Bank Digital Currency (CBDC) is a proposed new form for money to take—the latest potential refashioning of our ancient tool. CBDC would essentially be digital cash (created by central banks, different in form than existing forms of money that are created by central banks).
Now, a layman may think… Why… Don’t we already have digital cash, in the form of checking and savings accounts?
It is obviously true that we have checking and savings accounts (functionally money—a store of value, a medium of exchange) existing through digital rather than tangible means; in fact, such money constitutes roughly 92% of all money in circulation worldwide.  Most of what we treat as “money” exists as numbers on a computer screen—liabilities of private banks. What makes up the other 8% of money humans use in day-to-day life? Physical cash.
The difference between physical cash and demand deposits is not merely the trivial fact that one is virtual and one is physical.
The difference is actually much more profound than that. Money in the form of demand deposits is created and maintained by debt; it is a form of credit money. For every dollar there exists in a bank’s liability to its customers, there must also exist a corresponding asset, lest the bank become insolvent and go out of business. This asset could be physical cash reserves, or a private bank’s reserves at the central bank (in the United States’ case, The Federal Reserve), but the vast majority of assets a bank has to back up its liabilities are loan contracts—what a bank is owed by its own customers.
As demonstrated quite clearly by Werner , the loans that banks make create deposits—new money. A deposit created by a loan (a liability of a bank) is worth less than the value of a loan itself (an asset of a bank), because built into the value of a loan is the expected value of interest getting paid back by borrowers.  The difference between all of a bank’s assets and all of a bank’s liabilities is known as equity.
A private bank does not have an unlimited capacity to issue new loans. For one thing, a bank is limited by demand for loans. A bank is limited by the ability of its borrowers to go into the economy, work, and appropriate money for themselves to pay back these loans. However, banks have shown that they can be quite speculative and can loan to borrowers who lack the ability to repay, because many banks have been deemed “too-big-to-fail” and end up getting bailed out when massive amounts of loans go sour. To a great degree, we live in a society that privatizes benefits and socializes losses.
A bank is also limited by numerous legal requirements, including a reserve requirement to keep a certain amount of reserves (physical cash on hand or reserves held at the central bank) proportional to its liabilities (although not all countries even have this; Canada has no reserve requirement and, currently, due to the COVID-19 pandemic, the United States has a 0% reserve requirement). Insofar as a central bank is accommodative in its lending and provision of reserves, such reserve requirements, when they do exist, serve as minor limits to credit expansion. After all, a central bank is often given no choice but to provide reserves in times of financial crisis. 
Ensuring that we don’t get too much into the weeds, some essential concepts to grasp about private banks and credit money are these:
- Private banks are distinguished from any other type of business, in that they can lend out money that they do not have; effectively, they can create money. This same money that banks create in the form of loans is what we mostly use to pay back our loans. It’s most of the money we use! [to learn more about the mechanics of banking, and the role of reserves in facilitating bankmoney transactions, see Huber (2017)]
- Money of this sort (credit money) can only grow in supply if people, in the aggregate, become more indebted. Thus, if our money supply is to grow alongside economic growth (which is necessary to prevent deflation) people need to become increasingly indebted, as they have indeed become in practice:
Figure 1: U.S household debt, 1945-2018. Data: New York Fed’s Consumer Credit Panel (CCP).
Graphic: Haughwout, et al., 2019 / Federal Reserve Bank of New York
Contrast this form of money with what physical cash is: money that is not attached to any debt. When one has $20,000 in their bank account, one does not own said $20,000. One is owed that $20,000. It is a claim rather than a piece of property. And when you write a check and transfer that money into someone else’s bank account, you are transferring an IOU: an IOU for physical cash.
Physical cash, however, is not an IOU for anything. It is a thing that people confer value upon, out of the expectation that others will confer value upon it. Having $20,000 in cash is different from having $20,000 in your checking account, in the sense that you own your cash, whereas you are owed that which is in your bank account.
If everyone tried to redeem what they were owed in the form of cash at the same time, banks would not be able to comply. They would go insolvent, and chaos would ensue (what is known as a bank run). Paradoxically, people treat the numbers in their bank account—what they are owed in cash—as the same thing as cash itself!
Money indeed is a mysterious thing.
Long ago, physical cash had also been an IOU for something: an IOU for physical gold and also, at times, silver.
While the topic of the Gold Standard is outside this article’s scope, for more information you can look here.
Defining Central Bank Digital Currency
Now that we have established some basics about money, let us return to the topic at hand: Central Bank Digital Currency.
CBDC would be a digital form of physical cash… not something owed to an entity but something that an entity could legally own, like cash.
There are many different design features relevant to the function of CBDC. Is a CBDC account-based or token-based? Is a CBDC centralized or decentralized? Is a CBDC general-purpose, retail or wholesale? Is a CBDC direct/1-tiered, or indirect/2-tiered?
These 4 dimensions of how CBDC is designed have important implications for privacy, for monetary authority and government power, and for the power of private banks.
A CBDC could be one of many things. At its core, all a CBDC is is a digital form of money created by a central bank, different from existing forms of money created by central banks.
This leaves much room open for CBDC to be a wide spectrum of things. For this reason, one ought not to be wary of or gung-ho in endorsing a CBDC, until one knows what kind of CBDC is being created.
Without further ado, here is a guide to how CBDCs may be distinguished:
Wholesale vs Retail vs General-Purpose CBDC
Imagine you have an app on your phone created by your government. Call it your “FedAccount.” You could have $20,000 (in “Fedcoins”) on this app; unlike the $20,000 you have at your bank in our aforementioned scenario, said $20,000 legally belongs to you. You own it like property. Perhaps, you could easily exchange your CBDC to a friend, transferring it from your FedAccount to theirs, like Venmo.
What is described above is either a general-purpose or retail form of CBDC. Retail CBDC is currency only for use by individuals and companies. Wholesale CBDC, meanwhile, is CBDC available only for licensed financial institutions to utilize. General-purpose CBDC is currency for use by banks, individuals, and companies .
Token-Based vs Account-Based CBDC
“I know therefore I own” vs “I am therefore I own”
Another important design feature of CBDC is whether a CBDC is token or account-based. An account-based CBDC is defined by the relationship between a central bank and a holder of currency—who has an account at the central bank. In a world where all CBDC is account-based, every last bit of CBDC belongs to a certain person at a given time, as a balance at the central bank. The central bank can know who owns how many units, and where said units are getting sent to, at any given time. Someone is entitled to use account-based CBDC if they can prove that they are the person associated with the account at the central bank.
If Bob has $10,000 on his account at the central bank, all Bob needs to do in order to use said $10,000 is to prove that he is indeed Bob. Hence, with account-based CBDC, ownership is based on identity: “I am therefore I own.”
Token-based CBDC is significantly different. In the case of token-based CBDC, CBDC is closest in nature to cryptocurrency. Possession of a password or private key allows one to use CBDC. Think of knowing your private key or having a physical hardware wallet (like the Ledger Nano S or the Trezor 1) as being akin to having a physical wallet full of cash. Knowing the private key or possessing hardware that contains the private key is comparable to having a wallet. And having the wallet is what allows one to use the money that is in the wallet.
So if Bob has $10,000 in his Fedcoin wallet, all Bob needs to do to use the $10,000 is to know his private key, or possess hardware or software that knows his private key for him. Hence, with token-based CBDC, ownership is based on knowledge: “I know therefore I own.” 
Notice how, with token-based CBDC, a name does not have to be linked with the wallet. Individuals can freely share their private keys with others, and others can use the money in their CBDC wallets. Our government could keep track of the initial purchasers of CBDC wallets, but overall, a token-based system opens up all kinds of possibilities for fraud, tax evasion and illicit transactions.
For this reason, it is highly unlikely that any government would find it in its interest to create a token-based CBDC. As Agustin Carstens, General Manager for the Bank of International Settlements wrote,
The idea that CBDCs will be like $100 bills floating around is a mischaracterization of what CBDC would look like in practice. My own view is that CBDCs without identity (purely token-based CBDCs) will not fly. First, they would open up big concerns around money laundering, the financing of terrorism and tax evasion. Second, they may undermine efforts to enhance financial inclusion, which are based on good identification and building up an information trail for access to other financial services. Third, they could have destabilising cross-border effects, allowing large and sudden shifts of funds between economies. For these reasons, we need some form of identity in digital payments.” 
Centralized vs Decentralized CBDC
Also a salient question regarding CBDCs is whether they will be centralized or decentralized in nature, using centralized or distributed ledger technology (DLT) (not to be confused with blockchain, which is a specific type of DLT ). Another sub-question stemming from distributed ledger technology, is whether a CBDC is permissioned or permissionless.
Fundamentally, these questions are technological ones, that regards what type of encryption system may be used, and who or what entity validates transactions. These questions have less to do with the role of money in society, privacy, and the power of different institutions than questions regarding other design features. These questions are outside this paper’s scope; for this reason, these questions shall be deferred to other sources (On Permissioned vs Permissionless DLT ; On Centralized Ledger Technology vs DLT)
Direct/1-tiered CBDC vs Indirect/2-tiered CBDC
The categories of 1-tiered and 2-tiered have to do with the fashion in which CBDC is administered. A 1-tiered CBDC involves the central bank both issuing and administering the CBDC—whether it be through an app on which citizens keep their central bank balance or through the management of a DLT system.
A 2-tiered CBDC, in the meanwhile, involves private banks as the administrators of CBDC once it is issued. 2-tiered CBDC would be central bank money insofar as the central bank would create it before giving it to private banks. But private banks would manage the transfer of the digital cash units. In a 2-tiered system, CBDC would be a liability of private banks that is 100% backed up by central banks. 
It is easy to see how a 2-tiered CBDC would work within the context of a sovereign money system (where a monetary authority would bestow governments or individual citizens with newly created debt-free CBDC, for them to deposit at private banks, who would act as intermediaries). It is not as clear how 2-tiered CBDC would work in the context of our current banking system.
Defining CBDC: The Bottom Line
Central Bank Digital Currency could exist in the context of many different types of banking systems: the single circuit money system that we advocate at the Alliance, or in our current system of debt-based money.
As money generally is a tool, CBDC would be a tool we create. It would be legally and functionally equivalent to cash, except that it would be held and transferred digitally, and likely would not have cash’s token-like form. Other than that, no matter what design features go with a CBDC, a CBDC would be like cash: as discussed in the introduction, fundamentally different from most money—not created by debt or extinguished by loan repayments.
So, CBDC is a tool. But would it be a useful tool? Does it have any purpose if we already have physical cash and digital credit money? What is there to potentially gain with this tool? What damage can be done with this new tool? Is it reasonable to suspect that governments will responsibly safeguard this tool, and that people will net benefit as a result of its introduction? Lastly, how would this tool even be implemented?
All these questions and more ahead.
Figure 2: The Money Flower, Adaptation from the Bank for International Settlements .
This diagram is a very useful resource for distinguishing between different types of money.
Potential Advantages of CBDC
Ability of Monetary Authorities to Affect Aggregate Demand Immediately
One of the supposed advantages of CBDCs is that they may allow central banks to act directly and immediately.  Currently, central banks try to influence the money supply through open market operations and other indirect mechanisms for manipulating interest rates. While central banks actions can certainly affect the money supply, their effects are delayed, as private banks are the entities that ultimately create money through loans. Thus, a money supply increase that a central bank intends takes time to occur.
In contrast, if citizens could have accounts with the central bank (as in some versions of CBDC), the central bank (if given the legal authority) could change the supply of money instantaneously—at once giving a UBI to all citizens with accounts. Especially in recessions induced by demand-side shocks (like pandemics), getting money immediately into peoples’ hands may prove beneficial—especially if a monetary authority is independent, having clear guidelines not subject to political pressure.
Freeing ourselves from private banks & providing a government alternative to cryptocurrency
A commonly mentioned feature of 1-tiered CBDC is that it shares an advantage with cryptocurrency: people can bypass private banks when conducting transactions.
Being able to exchange money without having an account at private banks extends the people’s leverage over private banks. It diminishes private bank power.
Much of the motivation behind central banks putting so much research into CBDC is central bankers’ concern over increased transactions with cryptocurrency throughout the economy. In fact, Facebook’s introduction of libra served as a catalyst moment in getting central banks to research CBDC.
The continuing inroads of cryptocurrency worry some central bankers. Central banks are currently tasked with positively influencing the economy by regulating and supporting the private banking system debt-money creation power. They’d rather not have competition.
Central bankers try to fight recessions by lowering interest rates, monetizing public and private debt… giving private banks ample supply of reserves to encourage spending and lending. The more a country’s people conduct finance with non-government issued currency, the less central bankers can have an effect in doing these things in reaction to recessions. For this reason, many central bankers have opposed cryptocurrency, and have expressed interest in providing a similar alternative that exchanges with national currency.
CBDC as a Stepping-Stone to a Sovereign Money System
The issue at hand for the Alliance is the question whether CBDC could be a step in the direction of a sovereign monetary system. Some say CBDC is not only a practical extension of physical cash but will also make the public accustomed to the idea of a safe means of exchange independent of the banking system. Others would argue that CBDC is a distraction to real monetary reform, maybe even a power grab by CBs to get more control over citizens.
CBDC could be the beginning of a transition to a system of only debt-free money. Whether the introduction of CBDC leads to that depends on who the power players shaping banking are in the years and decades after CBDC’s implementation.
Potential Disadvantages of CBDC
Run on the banks to convert deposits into CBDC
If introduced abruptly, such that millions of Americans would attempt to transfer large amounts of money from their demand deposit accounts to their new FedAccounts, CBDC could have quite a destabilizing effect. 
Although there are plenty of things the government could do to intentionally slow citizens’ conversion to CBDC. The government could set limits as to how much citizens could convert to CBDC in a given period. Furthermore, they could offer lower interest rates than private banks do (if you’re earning less interest on your FedAccount than on your deposit, what incentive do you have to switch over?)
With competent administration and implementation of CBDC, a bank run would be highly unlikely. That said, its potentiality ought to be kept in mind by the policymakers that may devise a CBDC system.
Accompanying abolition of physical cash
Numerous individuals have come out against CBDC, as they perceive it to foreshadow an end to physical cash—citizens’ current only way to exchange national currency without having the transaction tracked by government or private corporations.
Of course, as was mentioned earlier, CBDC could be created in a way that not even the government that created it could track the identity of users (just as the creator of Bitcoin can’t find the identity of any given owner of any given bitcoin at any time)
However, even if the government chose to provide the same anonymity that exists with cash, there are other problems that arise when cash is gone: such as the increased inability of citizens to conduct transactions during power outages. 
All that said, citizens’ inability to conduct transactions without power is an existent problem, given how little cash citizens keep on hand to begin with. And there’s nothing about CBDC that necessarily implies that we must get rid of cash as a physical equivalent. Again, this a policy choice not inherent in CBDC itself.
A big issue with centralizing a great deal of finance onto one government-created interface is the possibility of cyberattacks. 
Money is integral to every aspect of our lives. We spend so much of our waking hours working for it or using it to buy things. It defines the social structure of society. Fascinatingly, despite money’s importance, so few people understand how it’s made!
Given money’s importance to stability and the meeting of people’s needs, it’s crucial that it doesn’t suddenly go away, as is possible in the event of a cyberattack. Cyberattacks wiping out people’s checking accounts is already possible with privately created credit money, but there is a difference insofar as there is a wide variety of banks. Hacking into, say, Huntington Bank, might not cause a crumbling of all of American society.
That said, a complete destruction of the record of Huntington Bank’s financial records would damage many individuals’ livelihoods. Thus, Huntington Bank has taken many precautions and employed many people in the realm of cybersecurity.
The government could do the same, although the risk may be higher, as a lot more of people’s savings would be kept presumably on one platform (How much? This depends largely on how governments implement CBDC and the degree to which they promote its adoption)
This paper does not contain expertise in cybersecurity, so it will not attempt to quantify these risks. That said, many private banks have become so big and wide in scope, that it seems that the cybersecurity risk of a FedAccount wouldn’t be much different than the cybersecurity risks we face currently.
Regardless, cybersecurity must remain at the top of central bankers’ minds if CBDC is implemented, as a national currency is a gigantic target for terrorists to seek.
Environmental Concerns and Transactions Speeds in the DLT Model
Another reason a CBDC using DLT is so unlikely is the sheer amount of energy it takes to run through high volumes of DLT transactions. All bitcoin transactions in a given year require more power than the Netherlands used in the entire year of 2019.
Figure 3: Bitcoin mining annual power consumption, compared to the power consumption of Google and various countries.
Furthermore, despite all of the energy required to use an anonymous, decentralized ledger format, the results in terms of transaction speeds are wanting.
Figure 4: The transaction speeds of various cryptocurrencies
compared with Visa and PayPal.
Given all the drawbacks of DLT, it seems very unlikely that DLT will be used in most future CBDCs, unless the technology is to improve in regard to its sustainability and efficiency.
However, DLT does not need to be used in a CBDC; thus, environmental impact and slow transaction speeds are not drawbacks of CBDC more generally.
CBDC and Privacy
Privacy of money is a complicated concept that can be hard to quantify (The Bank of Canada addresses that here). Privacy ranges from having complete anonymity (a certain agent cannot in any circumstance find anything out about you, your balance, or your payments) to having complete transparency against other entity (private individual, corporation or government can find out anything without any warrant or special permission), to everything in between.
The question as to how private a CBDC would be, again, depends on encryption and design, but also on legal framework, and how effectively institutions follow legal frameworks set before them.
If a CBDC did use a permissionless distributed ledger, opportunities for more privacy could be afforded. However, this comes at a cost (energy, speed, risk of losing one’s private key).
Moreover, since such a decentralized system is so unlikely, it stands to reason that a CBDC, if invented, would be account-based. Having a 1-tiered and account-based CBDC makes government the direct administrators of financial transactions.
No matter how many safeguards against surveillance and privacy breaching a legal framework creates, this type of a CBDC inevitably makes it easier for governments to access information about citizens. To many, this appears to be a disadvantage in and of itself; certainly, governments can use said information for nefarious purposes, such as the Chinese government does with their social credit system.
How this disadvantage is weighed can be a question for future analysis and judgement.
Government using CBDC to protect special interests
As said at this article’s beginning, CBDC is a potential tool. A means rather than an end. And like, any means, CBDC could be used toward ends both good and bad.
Thus, when considering whether we need to conjure up some “FedCoins”, we ought to ask, “How could FedCoins go wrong?”
A great degree of what could go wrong with FedCoins, aside from all the negatives earlier mentioned (surveillance, cyberattack, instability in transition) has to do with the institutional framework in which they’re embedded.
If we create debt-free money, such as CBDC, and create a monetary authority (such as the one prescribed in the N.E.E.D. Act) that creates CBDC out of thin air for the federal government to use, but continue to allow money to dominate politics, in what hands might we expect newly created money to fall?
The point must be made that debt-free money (whether in the form of CBDC or otherwise) is not a panacea. The political and social infrastructure into which CBDC is instituted matters greatly when estimating what effects it may have.
Conclusion: CBDC and AFJM Monetary Reform
As many who are familiar with the Alliance For Just Money know, we at the Alliance advocate for the N.E.E.D. Act to reform our monetary system, a piece of legislation devised in large part by the late Stephen Zarlenga, introduced to Congress in 2011 by former Ohio Representative Dennis Kucinich .
If that bill were to pass, all money in the U.S. would be transformed into “US Money”: money as a debt-free asset. Private banks would no longer be able to issue credit money. Loans would exist, but banks would be loaning out money already in existence: the money of those who have time deposits (people willing to stash away money they don’t get back until a certain date, in exchange for payments of interest).
To keep the money supply growing (in order to avoid a recessionary debt-deflation spiral, of the likes mentioned by Irving Fisher ), the government would spend new money into existence, just as private banks now lend new money into existence.
Figure 5: The United States M2 money supply, 1960 to the present, consisting of cash, reserves at the central bank, demand deposits, time deposits, and money market mutual funds. The Y-Axis is in billions. From Trading Economics 
The US Money described in the N.E.E.D. Act could take the form of CBDC, if the act were slightly adjusted, but the two things are not the same.
While U.S. Money and CBDC are both debt-free money, like the cash in your wallet, U.S. Money in the N.E.E.D. Act is different from CBDC, in that private banks still act in the role of safeguarding people’s bank accounts. If people want US money on demand to be held at their private bank, they’d have to pay a bank a small yearly fee to keep it there. If people want to make interest, they’d have to set their U.S. money aside in a time deposit, to be lent out.
In contrast, CBDC either would be (a) held in individuals’ own digital wallets (so, not at a private bank) or (b) held in individuals’ accounts at the central bank (again, bypassing private banks) or (c) held at private banks, taking a form that is different from current central bank money held at private banks (central bank reserves).
Whether we, at the Alliance, want to change the N.E.E.D. Act such that US Money takes on properties of CBDC, depends on a variety of factors:
Whether we want a public option for banking (allowing people to keep their money with an account set up by the government)
Whether we see cryptocurrency as a threat, and allowing Americans to exchange US Dollars anonymously in the form of “tokens” as a viable and/or desirable way to diminish that threat
These three issues are at the heart of the debate we will be needing to have at the Alliance in the coming months.
In fact, we will be discussing CBDC at an AFJM coffeehouse, available to all who want to attend, on Monday, May 24, 8 pm ET / 7 pm CT! See here for more details.
As a personal note, I hope this article has been of value in informing all potential readers of the nature of money. I still haven’t quite figured out why humans have put so much value on the thing. As the philosopher of money, Ole Bjerg, once said, “If you think you know what money is, you don’t know the first thing about it!” 
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