Can Bitcoin be Used as a Central Bank Digital Currency?

Central bank digital currencies, or CBDCs, have become a regular topic of discussion among banking institutions, including central banks. The movement of developed countries towards a cashless society has become apparent, though some are moving faster than others.

Seeing as China is quite public about its digital yuan progress, the United States and Europe have raised the alarm, calling for evaluation of the concept of creating and utilizing a central bank digital currency.

The current CBDC landscape

Some are skeptical, others are optimistic. However, the general consensus at the moment is clear – more research and testing is needed. In a previous article I answered, in-depth, the 10-year long question – can cryptocurrency replace central banks?

Compared to paper cash and other digital money used today, CBDCs come with a wide array of advantages, though downsides have also been pointed out. Some of the advantages include new monetary policy tools, easier exchange of money, and direct civilian access to central banks. Some of the downsides include questionable security and loss of privacy.

In any case, the debate for an optimal CBDC design is still ongoing. But there are even more unknowns in the characteristics equation of a central bank digital currency.

Some think that established financial systems should be used as the underlying technology for a CBDC. Others promote the use of blockchain. And then there’s the proposition to use bitcoin as a CBDC.

Bitcoin as a CBDC

Although highly unlikely to actually happen (close to impossible in my opinion), let us examine what would it take for bitcoin to be used as a central bank digital currency, and what pros and cons that would bring to the table.

If BTC is to be adopted by a central bank as its very own digital currency, the first thing that would happen is bitcoin becoming legal tender within the country/countries where the central bank operates. Legal tender refers to the enforced rule by governments that certain currencies must be accepted as payment. USD has a legal tender in the United States, meaning that if someone wants to settle their debt with you and they offer you USD to do so, you are obliged to accept it.

Problems

Since bitcoin’s monetary policy is mob-based, several problems arise. First of all, we got a very good taste of crypto chaos during the whole bitcoin cash civil war. The uncertainty surrounding the split caused mass panic on the market. Imagine if bitcoin cash was the predominant means of exchange of value in any country.

Moreover, bitcoin is not, at the moment, able to handle a large amount of transactions per second. Some estimations point to bitcoin maybe being able to handle 10 transactions per second, maybe. Comparatively, Visa handles more than 65,000 transactions per second. However, even that probably won’t be enough for a CBDC.

Then there’s the problem of security. Although bitcoin has performed very well in terms of security, all things considered, there are edge cases where BTC being used a a CBDC becomes a problem. A 51% attack on the network will bring unimaginable chaos to a financial system dependent on BTC. Furthermore, due to the nature of the underlying blockchain technology, lost BTC cannot be recovered and therefore is lost forever, though the ability of BTC to split all the way down to 1 satoshi might cover that issue.

Then there’s the problem of volatility. One look at the price graph of BTC since its advent in 2009 is enough to answer all questions about the currency’s stability. There is none. It can easily jump 10% in a day and then drop down 10% on others. Such extreme volatility is not desirable for a central bank-backed currency, especially when it is supposed to be used by the vast majority of the population within a country. It is important to note here that legal tender and vast use of bitcoin as a result of central bank backing should resolve the volatility issue, at least in theory.

Next on the list is immutability. Since public blockchains do not allow any tampering with their ledger, once a transaction goes through there is no way of reverting it. This poses many problems on its own as refunds, chargebacks, and plain mistakes will become difficult to handle.

Privacy. Since bitcoin is largely based on transactions between unknown individuals, a central bank digital currency using this concept is close to impossible to be implemented. The money laundering implications of bitcoin as a CBDC are far too probable.

And finally, there’s the problem of international usage. Since bitcoin works on a public permisionless blockchain, one country making it its official central bank digital currency doesn’t mean that other people in other countries won’t be able to use it. What happens if another country decides to purposefully bring the price of BTC down? What happens if they pump and dump BTC? What happens if a group of people in another country manage to obtain a large portion of BTC’s total circulation supply? All these questions bring about a level of uncertainty that makes the prospect of BTC being used as a central bank digital currency highly improbable.

Benefits

Let’s assume here that BTC has managed to solve the scalability issue and can handle a large volume of transactions per second. Low transaction fees is one of the first benefits that come up as a result of that. Fast transactions will also become a huge benefit, allowing individuals to exchange money within minutes, regardless of location. Furthermore transaction confirmations are handled by the system itself, making clearing houses obsolete.

Payment processors will also become obsolete, further lowering the cost of transacting. Integration with the system by vendors should be simple, making it easier for online businesses to start accepting the new CBDC quickly.

Lastly, although we mentioned privacy as a problem, it is also a benefit as it will preserve that great attribute of paper cash. No one wants the government to know all of their trade activity, and in a cashless society, a blockchain-based ledger with some level of privacy might be the way to go.

Conclusion

Bitcoin being used as a central bank digital currency is not probable at the moment. For that matter, a public blockchain being the underlying technology of a CBDC is also not probable at the moment. There are too many problems and unknowns that make this concept extremely unreliable, riddled with uncertainty and instability.