Digital Central Banks Are Here

Because bureaucratic governments handle these things so well.

Initiative, savvy, luck, circumstance, and convolution have taken over currencies – or at least digital creations purported to be currencies (but in reality don’t, and never will, quite fit the bill). Those entities that create and support real currencies are taking notice. In other words, welcome to government in action. Here come central bank digital coins

Luck rather than leadership, circumstance rather than foresight or political skill, seem to have been more helpful in triggering these developments. Digital coins (while loosely described as “currency” are more like a digital asset easily transferred and accounted for in a digital ledger) represent a handful of rather clever people taking on central government’s mighty bureaucrats. Armed with simplicity, clarity, and algorithms, they are defeating all administrations’ fondness for complexity, confusion, and rules. 

In general, bureaucrats are masters of the art of convolution. Essentially, governments work overtime to create farce in the spirit of precision. An example of bureaucratic absurdity can be found in France (admittedly, a country that has taken bureaucracy to an art form – perhaps more so than art itself). When the government started a new lockdown because of the pandemic, they devised a two-page permission form to leave home, with 15 different justifications, before, thankfully, shelving it in the face of ridicule. The French can buy alcohol, for instance, but not underwear. These rules were simply to be able to walk out the front door, and the government imagined that this kind of detailed process was somehow useful, and not the bewildering reality it represented.

Now imagine these “developed” governments (of whom France is probably not the worst offender) trying to deal with a global currency, currency exchanges, and the transfer of funds internationally. We don’t have to look too far to find the convoluted rules behind Bretton Woods, the WTO, and other international absurdities to recognize that this problem is not easily solved, or even understood. Bureaucrats are generally better at devising rules, charging fees, and collecting taxes and information than making anything that is useful or even comprehensible.

Here Come the Digital Coins

Banking is the interface between the state and the economy. It is possible to see a future in which banks play a smaller role, or even none at all, with digital money and deposits provided by central banks, financial transactions carried out by technology firms, and capital markets providing credit. Banking is in a period of very rapid change. The hope is that it may emerge in a better state. At some point, hope may triumph over experience.

Technological change is upending finance. Bitcoin has gone from being an obsession of anarchists to a $1 trillion asset class that many fund managers now insist belongs in any balanced portfolio. Swarms of social media-armed digital day-traders have become a force in the financial markets.

Digital payments are advancing and being adopted at breakneck speeds. The leader, China has digital payment giants Alibaba and Tencent with users in excess of 1 billion, and in the United States, PayPal has almost 400 million users. America is catching up with China’s digital-payments giants, and digital coins cannot be ignored by central governments. Yet, that seems to be the case.

The least noticed disruption on the frontier between technology and finance may end up as the most revolutionary: the creation of government digital currencies. What is truly revolutionary is that these digital currencies allow the direct deposit of funds with a central bank, bypassing money center banks and conventional lenders.

The Really New Money

These government-issued digital currencies would be a new incarnation of money. In their benevolent form, they would make finance work better. But this would also be a not-so-subtle power shift from individuals to the state, altering global geopolitics and potentially changing how capital is allocated. This is alarming.

Central government digital coins, while an interesting and arguably inevitable development, must also be treated with caution, thorough thinking, and humility – all of which central governments almost completely lack.

Decentralized Finance

During the 2008 financial crisis, Paul Volcker famously said that banking’s last useful innovation was the ATM. Since the crisis, the industry has evolved, slowly at first, but that evolution is becoming a revolution. While banks are modernizing, entrepreneurs are rapidly building systems of “decentralized finance,” which combines digital currencies like bitcoin, along with other tokens and databases functioning on a platform allowing for the creation of digital assets and exchange of value. An example of such a platform is Ethereum, which can act as a foundation for digital assets, but also a conduit that interacts to varying degrees with traditional finance. Meanwhile, financial “platform” firms now have over 3 billion customers who use e-wallets and payments apps. Alongside PayPal are other global specialists such as Ant Group, Grab, and Mercado Pago, established firms such as Visa and MasterCard, and Silicon Valley wannabes such as Facebook (in the form of a relentless experiment, Libra, now called Diem).

Government or central bank digital currencies are the next step – but they come with a twist. They would centralize power in the state rather than decentralize it through banking or lender networks. The idea behind them is simple. Instead of holding an account with a retail bank, your account would be with a central bank, accessed through user interfaces resembling apps such as Alipay or Venmo. Rather than paying online or with a card, you could use the central bank’s infrastructure along with the full faith of the state, not a fallible bank. There is no longer a need to deal with Citibank or MasterCard, paying fees and using their systems. The Fed is now at your service.

We’re in Charge Now

This metamorphosis where the central bank or government now serves the customer may sound far-fetched, but it is underway. Over 50 monetary authorities, representing the majority of global GDP, are exploring digital currencies. Most notably, China has begun deploying a digital version of its currency, the Yuan, in a pilot project to over 500,000 people. The EU has stated it wants a digital euro by 2025. Most importantly, the United States has initiated the study of a hypothetical e-dollar.

One motivation for governments and central banks is a fear of losing control. Today central banks harness the banking system to amplify monetary policy. If payments, deposits, and loans migrate from banks into privately run digital realms (decentralized finance), central banks will struggle to manage the economic cycle and inject funds into the system during a crisis. Unsupervised private networks could become an uncontrollable and chaotic system of inefficient allocations of capital along with fraud and privacy abuses.

The other motivation is the promise of a better financial system. Ideally, money provides a reliable store of value, a stable unit of account, and an efficient means of payment. Today’s money gets mixed marks. Uninsured depositors can suffer if banks fail, bitcoin is not a currency by any reasonable definition now or in the future, and credit cards and other forms of personal finance are expensive. Government digital currencies would be state-guaranteed and cheap.

We Are Cheaper and Better – Trust Us

As a result, digital currencies issued by central governments could cut the operating expenses of the global financial industry. Perhaps shockingly, these fees amount to over $350 a year for every person on Earth. Read that again, it’s absurd. Cutting these costs could make finance accessible for the 1.7 billion people who lack bank accounts. Government digital currencies could also expand governments’ toolkits by letting them make direct payments to citizens and cut interest rates. For ordinary users, the appeal of a free, safe, instant, universal means of payment is obvious.

It is this appeal, though, that creates dangers. Unconstrained, digital currency could fast become a dominant force in finance, particularly because network effects will make it almost impossible to be outside this network. Banks would be destabilized because they would no longer have deposits as a source of capital. Customers would now be depositing their funds directly with central banks. Banks would have to find other sources of funding with which to back their loans. What those sources would be is unclear.

If retail banks were suddenly unable to fund businesses, the uncomfortable reality would be inept bureaucrats inefficiently allocating credit. This would create an enormous opportunity for decentralized finance to fill the void this inefficiency would create. This unregulated finance with its own spiraling network effect may trigger another financial crisis, and then, in a flight two safety, a digital stampede to the central bank. Banks would be depleted of their funds and ultimately fail. This is not the kind of scenario innovative finance wants to create, but more typically, that’s what it does.

Did We Say Big Brother?

If government digital coins are pervasive, it enables the state to control citizens. All monetary activity can be monitored, and instant fines can be issued for whatever justification the government deems appropriate, without a reasonable due process. They would alter geopolitics by providing frictionless cross-border payments and attractive alternatives to the dollar. If the dollar is no longer the world’s reserve currency, American influence is upended, and global politics forever changed.

While open capital markets and property rights, unrivaled in most other countries, still make America and its dollar most attractive, the US relies on old payments systems, invoicing conventions, and inertia – making it ripe for disruption. For other countries, the local currency will suffer because digital currencies will become much more desirable and valuable. This will destabilize many small economies. Government detests a vacuum, but it hates instability and the loss of control even more.

Decentralized Finance and Central Government Digital Currency

The genie is out of the bottle. Digital currencies and digital asset creation will fundamentally change economic activity and the flow of funds. Opportunities and dangers abound, ranging from loss of autocratic control to the proliferation and (spotty efficacy) of controlling private platforms for finance and currency exchange. Even capping digital currency accounts, as China is attempting to do and the US is also proposing, seems like stomping down on mercury. The target may be obvious, but the flow will simply go elsewhere. The great threat is not government policy changing dramatically, it is decentralized finance on digital platforms (see Ethereum) taking over from inherently inefficient systems found in central governments.


Governments and financial firms need to prepare for a long-term shift in how money works, analogous to the use of coins and credit cards. The impact will permeate almost every element of society, especially how central banks, central governments, retail banks, and private financing sources function. State digital currencies are the next great experiment in finance, and they promise to be a lot more consequential than the ATM.