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How do CBDCs Compare to Bitcoin?

Updated: Apr 21, 2022

How do CBDCs Compare to Bitcoin?

Central Bank Digital Currencies (CBDCs) have become a hot topic among central banks in the last two to three years, with the rapid rise in the popularity of cryptocurrencies fueling discussions over the benefits and drawbacks of this new type of money. However, privacy advocates have warned that despite being intended to replace cash, CBDCs will reduce the amount of financial privacy offered to users, with some nations expected to mandate use of their CBDC when the technology proves viable.

Bitcoin supporters have long championed the cryptocurrency as the antidote to government-controlled fiat currencies, and with the possibility of widespread CBDC use coming closer with every passing year they say that Bitcoin’s use case has finally come. But what exactly are CBDCs, how do they work, and why are some people worried about them? Let’s find out.

What are CBDCs?

CBDCs are intended to be digital forms of the physical cash that society has been using to pay for goods and services for thousands of years. In a world that is rapidly going cashless, central banks and governments are developing ways for citizens to send and spend the cash in their bank accounts through their smart devices rather than through coins, notes, and cheques.

With the advent of contactless payments one could argue that this is already happening, but CBDCs present a different proposition altogether, being based on a different technology and with a slightly different purpose. Contactless payment allows you to buy an item in a store with the money coming off the account tied to the associated bank card, but you have different cards from different banks, and perhaps even different apps for those banks too. You can also use apps to send money to friends and family, but again you link the app to your bank accounts first.

How CBDCs work

CBDCs are intended to facilitate payments of all kinds, from buying something in store to sending money to family members on the other side of the world, all for free, or nearly free. The difference is that it won’t be your money that makes the journey, it will be a digital currency, which will be converted at the other end.

Let’s take an example. Justin is a Nigerian working in London who every month sends some of his salary back home to his family in Nigeria. Currently he has to use a remittance service to send the money from his bank account in the UK to his wife’s account in Nigeria. The remittance service takes a 5% cut and the money takes 2-3 days to arrive. With a CBDC, instead of sending the money Justin opens an app on his phone and buys the equivalent value in the country’s CBDC, which we’ll call digital pounds.

These digital pounds are not real money, although they hold value because they are issued by the Bank of England, and they travel on the blockchain - the same technology that Bitcoin uses. Think of the blockchain as a railway track and the digital pound tokens as trains. At the other end, Justin’s wife has an app that allows her to send and receive the Nigerian CBDC (which already exists), called the eNaira. Justin sends his digital pounds to his wife’s app, where they are converted along the way into eNaira. They arrive with his wife in just a few seconds, where she can exchange them for regular currency.

This is just one example of the benefits of a CBDC, but it’s not hard to imagine a world where the CBDC takes over almost every form of payment. After all, you can’t lose a CBDC down the back of the sofa or ruin it in the wash, and it would be much harder to spend a CBDC on a stolen phone than it would be to spend a wad of cash taken from a stolen wallet.

Taken on face value it’s easy to see why CBDCs are being discussed at such high levels by the world’s superpowers: it will make life easier for individuals, who can send money quickly and cheaply; businesses that only accept cash due to high card processing fees can start to accept digital payments; and the government can save money on the processes involved in making physical cash.

Privacy concerns may harm uptake

It is also a fact, even though most governments won’t admit it, that CBDCs will make a great tool for surveillance of the public. There is a reason why cash is still the preferred medium for money launders, drug traffickers, and a whole host of other dark acts - it is untraceable. Take out a bill from your wallet and you have no idea where it has been on its journey to your wallet, whose hands it has been through. This is great for criminals, but not great for governments and law enforcement agencies.

A digital currency however has an entire history attached to it. The blockchain records every transaction in a ledger, allowing anyone (in the case of a public ledger like Bitcoin) or privileged entities (in the case of a private ledger like a CBDC would be) to trace the journey of each fraction into which a CBDC token can be split. And because each CBDC wallet will be tied to an individual, the government in question will be able to open up your personal profile and see exactly what you’re doing with your money.

Now of course, some people will argue that they can already do this by looking at your bank account, but your bank activity doesn’t cover what you do with your cash - if you take €100 out of an ATM in cash, the government has no idea what you’re doing with it, which is at it should be. After all, it’s your money, so as long as what you’re doing isn’t illegal, why should they know? With a CBDC, they will know, because you can only send tokens to registered wallets. In short, there will no longer be such a thing as financial privacy.

Bitcoin offers an alternative

While Bitcoin runs on the same technology as CBCDs will, the ethos couldn’t be more different. Bitcoin was designed to offer freedom from unwanted oversight, a way to enjoy a level of privacy that its creators felt should be a human right. Unlike CBDCs, Bitcoin wallets do not have to be registered or even connected to an individual - they are a string of numbers and letters to which the owners’ holdings are attributed.

In this respect, Bitcoin is truer to cash than CBDCs will ever be, despite the fact that CBDCs are being touted as just that. Bitcoin is not anonymous, but it is far more private than CBDCs will be, and with cash being phased out, it could end up being the only alternative for those who strongly value their privacy.

‘Free’ comes at a price

One of the best examples of a fully formed CBDC is the Chinese digital yuan, which has been in development for over six years and has already seen real world tests. Privacy advocates are already concerned that the amount of oversight afforded to authorities through the rollout of the digital yuan is more than they already have through existing payment channels Alipay and Wechat Pay, something that shouldn’t be a surprise in a country that enjoys stricter control over its citizenry than western nations.

Bitcoin offers a kind of financial privacy and freedom only matched by cash, but with physical cash being phased out in preference of digital payment options soon it will be the only form of truly free money left. The first round of real world tests in Shenzhen in October 2021 saw 50,000 residents register for a digital yuan wallet, with The People's Bank of China airdropping each trialist 200-yuan (€28) ‘free’ money to spend in participating shops, a tactic they will likely adopt in some way when it comes to a full rollout, as will other nations when their time comes.

As we know now of course, this free money comes with a very high price tag indeed.

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