Where are we going? Will digital currency (CBDC) threaten cryptocurrencies?

Recent months have seen a marked increase in interest in two topics - the regulation of broadly defined crypto-assets (mainly cryptocurrencies) and the so-called Central Bank Digital Currencies (CBDC). In parallel, there is a debate (fight?) over the future of decentralized finance, which fires the imagination and emotions of both its supporters and opponents. Everyone is a little bit right because the decentralized model, most often using distributed ledger and blockchain technology, in a way challenges the current approach to providing financial services based on intermediation and often high (unjustified?) transaction costs. On the other hand, the high level of anonymity and the lack of control (including anti-money laundering) make us increasingly think of DeFi as a highly risky "venture".

In all this, there is the so-called CBDC, or central bank digital money (currency), which is a digitized form of the official currency of the state, the implementation of which can give great benefits (worth a look here), for example in the area of international or retail payments. The possibilities are as numerous as the CBDC concept. In this context, digital currencies, which are slowly being implemented in more countries, are mentioned as a means to combat cryptocurrencies (bitcoin and ether are just the tip of the iceberg). Cryptocurrencies today are not mentioned as a systemic threat to the economy or the financial system, but it is impossible not to notice that there is a growing interest in them not only on the part of "small" investors but also large corporations that are investing more and more funds in highly risky "instruments" that can probably be boldly called the next significant "achievement" of financial engineering.

Cryptocurrencies, the construction of which is largely based on trust, but also on the "work" of computers (proof of work - an alternative method of proof of stake is gaining importance), although of course, this is a very large simplification. I think that even the more ardent supporters of cryptocurrencies will not be offended if I write that cryptocurrencies are highly speculative, and their "stability" leaves much to be desired. Well, cryptocurrencies were (are?) intended to change the established order of financial markets, but in recent years they have become more a source of quick profit (or loss) for certain groups than a revolution of that system. Cryptocurrencies are not legal tender (virtually everywhere), and the AML law even defines virtual currencies, which are digital representations of value that are not, among other things, legal tender issued by central banks and similar institutions and authorities. This is of momentous importance in the context of (in)redeemability (payment in bitcoin is not universal and the seller may refuse to accept it). Another issue is the qualification of cryptocurrencies as electronic money, but I will talk about that on another occasion.

CBDC is the "official" version of money issued by central banks. In practice, different qualifications are adopted (direct and indirect responsibility of the central bank, model based on a current account and tokens), but the main "requirement" is that it is official tender based on the relevant legal basis (law, constitution). Such money can be provided (maintained) either on accounts maintained by commercial banks (as - in a simplified way - it looks today) or by the central bank itself, although the latter model seems to be highly inefficient and difficult to implement, if only because of the existing infrastructure. An attentive observer will notice that full digitization of money can lead to practically complete surveillance of the citizen's financial sphere, although various projects (including the digital euro) also include the possibility of anonymizing payments (at least to some extent), and already functioning legal solutions (such as STIR) allow for such "surveillance" (in the good sense of the word). (in a good sense of the word). At the same time, such digitalization does not give such "opportunities" as cash - unfortunately.

CBDC has obvious advantages, if only in the context of immediate and international payments, especially if we think of blockchain technology as a target (here we can see that achieving the model of banking or finance 24/7/365 becomes possible, which with the current limitations in payment systems and settlement seems unlikely), but also control of funds. Unfortunately, such a CBDC can also be an instrument for state authorities to somewhat controversially control supply and demand and stimulate the economy, as exemplified by the pilot Digital Yuan (Digital RMB), which has a sewn-in "expiration date" after which the money "disappears". This can therefore encourage consumption that is not always rational or investment that is not well thought out. However, it can also be an advantage, as long as it is introduced with a head start. For some, it will be another proof of state oppression, while for others it will be an innovative approach to finance. Who is right? Probably a little bit of each.

On the other hand, cryptocurrencies (in the "classic" perspective) offer the possibility of making fast and safe (abstract here from the concept of wallets and the associated risks) transactions, which, however, have little to do with payments in legal terms, and are additionally burdened with very high fluctuations of "exchange rates" against fiat currencies, i.e. traditional ones (we are not talking here about the so-called stablecoins).

Okay, but will the introduction of CBDCs cause the cryptocurrency market to collapse? To begin with, we need to realize that the introduction of a central bank digital currency is a painstaking process that often requires the consent of the majority of the population, specific legal and infrastructural changes (as a rule), and education and gradual implementation (due to the risk of financial and digital exclusion), which is not a simple legislative "exercise". Globally, we don't have examples yet of significant jurisdictions (except maybe China) that have successfully implemented CBDCs. And add to that the thread of so-called interoperability and creating a truly global payment system. So in most countries, we have either pilot projects or even so-called researches, i.e. analyses of the possibility and legitimacy of introducing CDBC. So if the CBDC will reach a high level (we are not talking about full) of coverage, it will not be shortly.

In the meantime, unless more decisive action is taken, the cryptocurrency market may grow to a size that justifies recognition as systemically important. This, in turn, will already require more than just analysis and "scaring" about the risks associated with cryptocurrencies. Then it may be difficult to apply tools to "discipline" the market, which itself may not want to submit to new "oppression" by the state. The question is whether even today the introduction of state regulation will "curb" the activity associated with cryptocurrencies.

At the same time, one should be aware that for today it is difficult to talk about "what" legal-regulatory tools could have an appropriate effect, i.e. whether there is anything other than an attempt to "hook" cryptocurrencies to existing regulations (e.g. in the area of payment services) and enforce possible abuses or circumvention of regulations. Cryptocurrencies (I'm not thinking here of investment tokens) have a rather specific structure that often escapes traditional law, and I don't think anyone has yet identified a meaningful way to regulate this issue, other than the "exercise" of tethering to already existing regulations I mentioned.

Cryptocurrencies tempt with big profits. From my observations, it seems that for a growing number of people this represents their first collision with "investing", which can have both positive and negative consequences. This market is quite unusual and you can "sink" a lot of money in it, but if you draw specific conclusions from it, you can perhaps avoid mistakes in the future. On the other hand, improper "first" learning may alienate to other forms (classical) related to the broadly understood financial services, and this is already a big problem also for the global financial system. A good understanding of how the economy and the aforementioned systems work is crucial here.

In this sense, it seems to me that the CBDC will not "eliminate" the cryptocurrency market, and this is regardless of how quickly solutions are adopted. This does not change my skepticism about these "instruments", however, the concept of partial disintermediation itself is not bad. The problem is often an unwillingness to submit to regulation or legal requirements (including fiscal, in the AML area) and vulnerability to fraud (and reprimand). In this sense, it is a big challenge for public authorities, not only financial market supervision. How to solve it? The discussion is still ongoing.