Across the world, a very large number of central banks are looking at the mix of digital currencies, and they all seem to want some. China, India and a lot of others are already trying it. Those who aren’t trying, like Bank Of England, are theorising on how to try with Britcoin. And others, like the Fed, are thinking about it.

From Bank of England website:

Central bank digital currency (CBDC) is money that a country’s central bank can issue. It’s called digital (or electronic) because it isn’t physical money like notes and coins. It is in the form of an amount on a computer or similar device.

But while this is cool, I remember that I went cashless like a decade ago, and that’s been pretty great! Not just with cards either, paying people bank to bank is free and instant, and it works just fine.

Which makes me wonder, why exactly is everyone looking at this? What am I missing?

What is the problem to which CBDCs are the answer?

I. The fabled beginning

Once upon a time, in cryptoverse, people realised that hey, this having the same database for everything that we all trust is kind of cool. Wouldn’t it be nice if we used it to send my USD from here to you there?

And they learnt the problem. Sure, you could do that, but by the time it actually converted twice and went through the banking rails in the middle, it took a lot longer and cost a ton more than Venmo does. And it cost more because cryptocurrency was (is, will be) extremely volatile. What it was worth a few minutes or hours ago doesn’t predict what it will be worth a few minutes or hours from now well enough for you to buy a coffee.

Which is why people ended up buying $2 million worth of pizzas with their Bitcoin and felt silly forevermore.

So, the solution was born. What if there was a crypto thing, that looked and smelt and behaved like crypto, with all the benefits of there being a single, distributed, but trusted database, but whose value never wavered? That would be nice!

And hence was born, the stablecoin.

There were some problems though. The "stable" part of the stablecoin, to be precise. For stability to happen, you needed a way to keep the thing stable, which in practice meant either overcollateralising (keeping a ton of collateral, well in excess of the value) and hoping that was enough, or keeping a ton of "real" USD in reserve. If the latter reminds you of the good old gold-standard days, you’re not alone.

But now, these institutions which give you stablecoins and lets you move that around as money, and have assets which hopefully are enough for the stablecoin to translate into real coin, they are, effectively, banks. And banks are complicated businesses, and can go bust if the assets are bad. And they’re especially great if the alternative is Bolivar, or if you want to shine some insight into a dark economy.

And, so they did.

And then the problems started.

II. The problem (that maybe really isn’t a problem)

Here’s one problem central banks kind of had, as a result. They create money which circulates in the economy1. Well, if it was just printing money that would be one thing, but they don’t do that actually. They create money to buy debt instruments (well, mainly) from the banks so that the money created is used to buy something real, which has the full power of the state behind it. So effectively the money that’s created is kind of like a symbol of the fact that the economy can make more stuff.

But in any case, they create money, and then they have to constantly keep an eye on the money that circulates, that it created and created rules to buy back, and changed value of, and gave to intermediaries (banks), in order to make sure the amount of money it made is what’s needed to get the country running properly.

This is true for both coins and notes, physical money, but also for digital bank balances, which is most of what most people call money.

And if you create some funny money that’s invisible to them then, well, you’re kind of putting a blindfold over their operations.

As a central bank you want to encourage spending sometimes, encourage savings at other times, to match the expectations of the people within the economy to reality. You’re the juggler making sure the spinning plates of expectations don’t come crashing down to earth.

And I mean this in the least conspiratorial way possible, central banks have been the bureaucracies that have done pretty well all things considered in the last few years2!

How do they do that? Well, they get extensive data collection on all sorts of bits and bobs about the economy and analyse them endlessly, with all sorts of statistical sophistication, and then decide to use all that insight to move the interest rates up or down by 50 basis points.

A blunt tool for an extremely fine grained economy. And when people find new ways of making this blunt instrument even blunter, makes sense that they try to find ways around it. Right?

It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different

Deputy Governor Ravi Shankar, RBI

III. The theories

Well, in the real economy, turns out there are a few problems that people highlight, for which . These are at least the most prevalent theories on why CBDCs could have some value. The major ones are these.

Reduce cost of transactions

Settling transactions is painful and time consuming. You got to check that the money Vendor A paid Vendor B is actually money, that they were allowed to, and that it’s moved correctly. This is true even if the money in question isn’t sacks of gold but rather entries on a ledger. The cost of interbank transactions today are anywhere from few cents to few hundred, depending on the transaction, plus probably a fee of 0.1% to like 1%.

Even for retail payments from like credit cards, the merchants have to pay up to like 2.5% of the transacted volume, in exchange for protection from fraud, primarily. Fraud in all forms, from merchant to chargeback to stolen card and everything in the middle.

The fees come from the multitude of middlemen who make the payments happen, including the banks themselves who make money because they take on credit risk. The argument is that if the payment is settled instantly, then there’s no point in having middlemen take credit risk.

Even otherwise, T+2 settlement feels like an archaic remnant that shouldn’t exist, because there shouldn’t need to be that big a time gap to just move bits around. But still, how big a problem is this?

And for bank-to-bank transfers, at least in places that aren’t the United States, its free in any case. I don’t know why central banks would want to help merchants save a couple percent in transaction fees, maybe they are just really nice and like helping out small businesses. I’m skeptical. And I’m not sure why a central bank would be better at doing this anyway, you’re still going to need banks to intermediate, as the "boots on the ground" as it were.

BYOB - Be your own bank

Banks have this privileged position, in that they have accounts directly with the entity that creates money, the central banks. At the end of every day they get to borrow or withdraw money, at rates set by the central bank, to make their books balance.

If you had an account directly with the Central Bank, the creator and arbiter of real money, they could just move real money back and forth from your accounts. But unfortunately you, Vendor A, don’t have that account. Only your bank does. And some people hate that banks have this privilege.

This is similar to the overdraft facilities we have with our bank accounts, in some ways at least. So if you could be your own bank, theoretically there’s some benefit to you. I don’t know what they are though, since liquidity constraints traditionally aren’t the biggest problem that individuals face. And I’m not sure why a central bank would be better at doing this anyway, you’re still going to need banks to intermediate, as the "boots on the ground" as it were.

Central banks get more details about transactions

The theory is that today, central banks can’t really get transaction level data very easily, especially linked to an individual’s history. The idea is that having this information is helpful. Some think for nefarious reasons (something about controlling all of us) and some think for useful reasons.

But they can already get info on transactions from the banks themselves. Like the Chinese central bank already knows when you use Alipay. All UK banks report transactions to HMRC, as do FCA regulated companies like car finance folks. HMRC might not do a hell of a lot with it today, but that’s not the issue. The data’s already transparent, though at an arms length removed.

Also, if they do get the transactions, what’s the benefit? They will be able to perhaps better target the things they’re doing? I doubt it, their instruments aren’t all that fine anyway. I mean, it’s always nice to know more I guess though, so I can see it. Nobody gets fired for suggesting they collect more data.

Conspiracy to stop stablecoins

Central Banks would love to have instruments to guide the monetary policy in an economy that doesn’t revolve around bank chair’s carefully worded koans that the markets spend an endless amount of time analysing and measuring. Right now they have a blunt instrument (moving the interest rates in pretty 25 bps increments) and a fine instrument (talking carefully without saying much). It’d be nice to move this the other way around.

Considering that a bunch of stablecoins haven’t been all that stable, this feels unnecessary. You could just wait!

Ok, that’s unfair, USDC is collateralised with USD and therefore good. But still there’s escape hatches that a government might not be happy about, because it creates payment disintermediation and therefore has KYC/ AML implications.

Moreover, since it competes with national currency, as a sort of quasi-bank, it creates the same issues that non-banking financial institutions do, which is to reduce the efficacy of the regulatory system, reduce impact of monetary policy at the margins, and increase avenues for vulnerability.

Cash is expensive

If you do your business with cash, like physical cash, it’s instant settlement, because cash is a bearer instrument. Which means that the person who bears it has the legal right to treat it as money, and a claim on the central bank. But, you know, cash is painful to lug around. It’s heavy and can be stolen (again, bearer instrument) and generally kind of messy. Currency costs India $600 million, and its $3 trillion GDP is 14% cash.

Cash is expensive to print and store and move and collect, and digital cash is much easier. Though digital cash requires expensive programmers to maintain it, so I’m not sure it’s all that better.

We already disintermediated cash with electronic money, and everyone’s kind of fine with it. (Aren’t we?) And especially if you’re going to do it via the banks, then basically you’re replacing one digital money with another. Which is … nice I guess, but I don’t get why it matters!

And even if you put it all together, this just restates the existing situation in slightly new words, which is what leaves me confused about why so many countries are doing this thing in the first place.

IV. A conclusion

So … Well, it differs a bit depending on how exactly the CBDC is supposed to work. Like in some places it is a direct account everyone has with their central bank, and in others it’s a disintermediated system which looks a lot like what we have today.

The problem that central banks have is that they have a blunt instrument for a confusing economy. Inflation, caused by inadequate supply or higher aggregate demand, is dealt with the crushing blow that is bringing pain to the entire economy so that enough people in enough jobs get laid off enough, that the whole economy cools.

"Doesn’t this also impact increasing supply, since borrowing is more expensive?" Yes, yes it does. But it’s a tightrope and someone has to walk it.

The power that the Central Banks have is the power to decide how much money is in the economy, and what the price is at which we can all collectively use the money to quantify our levels of trust and belief in each other.

But if you could see where the money was being used, and surgically slice around it, well, then you don’t need to have Bob the engineer laid off in Ohio just because grain from Ukraine wasn’t available or large chunks of people in the northeast decided to splurge on buying more milk simultaneously.

The problem Central Banks have is that money is fungible. Demand decrease due to job destruction is roughly the same as long as it hits the price levels. i.e., money is no longer something that’s fungible. I mean, it technically isn’t already, all banknotes have a serial number, but in practice it is. If I sent you $10 and you sent me $10, asking which $10 it was is kinda silly. But if the digital money had a "tracker", you could make money do different things under different circumstances.

This is programmable money, or at least my version of it. Money doesn’t know who spent it, but we can perhaps teach it. What’s the point? Well, we’ll get to that.

Which means that going back to basics, the entire point behind CBDC comes down to two major benefits:

Since I don’t understand it, I have two slightly conspiratorial theories as to the benefits that I see. These are my speculations, for what it’s worth, though I think logically they’re the only real reasons you see 91 Central Banks dutifully act like lemmings.

1. Build an alternative to the monetary system we have today

Imagine you wanted to update the database that the existing money rails run on. It’s pretty much impossible, because there are too many people involved and they all need to talk to each other and none of them want any downtime, and therefore the banks end up running COBOL servers with 65 year olds being brought back from retirement just to make sure it’ll run3.

But now imagine if you could introduce a parallel system, and kind of slowly make that actually function. It starts by only being in bits and pieces of the economy, but you could slowly balloon it to take over more of the actual payments and money movement ecosystem.

And then, like was done with demonetisation movements in India and Philippines etc, you switch over.

The bad side is that if this happens and the CBDC at the bottom is e-CNY, you’ve ceded control from US led SWIFT to China. The good side is that if this happens with e-USD, or something else equivalent, you have international payments working the same way debit card payments already work in Europe, plus with instant settlements.

Is this good? I don’t know. Is it useful? I also don’t know. I guess it’s nice that there are new rails being created and tested and hopefully used, but I have no theoretical or practical affinity towards it, beyond the fact that I like that someone’s experimenting here.

2. Better or more targeted monetary policy

The second, and maybe slightly conspiratorial theory, is that this allows the central bank to directly mess with the money in interesting ways, and impact demand in a more direct fashion.

What could they do?

CBDC kind of means everyone has an account directly with the central bank, which means you can now transfer money with the benefits of cash (instant settlement) and electronic transfer (no touching the grubby physical banknotes).

So for instance if they saw that inflation was running high, the normal method would be to hike interest rates. That impacts inflation, ideally, by making the cost of money higher (borrowing is more expensive, saving is more attractive), which makes labour markets tighter (can’t pay everyone so much so easily if you got higher interest payments to make), reduces number of jobs and/or wages for the jobs, and that reduces demand for stuff.

Instead, imagine if you saw inflation was running high because people were piling up on milk and toilet paper. You could theoretically tamp this down by focusing on making just those things more expensive. You can’t rely on Big Milk and Big TP colluding to do this, because, well, that’s illegal. But if you, as the central bank, made those purchases more expensive by making the money that made those purchases worth less, that could be interesting.

But perhaps that’s a tad too Big Brother. Instead how about if you could make trading monkey jpegs more attractive by introducing deflationary pressures for those digital goods. That attracts the e-money you made to come there, and voila, goods inflation in the real world is down.

Or, it could privilege certain transactions with airdropped interest rates, if it wanted to boost demand. Hey, you spent your e-money on education and self-improvement, so perhaps you should get a bit more.

They could look at inflation with far better fine-grained data. No more CPI vs PPI vs BLS for wage increases, and then arguing about which one of those is actually right, to do a vibes based rate adjustment up or down. You could get "real" transactional data, directly from the source, assuming that is that the e-money you printed is actually being used. It’s literally the most raw look at consumer spending you could possibly get.

Is this all ‘good’? I have no idea. Kneejerk reaction says no, but then kneejerk reaction would’ve said no to the Fed being able to collect various bits of data too, the way they do today. Or to the internet. Or to having discount windows or messing with interest rates. Centralisation of power generally feels a bad thing, though we’ve found checks and balances.

So, I don’t know. Feels like it has potentially bad consequences for sure. But then I know that relying on the fact that our current financial system is held together by duct tape shouldn’t be the reason we feel so secure either. "We don’t want to make things more efficient lest it be bad" feels a tough slogan, even if it’s true and sometimes menu costs are our friend.

The truly interesting thing to me is that these are traditionally benefits that you’d get from the government - via fiscal policy - but now you have an easier way to actually implement that! CBDCs could be a way by which the separation between fiscal and monetary policy link together, because you’re messing with the core of what "money" means in the first place.

And if you do, you also get slightly cheaper ways to pay for your coffee and for the cafe to pay for their bank loans. That’s not nothing.

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• How to create money