This article briefly:
A digital dollar raises privacy concerns because it could facilitate government overreach.
Cybersecurity threats, including cyberattacks and the costs of protecting digital currencies, pose further risks.
Adopting a digital dollar could exacerbate financial inequality, widen the digital divide, and harm small businesses.
As central banks around the world explore the concept of central bank digital currencies (CBDCs), the potential introduction of a digital dollar in the United States has sparked heated discussions.
What are the dangers associated with a digital dollar, and what is the relationship between potential risks and perceived benefits?
What is a Central Bank Digital Currency (CBDC)?
CBDC is a digital representation of a country’s central bank currency that is available to the public. Unlike digital currencies used in bank accounts and digital wallets that are liabilities of commercial banks, CBDC is a liability of the central bank.
While physical currency and digital balances held by commercial banks at central banks currently exist, CBDCs are designed to provide additional, secure and efficient payment options.
The Federal Reserve (Fed) is considering CBDCs to “enhance the safety and efficiency of the U.S. domestic payments system.” This is due to the rise of new private sector financial products and services, such as digital wallets, mobile payment applications, cryptocurrencies, and stablecoins.
A CBDC could offer benefits such as easy access to central bank money. It could provide a platform for innovative financial products and services, faster and cheaper payments, and greater financial inclusion for consumers.
Nonetheless, there are risks and policy issues with a U.S. CBDC. These include its impact on the market structure of the financial sector, the availability and cost of credit, the safety and stability of the financial system, and the effectiveness of monetary policy.
The Fed’s approach to a potential CBDC emphasizes that the benefits outweigh the costs and risks. It is intended to complement the current dollar and financial services to balance consumer privacy and transparency to prevent criminal activity.
The Dangers of a Digital Dollar: The Risks of CBDCs
Loss of privacy
One of the most important dangers of a digital dollar is the potential loss of user privacy. Unlike physical cash transactions, which can be anonymous, digital transactions can be easily tracked and monitored.
This means that governments have unprecedented access to citizens' financial data, which in turn has raised concerns about surveillance and the erosion of financial privacy.
With the ability to track digital transactions, governments may be tempted to use this information to monitor citizens, leading to potential abuses of power. This could include tracking dissidents and whistleblowers, or simply monitoring the spending habits of ordinary citizens.
Li Bo, Deputy Managing Director of the International Monetary Fund (IMF), said:
“CBDCs could allow government agencies and private sector actors to enact… targeted policy functions. By programming a CBDC, money could be precisely targeted to what people can own and what they can do.”
The potential for abuse raises serious concerns about the erosion of privacy rights in the digital currency environment.
In addition to government surveillance, a digital dollar could expose users’ financial data to third parties, such as companies or advertisers. This could lead to the commoditization of personal financial data as companies seek to use this information for targeted marketing or other purposes.
Decreased financial freedom
In addition to privacy concerns, a digital dollar could also erode financial freedom. As governments are likely to increase control over financial transactions, individuals may find their ability to transact freely restricted.
A digital dollar could make it easier for governments to freeze or seize assets. Freezing physical cash assets requires a court order, but a digital dollar could streamline that process. Thus, raising concerns about due process and individual property rights.
Fed Governor Michelle Bowman has maintained that such controls could lead to the politicization of how money is used.
“A CBDC that allowed for such controls would not only potentially allow the government to restrict certain types of private spending or limit access to bank accounts, it could also threaten the independence of the Federal Reserve.”
Central banks could more easily implement negative interest rates through a digital dollar, effectively punishing savers and inducing them to spend or invest.
Rep. Tom Emmer (R-MN) believes this could have far-reaching implications for personal financial decisions and autonomy. He maintains that a digital dollar represents “government-controlled, programmable money that could be easily weaponized as a surveillance tool.”
Cybersecurity risks of CBDC
The digital nature of digital dollars makes them more vulnerable to cyberattacks. Masato Kanda, Japan’s Vice Finance Minister for International Affairs, believes that cybersecurity is one of the main challenges facing CBDCs.
Hackers could target central banks or individual user accounts, potentially causing widespread damage to the financial system.
A successful cyberattack on the digital dollar infrastructure could result in systemic risk, leading to a loss of confidence in the currency and the broader financial system. This could have serious economic consequences, as trust is a fundamental component of a properly functioning financial system.
Cybercriminals can also target individual users of digital dollars. They may exploit security vulnerabilities or use social engineering techniques to gain access to accounts. This could result in severe financial losses for victims and undermine trust in digital currencies.
Exacerbating financial inequality
Implementing a digital dollar could exacerbate financial inequality by widening the digital divide. Not everyone has access to the technology needed to use digital currency, such as a smartphone or a reliable internet connection. This could disproportionately affect low-income and rural communities, leading to further financial exclusion.
While some proponents argue that CBDCs can promote financial inclusion, a digital dollar could leave those who are already marginalized behind. The deputy director of the International Monetary Fund asserted that “CBDCs could lead to financial stability risks if not designed properly.”
Individuals without access to digital devices or an internet connection may find themselves at a distinct disadvantage. They may be unable to participate in the digital financial ecosystem.
A digital dollar would also promote reliance on technology to access financial services. In the event of a technological failure, natural disaster, or other disruption, this reliance on technology could leave vulnerable groups without access to funds, exacerbating existing financial inequalities.
The transition to a digital dollar could also have a negative impact on small businesses and the cash-based economy. Businesses that rely on cash transactions could face challenges as digital transactions become the norm.
Small businesses may face increased costs when transitioning to digital payment systems, including hardware, software and transaction fees. This could put additional financial pressure on businesses that find it difficult to compete with larger, more technologically advanced companies.
Is the digital dollar the future of money?
Although many central banks, including the Federal Reserve, are studying and considering the development of CBDCs, no final decision has been made. The future of a digital dollar depends on thorough analysis and consultation with key stakeholders to ensure that the benefits outweigh the risks.
As technology improves and demand for digital financial services grows, the idea of a digital dollar is likely to gain more traction. However, the path to widespread adoption remains uncertain, and policymakers must consider the potential consequences of implementing a digital dollar.