The Risks to Society of Central Bank Digital Currencies

There is a lot of writing about digital central bank currencies but little about the risks that digital currencies can create on society.

I see these risks fall into three categories:

1. Economic

2. Finance

3. Human rights

Economic risk

The main economic risk is inflation. CBDCs can be created at the push of a button and distributed widely, inflating the money supply without any corresponding increase in GDP. This risk can be mitigated by issuing central bank digital currency to individuals and companies only against bank deposits, or collateral paid with bank deposits; And the government only exchanges bonds that have a reasonable chance of paying them back through taxes. Unfortunately, because governments control central banks, this risk cannot really be mitigated, and as we’ve seen with quantitative easing and rampant inflation today, governments can always find ways to create money to spend — with digital central bank currencies, the temptation to do so will only increase.

The second economic risk is the widespread misallocation of capital and efforts to implement a central bank digital currency. Central bank digital currencies require a nationwide infrastructure for distribution and payments, and this needs to be in place for the underlying digital currencies to be useful. The private sector is in a better position to provide this infrastructure, but there are risks that CBD infrastructure will be designed and built by bureaucrats separate from private sector initiatives which has led to lower adoption of central bank digital currency due to poor facilities and poor user experiences.

financial risk

Financial risks include exchange rate risk, rising borrowing costs and operational risk.

Central bank digital currency should be just another form of central bank money, but could governments be inclined to replace it with existing forms of money for the national currency at less than 1:1?

Central bank digital currencies can lead to higher lending costs. In its recent discussion paper on “New Forms of Digital Money,” the Bank of England identified increased lending costs as a risk arising from lower bank lending with central bank currencies and more expensive market-based financing.

Then there is the risk of the central CBDC system being exposed to outages and cyber attacks. Even a short power outage can badly affect the entire nation by disrupting everyone’s financial transactions.

human rights risks

If improperly designed, the underlying digital currencies are likely to be used as tools for monitoring and oversight by governments. Every transaction is recordable and any authority that has access to the CBI ledger can see all transactions. They can also control people through the ledger – such as setting expiration dates on their digital banking, deciding how much they can hold, changing interest rates and rates depending on who they are, blocking purchases and deducting fines automatically.

Combining digital ID and CBDC is also very risky. Access and addressability are essential to digital payments, but they are different from digital identity. In the world of programmable finance, digital identity can go beyond just giving access to your money. The use of these funds can be made contingent upon the attributes of your digital identity. If this money is in central bank currencies, then the central bank and implicitly the government can directly control how you spend and receive money.

Be wary of anyone who advocates associating digital identity with a CBDC – while digital identity is essential to finding fraudsters, money launderers, and other criminals, there is no financial reason to combine a CBDC with a digital identity.

Engineering to avoid the risks of CBDCs

To a large extent, preventing the risks of CBDCs rests with society as a whole to accept only CBDC solutions that are free of these risks.

Crucial to risk mitigation is to initially design a central bank digital currency to prevent these risks from being possible, rather than simply design controls to mitigate them (the controls can be dismantled in the future).

Layered architecture is required.

At the base layer there is a CBDC as collateral for the payment system in the country. Risk-free digital central bank money issued on demand by the central bank in exchange for government securities, reserves from commercial banks, or bank deposits from the non-bank private sector.

The next layer is programmable private money. These are simply IOUs, often described as stable currencies, but better described as “stable currencies” as they are used and redeemed on an equal footing. They are issued by commercial banks (which they create when issuing loans, as with ordinary bank deposits) and by private (licensed) institutions.

This layer is critical in separating the programmability of payments from the issuance and maintenance of a CBDC – the CBDC must have the hooks to support the special programmable funds in this layer, but there should be no programmability in the CBDC itself. Smart contracts are embedded in the private funds layer to access the CBDC layer to manage collateral and access the above layers to manage payments. This layer is likely based on distributed ledger technology.

Addressability forms the next layer, providing connectivity and interoperability for payments to flow seamlessly across different fixed currencies on different infrastructures.

Finally, in the upper tier are the commercial applications – wallets, applications, gateways, devices, etc. in which fixed currency payments are included.

Digital identity is separate, outside and separate from this architecture.


Central bank digital currency poses a range of risks to consumers – financial, economic and human rights that are potentially severe if poorly designed or built.

However, as a basic layer in the monetary architecture, CBDCs as collateral for the state’s payment system and for programmable private funds can push a new innovation.

The challenge is to design and implement a central bank digital currency so that it can never evolve from the base layer and be misused to reduce the money supply, transfer debt, or control society by making rules about how people receive and spend their money.

A layered CBDC architecture like this has the potential to drive innovation, the proliferation of the next generation of payment applications and the digital business models that use them, for the benefit of society as a whole.

See my Linkedin account for a longer version of this blog.


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