Difference between cryptocurrencies and central bank digital currencies

Today we'll look at the distinction between cryptocurrencies and central bank digital currencies. We're discussing this because there appears to be a lot of confusion about the differences between cryptocurrencies and central bank digital currencies, as well as some of the other DeFi projects recently, especially with the rise of central bank digital currencies. Furthermore, central bank digital currencies, or CBDCs, are used as an example by those who claim that once CBDCs are implemented, bitcoin and other cryptocurrencies will be illegal. So, in this article, we will look at the main differences between central bank digital currencies, CBDCs, and cryptocurrencies so that you can understand the distinction between the two and the distinction between a CBDC and the current monetary system.

We are going to focus on four key distinctions between CBDCs and cryptocurrencies. Which are:

• Permission
• Anonymity
• Centralisation/Decentralisation
• Primary beneficiaries, who benefit by using them

To be clear, I'm using the term cryptocurrencies, but most of what I'm saying is primarily about Bitcoin. Other cryptocurrencies are simply variations of Bitcoin in this context, but for the sake of simplicity, the points I'm making apply to most cryptocurrencies, but primarily to bitcoin. It is the first and most widely used cryptocurrency, as well as the most time-tested and proven.

So point number one, we have permission.
Permissionless public blockchains are what cryptocurrency is. You can examine every single transaction that has ever taken place on the bitcoin network. It's a public ledger, and no single person, entity, CEO, or team can prevent you from connecting to the network. You can view every bitcoin transaction and every address it has ever been associated with. You can join the network without obtaining permission from anyone. All you need is the right hardware and software. To verify transactions and earn cryptocurrency rewards, you can become a miner. You can also sell time, labour, or other currencies in exchange for cryptocurrency. You can also use cryptocurrency to make a payment to someone who accepts it. It is permissionless, meaning that no one has to grant you access to obtain a wallet for that cryptocurrency for you to receive or send it. Nobody can prevent you from using it or force you to use it.

On the other hand, a central bank digital currency will be the opposite. It will be a private, permissioned blockchain. This means that to receive payments, send payments, have a wallet, see transaction history, or access the ledger, you'd need permission from the person who established the CBDC, which would be the central bank. In practice, this means that the central bank and the banks they use to run nodes and operate their network would most likely be the only ones with access to all of the information behind the scenes. Then they'd grant wallet access for payments and receiving payments to those they wanted to give that access to. At first, it could just be people who want to participate in a pilot programme, similar to what's happening in China right now. Then it could be rolled out to anyone with a Social Security number, to citizens, or to residents. And, of course, because it's permissioned, there's always the risk that if something goes wrong, they'll revoke your access to the network, your wallet, and your ability to spend or receive payment in that currency.

The second distinction is the degree of anonymity. Transactions are not anonymous when using cryptocurrency. This is a huge widespread misconception today. Bitcoin is not anonymous; rather, it's referred to as pseudonymous. The blockchain is public information that anyone can access. You can see every wallet that has ever been associated with a Bitcoin. All transactions are visible. Now, it's called pseudonymous because each wallet address is essentially just a fictitious name for the person who controls that wallet. Just because you can see a wallet address does not mean you can tell who owns that wallet. However, because the information is publicly available, many criminals have been tracked down. Even though Bitcoin is pseudonymous, lawmakers and law enforcement can track and see all transactions, they can follow the trail, and they've been able to find people who have used it for crimes, especially online. In comparison, physical cash doesn't offer a transaction record. This means that physical cash, or government fiat money, is far superior to Bitcoin or other cryptocurrencies for anonymously committing financial crimes. Ironically, politicians and others in power use Bitcoin's criminal appeal as an argument against it, while physical cash is a far better medium of exchange for criminal activity.

Let's take a look at how CBDCs compare in terms of anonymity.
We already know the amount of information people must provide to participate in the current financial system. If you've recently opened a bank or brokerage account, you're aware that you must provide a massive amount of personal information. They pretty much know everything about you. Your birth date, Social Security number, address you've ever lived in, net worth, and income level. As I previously stated, they basically know everything about you because, as the explanation goes, they want to ensure that you are indeed you. CBDCs are going to require the same amount of information. Due to the nature of the central bank's digital currency, this means that to have a wallet with your central bank and access to the CBDC, the central bank will have full information on every single user, ensuring that no single user has multiple wallets. Because if they are going to try to send out stimulus payments, they want to ensure that each person only receives one payment. And people who do not deserve or qualify for the payments are not unintentionally given them. As a result, they'll have a massive amount of data on each user, each person, and each wallet.

Now, as I mentioned in the first distinction, it is not a public blockchain. In contrast to cryptocurrencies, where a wallet address is controlled by someone you don't know, with a CBDC, the information is fully known. So you can't just go to the Federal Reserve's website and get all the information for everyone who has a wallet if they issue a Fed coin or something. However, they would have access to all of that information, making it a prime target for anyone attempting to hack in and obtain that information. Because it contains all of the information about every single citizen, particularly financial information, it is arguably the largest target for cyber attacks ever devised.

This brings us to the next distinction: centralisation versus decentralisation.
A cryptocurrency is a decentralised ledger. This means it is controlled and operated by hundreds, thousands, or millions of decentralised individual nodes spread across the globe that record all transactions, monitor all activity on the blockchain, and reach an agreement on the rules that apply to that cryptocurrency. This means that users also control cryptocurrencies and vote on changes. This is also known as democracy, in which each individual user has the same vote as all other users on what rules apply to the network. Rules that govern monetary policy, such as whether the total supply of that currency is capped or unlimited. Because cryptocurrencies, specifically Bitcoin, are decentralised, users decide what those rules are, and users are the ones who benefit from those rules. As a result, everyone using it is vested in ensuring that the rules benefit them.

In contrast, a CBDC is an absolute opposite. It is entirely centralised, with the central bank issuing it having complete control over it. This means that if monetary policy changes, the central bank, comprised of a few individuals, will decide whether to increase the number of currency units in circulation or decrease the number of currency units in circulation. Are we going to give some currency units to people who have a low income, have lost their jobs, or have a certain number of children, or will we take currency units away from other users? From a Central Bank perspective, maybe they have too much income, perhaps they're a criminal, maybe they don't have too much income, but perhaps they have too much wealth. So we're just going to take some of the currency units we've previously assigned to them because their net worth is so high.

Most central banks do not have the infrastructure to run a CBDC for their entire population. They can only roll out pilot programmes for a very small number of people due to the sheer amount of data that needs to be collected and processed. This means they will likely rely on the banking system to roll out the infrastructure in the long run. With cryptocurrency, anyone can become a node or a miner and contribute to the network. With a CBDC, the legacy financial institutions, the large banks, will most likely roll out the infrastructure and operate as nodes, miners, or verifiers. Banks will also be responsible for security, information gathering, and data processing.

The last distinction between cryptocurrencies and CBDCs is the beneficiaries. Who will benefit from the adoption of that currency? The users will be the ones to benefit from cryptocurrencies. It is a free market, by which I mean that it is unregulated. No controlling entity with a monopoly on violence imposes control over a free market system. Nobody can force anyone to use any cryptocurrencies. Nobody can stop anyone from using any specific cryptocurrency. Free markets let people use what they want. Bitcoin users believe it will benefit them. Thus, the best-governed cryptocurrency will win. The most useful one will be the most popular. This is one reason why, despite many attempts over the years to change the rules of bitcoin to make it more efficient, which would make it less secure due to how the technology works, the vast majority of users do not want that to happen.

In contrast, the main beneficiaries of a CBDC will be the controlling entity, such as the government or the central bank. Now, I'm not saying that this is inherently bad, but power corrupts, and this would give the central government and central bank a significant increase in power over the current financial and monetary systems, over which they already have a lot of control. It gives the central bank and central government the authority and capability to assign purchasing power to specific individuals or institutions at will, as well as remove purchasing power from individuals and institutions at will, in order to allow access to the financial system, to the monetary system, or to block access in countries where certain people, perhaps with certain political views, are not allowed to spend money, transact, and do business. It would only take one click to lock that person out.

Because you simply set out the rules built into the money that is based on income or net worth, it has the potential to make the tax system far more efficient. New currency units are either assigned to or withdrawn from people. As a result, the tax code could be changed and implemented in real-time. It gives them the flexibility to deal with things like recessions, depressions, and crashes. If they want people to go out and buy stocks, they could put money in wallets and say that the money can only be spent on stocks, so if you tried to spend it at Starbucks, it would be like taking a B&Q gift card to Starbucks. It simply would not work. A B&Q gift card can only be redeemed at B&Q. So a central bank digital currency would be the same. They could assign specific uses to the currency units they distribute to people. They could, for example, change expiration dates. So, if they just want to stimulate spending in general, they could say, hey, we're giving everyone $1,000, and if you don't spend it within two months, it'll expire and disappear from your account. As a result, those in power who want to make decisions about how money is distributed throughout society will be the primary beneficiaries of a CBDC.

In conclusion, those are the four primary distinctions between a central bank digital currency and a cryptocurrency.

Permission
Cryptocurrencies are permissionless, meaning that anyone can use them.
A CBDC is both authorised and private. As a result, only those authorised by the central bank will be able to participate in the network or view the transactions.

Anonymity
Cryptocurrencies are pseudonymous. Transactions are permanently recorded, but wallets are a pseudonym for the person who controls them.
The CBDC, on the other hand, will have all of the information about the person to confirm that it is the real person. Because there would be so much financial information on every single person involved, it could potentially be a massive source of cyberattacks.

Centralisation/Decentralisation
A cryptocurrency is completely decentralised and controlled by any individual who wishes to have any say in the network, whereas a CBDC is completely centralised controlled and operated by the central bank and the banks that it chooses to assist it in running the network.

Beneficiaries
In the case of cryptocurrencies, the beneficiaries will be all of the users, the people who are actually using the cryptocurrency, and the rules will be exactly what all of those users vote for.
The main beneficiaries of a CBDC will be the central government and the central bank, which have the desire and capability to maintain and increase control over the financial system.

On a side note, you can't kill cryptocurrencies, particularly Bitcoin, because passing laws is not the same as enforcing them. We recently saw India reverse its stance on cryptocurrencies after initially prohibiting them. Then they just issued a statement saying, "Oh no, we're not actually banning this," because it turns out that something like that is extremely difficult to enforce. While many argue that the introduction and widespread use of CBDCs will be another nail in the coffin for Bitcoin and other cryptocurrencies, game theory suggests that government moves toward CBDCs are more likely to be bullish for cryptocurrencies, specifically Bitcoin. Government tries to force people to use money that is getting worse and worse for them, it creates stronger incentives and more benefits for more people to simply leave the system and start using cryptocurrency instead, which is by nature designed to be the best suited for their needs.