From forcing people to spend to making them save, central banks around the world may soon be using CBDC to create a dystopian nightmare.

During the financial crisis of 2007-2008, many people lost trust in traditional financial institutions and turned to alternative forms of currency, such as cryptocurrencies. It’s a way for people to maintain financial freedom and privacy in a system that fails them. However, the rise of central bank digital currencies (CBDC) has raised serious concerns about privacy and freedom.

One of the most important concerns about CBDC is the death of anonymity. Currently, cash transactions provide the confidentiality and anonymity needed for financial freedom. The ability for people to conduct transactions using cash without leaving a paper trail is a fundamental right in a democratic society. However, the introduction of CBDC may change this.

CBDCs will be fully traceable, meaning every transaction will be recorded and monitored by the central bank. This will allow central banks to monitor and control financial transactions in ways that were not possible before. While this sounds like a positive development, it raises serious concerns about privacy and civil liberties.

The potential negative impacts of CBDCs can also be understood by examining the government’s response to the global financial crisis. For example, in the aftermath of the crisis, governments around the world enacted policies to stop the financing of terrorism and combat money laundering. Unfortunately, these regulations often come at the expense of people’s freedom and privacy.

For example, the Russian government has skillfully used the AML framework to advance objectives unrelated to combating terrorism and organized crime. However, research shows that the AML regime has been used by the Russian government to expand its strategic influence over domestic politics and business and to attempt to restructure the banking system. The ineffectiveness of AML rules and their use for clandestine purposes undermines the overall legitimacy of the regime.

The Patriot Act of 2001 led to abuses of power and violations of civil liberties in the U.S. According to the Electronic Privacy Information Center, the FBI's Office of General Counsel found 13 cases of suspected FBI misconduct in intelligence operations between 2002 and 2004 alone.

Additionally, some policies implemented in response to the crisis have led to restrictions on personal financial activities. For example, some countries have imposed capital controls to limit the flow of funds across borders and stabilize their financial systems. For example, the Bank for International Settlements noted in a November 2022 report that “personal and merchant wallets for eNaira” — Nigeria’s CBDC — “have different caps on daily transaction limits and the amount of eNaira that can be held in them, depending on their customer due diligence tiers.”

The ability to impose restrictions on people’s everyday financial holdings and spending could severely erode privacy and freedoms, and have a chilling effect on free speech and political dissent.

Furthermore, central banks could use CBDC to implement negative interest rates, which would incentivize people to spend rather than save. This could lead to a surge in consumption and inflation, which could destabilize the economy. This would also lead to some technical challenges. For example, a cap on an individual’s CBDC holdings could limit the amount or volume of payments, as it would be necessary to know the recipient’s CBDC holdings in order to complete the payment.

In addition to these concerns, CBDCs could exacerbate existing inequalities. For example, those without access to the internet or digital gadgets would be excluded from the financial system. This could apply to underrepresented groups such as the elderly, the poor, and residents of rural areas. CBDCs could lead to new types of financial exclusion, as central banks could refuse to do business with those who are seen as high risk.

For example, the Bahamas implemented the Sand Dollar to address the root problem of financial exclusion. However, from January 2021 to June 2022, Sand Dollar balances increased by less than $300,000, while the value of the notes increased by $42 million—suggesting that the Sand Dollar barely qualifies as a means of payment.

Central banks should carefully consider the impact of CBDCs on privacy, freedom, and financial stability. To ensure that CBDCs are created in a way that respects individual rights and freedoms, they must also consider frequent consultations with stakeholders such as companies, civil society organizations, and individuals.

Ultimately, the rise of CBDCs may be a double-edged sword. Government-backed digital currencies may enable faster, cheaper, and more secure transactions, but they also raise important questions related to freedom, privacy, and financial stability. As we saw during the global financial crisis, the goal of financial stability can come at a significant cost to individual freedoms and privacy. Central banks should make defending individual freedoms and rights a top priority when considering their approach to CBDCs.

C3 Tip: The views, thoughts and opinions expressed here are the author's own and do not contain investment advice or recommendations. Every investment and transaction involves risk.