A world with central bank digital currencies
In this post, a group of IMF economists examine why central banks might consider issuing digitial currency, and how households and firms might adapt.
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Every day, it seems, brings a new privately issued crypto-asset to the fore. But the official sector has not gone dormant. Several central banks, including the Bank of Canada, Bank of England, Norges Bank, and Sveriges Riksbank are actively investigating the possibility of issuing central bank digital currency (CBDC).1
Doing so may be the natural next step in the evolution of official coinage, from metal-based money, to metal-backed banknotes, to physical fiat money, and beyond. In a recent study (Mancini Griffoli et al. 2018), we consider why central banks might consider taking this step, and how households and firms might adapt.
Digital forms of payment are not new to central banks; they have been issuing reserves to settle interbank payments for some time. But CBDC would be available to the public at large, as a digital form of fiat money that could serve as legal tender. Like its physical equivalent – cash – CBDC would satisfy the traditional functions of money: a unit of account, a means of payment, and a store of value.
But would there be any demand for CBDC, and why might central banks wish to dust off their payment systems to introduce something new? Users may not necessarily swarm to CBDC, at least not in all countries. Payments in commercial bank deposits are becoming increasingly efficient, as banks partner with tech companies to offer more user-friendly interfaces and central banks roll out improved back-end systems to settle retail transactions. Even in lower-income countries, private sector initiatives allowing transactions between mobile phones, such as M-Pesa in Kenya, are increasingly popular. Nevertheless, in countries with underdeveloped payment systems, there may well be demand for CBDC. And CBDC may have further allure if it allowed for some degree of anonymity in payments, such as to transaction parties or third parties. As such, it may one day replace cash, which will seem increasingly anachronistic in the digital world.
Why might central banks consider introducing a digital currency? One reason is to encourage financial inclusion in countries or areas where the private sector under-delivers. CBDC could reduce costs to access money and related services by the unbanked and inhabitants of remote areas. Also, if the CBDC encroached on cash usage, it would help lower costs stemming from the printing and distribution of paper bills and coins (see Box 4 in the IMF's April 2018 Global Stability Report. Finally, as a palatable alternative to private forms of money, CBDC could help spur competition in the payments sector and keep prices low and quality high. It could also bolster the security of the payments system by preventing it from being entirely run by private firms.
But not all is rosy. There are risks from introducing CBDC, as well as costs and technological hurdles which need to be ascertained.
The design of the CBDC in terms of anonymity (traceability of transactions), security, transaction limits, and interest earned will largely determine these risks. A CBDC design that mimics the features of bank deposits could divert funds from banks and increase their cost of funding. This could raise lending rates and impact investment and consumption. Also, the adoption of CBDC could facilitate runs from the banking system during periods of financial stress under certain circumstances.
However, the potential costs and risks can be contained through design choices and policies. For example, a central bank could limit the risk of deposit flight by setting limits on individual CBDC holdings. In addition, during episodes of runs, a central bank could lend the funds it collects from deposits back to banks, and more easily service withdrawal requests from bank clients.
No universal case exists yet for CBDC. IMF research suggests that the popularity of CBDC and its impact will largely depend on its design features and, while risks exist, policies can be introduced to mitigate the costs and increase the benefits. As IMF Managing Director Christine Lagarde recently said in an influential speech, central banks should “investigate [CBDC] further, seriously, carefully, and creatively.”