Central bank digital currency

Central bank digital currency (CBDC, also called digital fiat currency[1] or digital base money[2]) is the digital form of fiat money (a currency established as money by government regulation, monetary authority or law).

Not to be confused with Digital currency or Virtual currency.

The present concept of CBDCs was directly inspired by Bitcoin, but CBDC is different from virtual currency and cryptocurrency, which are not issued by the state and lack the legal tender status declared by the government.[3][4][5] Proposed implementations may not even use any sort of distributed ledger.

CBDCs are presently in the hypothetical stage, with some proof-of-concept programmes.

History

Although central banks have directly released e-money previously - such as Finland's Avant stored value e-money card in the 1990s[6] - the present concept of "central bank digital currency" was inspired by Bitcoin and similar blockchain-based cryptocurrencies.

The Bank of England discussed a blockchain-based central bank currency in a September 2015 speech by chief economist Andrew G. Haldane, on possible ways to implement negative interest rates.[7] A March 2016 speech by Ben Broadbent, the bank's deputy governor of monetary policy, appears to be the first use of the phrase "central bank digital currency", and notes direct inspiration by Bitcoin.[8][9]

The central bank of Sweden mooted an "e-krona" in November 2016,[6] and started testing an e-krona proof of concept in 2020.[10][11][12]

In November 2017, the central bank of Uruguay announced to begin a test to issue digital Uruguayan pesos.[13][14]

In March 2019, the Eastern Caribbean Central Bank announced it would engage in a pilot CBDC project with Barbados based FinTech company Bitt.[15]

In the Eurozone, the Bank of Spain's former governor Miguel Angel Fernandez Ordoñez has called for the introduction of a digital euro, but the European Central Bank (ECB) has so far denied such possibility.[16] Nevertheless, in December 2019, the ECB stated that "The ECB will also continue to assess the costs and benefits of issuing a central bank digital currency (CBDC) that could ensure that the general public will remain able to use central bank money even if the use of physical cash eventually declines".[17]

Implementation

A central bank digital currency would likely be implemented using a database run by the central bank, government, or approved private-sector entities.[18][19] The database would keep a record (with appropriate privacy and cryptographic protections) of the amount of money held by every entity, such as people and corporations.

In contrast to cryptocurrencies, a central bank digital currency would be centrally controlled (even if it was on a distributed database), and so a blockchain or other distributed ledger would not be required or useful - even as they were the original inspiration for the concept.[18][19]

Characteristics

CBDC is a high security digital instrument; like paper bank notes, it is a means of payment, a unit of account, and a store of value.[20] And like paper currency, each unit is uniquely identifiable to prevent counterfeit.[21]

Digital fiat currency is part of the base money supply[22], together with other forms of the currency. As such, DFC is a liability of the central bank just as physical currency is.[23] It's a digital bearer instrument that can be stored, transferred and transmitted by all kinds of digital payment systems and services. The validity of the digital fiat currency is independent of the digital payment systems storing and transferring the digital fiat currency.[24]

Proposals for CBDC implementation often involve the provision of universal bank accounts at the central banks for all citizens.[25][26]

Benefits and impacts

Digital fiat currency is currently being studied and tested by governments and central banks in order to realize the many positive implications it contributes to financial inclusion, economic growth, technology innovation and increased transaction efficiencies.[27][28] Here is a list of potential advantages:

  • Technological efficiency: instead of relying on intermediaries such as banks and clearing houses, money transfers and payments could be made in real time, directly from the payer to the payee.
  • Financial inclusion: safe money accounts at the central banks could constitute a strong instrument of financial inclusion, allowing any legal resident or citizen to be provided with a free or low-cost basic bank account.
  • Preventing illicit activity: A CBDC makes it feasible for a central bank to keep track of the exact location of every unit of the currency (assuming the more probable centralized, database form); tracking can be extended to cash by requiring that the banknote serial numbers used in each transaction be reported to the central bank. This tracking has a couple of major advantages:[29]
    • Tax Collection: It makes tax avoidance and tax evasion much more difficult, since it would become impossible to use methods such as offshore banking and unreported employment to hide financial activity from the central bank or government.
    • Combating crime: It makes it much easier to spot criminal activity (by observing financial activity), and thus put an end to it.[29] Furthermore, in cases where criminal activity has already occurred, tracking makes it much harder to successfully launder money, and it would often be straightforward to instantly reverse a transaction and return money to the victim of the crime.
  • Protection of money as a public utility: digital currencies issued by central banks would provide a modern alternative to physical cash – whose abolition is currently being envisaged.[30]
  • Safety of payments systems: A secure and standard interoperable digital payment instrument issued and governed by a Central Bank and used as the national digital payment instruments boosts confidence in privately controlled money systems and increases trust in the entire national payment system[31][32] while also boosting competition in payment systems.
  • Preservation of seigniorage income: public digital currency issuance would avoid a predictable reduction of seigniorage income for governments in the event of a disappearance of physical cash.[33]
  • Banking competition: the provision of free bank accounts at the central bank offering complete safety of money deposits could strengthen competition between banks to attract bank deposits, for example by offering once again remunerated sight deposits.
  • Monetary policy transmission: the issuance of central bank base money through transfers to the public could constitute a new channel for monetary policy transmission[34][35][36] (ie. helicopter money[37]), which would allow more direct control of the money supply than indirect tools such as quantitative easing and interest rates, and possibly lead the way towards a full reserve banking system.[38]
  • Financial safety: CBDC would limit the practice of fractional reserve banking and potentially render deposit guarantee schemes less needed.[39]

Risks

A general concern is that the introduction of a CBDC would precipitate potential bank runs[40][41] and thus make banks' funding position weaker. However, the Bank of England found that if the introduction of CBDC follows a set of core principles the risk of a system-wide run from bank deposits to CBDC is addressed.[42]

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References
  1. "Focus Group on Digital Currency including Digital Fiat Currency". ITU. Retrieved December 3, 2017.
  2. Bank, European Central. "Digital Base Money: an assessment from the ECB's perspective". European Central Bank. Retrieved November 9, 2017.
  3. Silva, Matthew De. "What China could gain from a digital yuan". Quartz. Retrieved September 28, 2019.
  4. "Speech by Jen Weidmann at the Bundesbank Policy Symposium "Frontiers in Central Banking – Past, Present and Future"". www.bundesbank.de. Retrieved November 9, 2017.
  5. "Financial innovation and monetary policy: Challenges and prospects" (PDF). European Parliament. 2017.
  6. https://pdfs.semanticscholar.org/9fa6/e095fa409d199e7aec8b50b657a7075fbe9e.pdf
  7. https://www.bankofengland.co.uk/speech/2015/how-low-can-you-can-go
  8. "Central banks and digital currencies - speech by Ben Broadbent | Bank of England". www.bankofengland.co.uk. Retrieved November 12, 2017.
  9. Bjerg, Ole (June 13, 2017). "Designing New Money - The Policy Trilemma of Central Bank Digital Currency". Rochester, NY. SSRN 2985381. Cite journal requires |journal= (help)
  10. "Sweden's Riksbank eyes digital currency". Financial Times. Retrieved November 9, 2017.
  11. Riksbanken. "The E-krona project – First interim report". www.riksbank.se. Archived from the original on November 1, 2017. Retrieved November 10, 2017.
  12. Riksbank. "The Riksbank to test technical solution for the e-krona". www.riksbank.se. Retrieved February 25, 2020.
  13. Uruguayan central bank to test digital currency - Agencia EFE, 20 September 2017
  14. El BCU presentó un plan piloto para la emisión de billetes digitales - Central Bank of Uruguay, 3 November 2017
  15. Eastern Caribbean Central Bank CBDC - March 2019
  16. "ECB rejects implementation of "digital euro" for wrong reasons". Positive Money Europe. September 28, 2018. Retrieved September 28, 2018.
  17. "Innovation and its impact on the European retail payment landscape" (PDF). European Central Bank. December 2019.
  18. Yang, Yuan; Lockett, Hudson. "What is China's digital currency plan?". www.ft.com. Financial Times.
  19. "Analytical Report on the E-Hryvnia Pilot Project" (PDF). National Bank of Ukraine.
  20. "Should the Riksbank issue e-krona?" (PDF). Sveriges Riksbank.
  21. "Medium Term Recommendations to Strengthen Digital Payments Ecosystem" (PDF). Committee on Digital Payments: Ministry of Finance, Government of India. Archived from the original (PDF) on July 9, 2017. Retrieved July 17, 2017.
  22. "Broadening narrow money". Bank of England. 2018.
  23. "Central Bank Digital Currencies" (PDF). Bank for International Settlements. Retrieved April 13, 2018.
  24. "Central Bankers Explore Response to Bitcoin: Their Own Digital Cash". Wall Street Journal.
  25. "Digital Cash: Why central banks should issue digital currency". positivemoney.org. Retrieved November 9, 2017.
  26. "Sovereign Digital Currency". sovereign money. Retrieved November 10, 2017.
  27. "Canada Has Been Experimenting With A Digital Fiat Currency Called CAD-COIN". Forbes.
  28. Bordo, Michael; Levin, Andrew (September 23, 2017). "Central bank digital currency and the future of monetary policy". VoxEU.org. Retrieved November 10, 2017.
  29. Bindseil, Ulrich (January 2020). "Tiered CBDC and the financial system" (PDF). ECB Working Paper (ECB Working Paper Series No 2351 / January 2020): 6–7. Retrieved February 2, 2020.
  30. "Think Twice About Going Cashless". Bloomberg.com. May 21, 2017. Retrieved November 9, 2017.
  31. "What should the future form of our money be?". Norges Bank.
  32. Riksbanken. "Ingves: Do we need an e-krona?". www.riksbank.se. Retrieved December 13, 2017.
  33. "Central Bank Digital Currency: Motivations and Implications". www.bankofcanada.ca. Retrieved December 3, 2017.
  34. "Central Bank Digital Currency: A Monetary Policy Perspective". Central bank of Malaysia.
  35. "The implications of digital currencies for monetary policy - Think Tank". www.europarl.europa.eu. Retrieved November 9, 2017.
  36. "Helicopter money is "a real possibility," says Czech central banker". Positive Money Europe. March 15, 2018. Retrieved September 28, 2018.
  37. Hampl, Mojmir; Havranek, Tomas (2019). "Central Bank Equity as an Instrument of Monetary Policy". Comparative Economic Studies. doi:10.1057/s41294-019-00092-1.
  38. Stevens, A (June 2017). "Digital currencies: threats and opportunities for monetary policy | nbb.be". www.nbb.be. National Bank of Belgium. Retrieved November 10, 2017.
  39. Mayer, Thomas (November 6, 2019). "A digital euro to save EMU". VoxEU.org. Retrieved November 10, 2019.
  40. Pfister, Christian (September 2017). "Monetary Policy and Digital Currencies: Much Ado about Nothing?" (PDF). Banque de France.
  41. Smets, Jan (2016). "Fintech and Central Banks" (PDF). National Bank of Belgium.
  42. Kumhof, Michael; Noone, Clare (May 2018). "Central bank digital currencies — design principles and balance sheet implications" (PDF). Bank of England. Retrieved January 10, 2019.
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