New digital monies issued by the private sector and novel payment systems are rapidly spreading worldwide as technological change and financial innovation are ripe. The Covid-19 pandemic exposed their convenience amid social distancing policies and a mighty expansion of e-commerce. Benign neglect is no longer a (reasonable) option for central bankers. Denial was due, perhaps, when Bitcoin mining began in January 2009. Strong criticism had a reason when Bitcoin was proposed later as a superior alternative monetary regime to sovereign fiat currencies. In 2018 officials referred to cryptocurrencies as crypto-assets to stress the weakness of their first-generation as a medium of exchange. But stablecoins come in a second wave correcting those flaws. The long-delayed Libra Project (now Diem) propelled by Facebook revealed in June 2019 that giant global digital platforms might develop their currencies and built-in payment systems as a natural extension of their businesses. They already have colossal user bases to facilitate massive adoption. No surprise that central bankers are no longer disdainful. Many evaluate issuing digital currencies (CBDC), even those reluctant not long ago. As ECB´s Executive Board member Fabio Panetta said, "We need to make sure that our currency is fit for the future." Central bankers face a complex challenge. It is systemic and multidimensional but also a moving target due to the frantic dynamics of digital change.
G7 central banks are exploring the opportunities and risks related to CBDCs. Last year, the BIS and the central banks of Canada, Europe, Great Britain, Japan, Sweden, Switzerland, and the US agreed on three common foundational principles to guide their examination. They comprise not harming the central bank´s mandate for monetary and financial stability, the coexistence with conventional cash (as long as there is sufficient public demand for it), and fostering innovation and efficiency.
A CBDC means providing access to central bank reserves. That could be done at the wholesale level only (for non-bank intermediaries or payment service providers) or at the retail level (“reserves for all”). Hybrid currencies could emerge by combining central bank and private sector participation (they will not be considered CBDCs if they are not a central bank liability).
A CBDC might lower transaction costs, increase financial inclusion, expedite domestic and cross-border payments, impact the effectiveness of monetary policy, facilitate direct fiscal transfers, and advance innovation through new services and features. However, there is no single design that can deliver all those benefits altogether. Some of those benefits could also be provided by alternative means of payments such as real-time gross settlement systems (RGTS), especially if they are enhanced with application programming interfaces (API) functionality and subject to more flexible regulation.
For advanced economies´ central banks, the main motivation to issue a retail CBDC lies in its utilization as a means of payment. The decline in the usage of cash could be dealt with by a CBDC in order to keep access to central bank money and preserve consumer welfare. Paradoxically, powerful network effects and competition among monies might eliminate alternatives whose utilization declines below a certain threshold and reduce consumer choice. In the same logic, CBDC interoperability will be essential to avoid digital fragmentation. For emerging markets, financial inclusion looks the top priority as they have a higher proportion of their population unbanked, even among those that have mobile devices or access to the internet. In October 2020, the Bahamas Central Bank launched the first national CBDC – the “Sand dollar” – to benefit from the lower cost of digital logistics relative to managing conventional cash in a land made of so many scattered islands. Countries heavily exposed to natural catastrophes may find that a CBDC gives them increased financial resilience.
Non-conventional monetary policy actions such as the implementation of deeply negative nominal interest rates or “helicopter money” transfers to the public could be better handled if a CBDC belongs in the central bank toolbox. “Programmable” monetary policy could implement transfers with an expiry date (a digital version of Gesell´s "stamped money” to penalize hoarding). Finally, a CBDC might anchor a payment system capable to function outside banks and so reduce the “too big to fail” problem. But CBDCs do not come without perils. They could trigger bank disintermediation and bank runs if not aptly designed. Currency substitution (digital "dollarization") and loss of control over monetary policy might happen as a cross-border effect. However, monetary policy will not be a central motivation for embarking on a CBDC.
Digital risks deserve paying attention. The G7 maintains that no global stablecoin project should begin operation until it adequately addresses relevant legal, regulatory, and oversight requirements and adheres to applicable standards. It supports the work of the FSB, FATF, CPMI, and other standard-setting bodies to analyze the risks associated with and determine appropriate policy responses. Perils come from multiple fronts. Cyber-security and operational resilience, legality and governance, data privacy and protection, consumer and investor protection, and financial integrity and tax compliance are strong issues. Many of these risks do not require a CBDC to mitigate them, but a more encompassing regulation and surveillance framework. Big Tech companies entering finance are far larger players than SIFIs deemed “too big to fail”, but operate with no (or weak) oversight. In the short term, central banks might choose between building a more sophisticated technological infrastructure or a more complex regulation, but with a longer time horizon, the digital era might transform the financial industry in ways that will require upgrading infrastructure as the best welfare-enhancing policy.
By mid-year, the Eurosystem will decide whether to launch a digital euro project, which would start with an investigation phase aimed at developing a minimum viable product. The digital euros could be
two: one to be used offline and another one that can be used online and remunerated at a rate that varies over time (that could feature advanced functionalities). Since March 2020, the Bank of England has launched a public consultation on the appropriate design of a CBDC. In Japan, the central bank is expected to start the first phase of experiments in April. A digital currency is under active Federal Reserve study, Governor Richard Clarida has said. And the list goes on.
Keep in mind that the decision to issue a CBDC or not will be rooted in domestic considerations. Nonetheless, it has strong potential international implications. So G7 countries are working in a coordinated way, but China has moved ahead of the pack following a carefully crafted independent path. The People´s Bank of China is a pioneer. In 2014 it started a special investigation group on digital currencies. In 2017 it announced its Digital Currency /Electronic Payment (DCEP) project. Its pilot was launched in four mainland cities in April 2020. The digital renminbi is a scalable legal tender fully backed by fiat reserves (M0 supply), with manageable anonymity and encryption features. Payments do not require holding a bank account or internet connection (transactions work online/offline). The DCEP is programmable, but deliberately does not add more functionalities than conventional M0. According to Zhou Xiaochuan, the former governor of the People´s Bank of China – it is focused on propelling the domestic retail system and preventing US dollarization within the country.
In the near future, digital currencies will complete cross-border transactions on a big scale without SWIFT and US correspondent banks, eroding US financial dominance. China created its Cross-Border Inter-Bank Payments System (CIPS) in 2015 to provide clearing and settlement services for international renminbi transactions and will develop an independent messaging system that does not utilize SWIFT. But it is not only China. The central banks of Canada and Singapore, and monetary authorities in Hong Kong and Thailand are testing bilateral payments in their respective currencies without intermediaries.
The digital era, with blockchain and decentralized ledgers, smart contracts, artificial intelligence, big data promise, and other innovations down the road promises a radical change in the financial architecture. It is not easy to tell in advance whether it will deliver. That notwithstanding, central banks might want to get their own digital tools ready as a call option, even if now they might be “out of the money”. The world is just in an early phase of development. To be premature is a mistake you can afford, but you do not want to be wrong and late.