- Principles of introduction of digital currency
- Benefits of implementing digital currency
- Risks of introducing digital currencies
- Power to the state
The Bank of Canada, European Central Bank, Bank of Japan, Sveriges Riksbank, Swiss National Bank, Bank of England, Board of Governors of the Federal Reserve System and Bank for International Settlements jointly produced a report outlining the general foundational principles and core features of a “general purpose” central bank digital currency, CBDC. These principles emphasize that certain criteria must be met before any jurisdiction can consider proceeding to a CBDC. In particular, authorities must first be certain that the issuance will not jeopardize monetary or financial stability and that the CBDC can coexist with and complement existing forms of money, fostering innovation and efficiency.
It looks like the US Federal Reserve and central banks in other countries will introduce CBDCs (central bank digital currencies) in the near future. With the support of the Bank for International Settlements, 105 countries accounting for more than 95% of global GDP, including the US, the European Union and China, are testing or actively considering digital currencies.
Although the details are not yet clear, the technology of CBDCs is likely to be similar to bitcoin and other cryptocurrencies, but have certain significant differences:
- CBDCs will be a central bank bond, basically digital cash, completely backed by the government.
- The value will be pegged to the national currency, compared to cryptocurrencies, the price of which depends solely on supply and demand.
- The CBDC would function identically to paper money and allow for usual payments and fulfilling financial or commercial obligations.
- The sole difference from cash would be the absence of accounts and the ability to physically transfer, because the CBDCs would be based on electronic transactions, which would be similar to the traditional transfers of funds through banks. Although it would be voluntary initially, it could easily be made mandatory.
All arguments in favor of CBDC, as with banning cash, are based on increasing efficiency. At the same time, since most advanced economies already implement efficient transfer systems, and most payments are already electronic, it is not clear what additional benefits will come from the introduction of digital currency.
The main argument is the speed and cost of transactions. Current payment systems, particularly cross-border ones, are slow and expensive; improved interoperability and digital currency clearing systems will provide efficient solutions.
CBDCs might also provide additional benefits such as fighting crime and terrorism, supporting the legal economy by reducing shadow transactions, fighting tax evasion, decreasing the cost of printing money, and even preventing exposure to bacteria and virus carriers through banknotes.
At the same time CBDCs also pose new problems. If depositors give up on bank deposits, funding for the banking system could decrease, interfering with the flow of credit. This could increase the likelihood of bank failures (if investors abandon deposits in favor of CBDCs) during periods of financial instability. These risks would require complex measures, such as permanent or temporary restrictions on transfers to central bank accounts and deposit withdrawals. Such workarounds would detract from the core idea and fragment the payments system.
Central banks also run the risk of losing income from senorage (income from issuing currency at less than its face value or income from securities financed by money creation). For example, annual income from senorage in the US is estimated to be around 20 to 25 billion US dollars (or 0.1% of GDP).
Like all restrictions on the use of cash, CBDCs are designed to enhance the power of the state:
- CBDCs would reduce anonymity and confidentiality, allowing the state to monitor spending habits and also the behavior of citizens, because of the full traceability of CBDCs.
- Negative rates (which have been widely used in Europe and Japan in the last ten years) can be avoided by holding cash. Substituting cash by CBDCs allows central banks to track assets and charge negative interest rates for their digital currencies.
- Central banks can promote consumption by setting time limits on digital currencies, when they must be spent or lost forever. This can direct spending to certain areas through incentives or penalties.
Like with all electronic transactions, there are familiar cybersecurity issues and disruptions due to technology or power failures.
The actual motives behind CBDC are complex. Governments fear the loss of a monopoly on currency creation, monetary control, and lagging behind the demands of emerging markets, effectively ceding control to private interests. Central banks are also aware that they are not seen as an obstacle to “innovations”.