A Staff Discussion Paper – Central Bank Digital Currencies: A Framework for Assessing Why and How – from the Bank of Canada raises a number of important questions concerning the role a Central Bank may play with regards to Digital Currencies.
Digital currencies have attracted strong interest in recent years and have the potential to become widely adopted for use in making payments.
Whilst public authorities and central banks around the world are closely monitoring developments in digital currencies and studying their implications for the economy, the financial system and central banks, one key policy question for public authorities such as a central bank is whether or not to issue its own digital currency that can be used by the general public to make payments. They suggest three public policy arguments for why a central bank might do this.
First, a central bank may explore whether issuing a central bank digital currency (CBDC) would improve the efficiency of its currency function. For example, as the sole issuer of bank notes in Canada, the Bank of Canada supplies bank notes that Canadians can use with confidence. In carrying out this function, the Bank is responsible for the design, production, distribution and destruction of bank notes. As such, the Bank is constantly exploring ways to improve the efficiency of currency operation and reduce the cost of cash handling. The evolution from paper bank notes to polymer bank notes—both in Canada and elsewhere—has improved the efficiency of the currency function and enhanced bank note security and durability. Going forward, it is important for a central bank to examine if it would further improve efficiency and security by issuing future generations of bank notes in digital form, taking advantage of the latest technological advances.
Second, a CBDC could improve the efficiency and safety of both retail and large-value payment systems. On the retail side, the focus is on how a digital currency can improve the efficiency of making payments—for example, at the point of sale (POS), online and peer-to-peer (P2P). There could also be benefits of having a CBDC for wholesale and interbank payments; for example, it could facilitate faster settlement and extended settlement hours.
Third, a CBDC could be an appropriate policy response to payment innovations such as privately issued e-money and digital currency that might impair the central bank’s ability to achieve its monetary policy goals and to implement policies promoting financial stability. For instance, widely adopted private cryptocurrencies could severely weaken the transmission of monetary policy and also restrict the ability of the central bank to act as the lender of last resort. Moreover, it has been suggested that replacing physical bank notes with a CBDC would remove the effective lower bound on policy interest rates, permitting the central bank to implement negative policy interest rates if that were warranted by economic circumstances.
If private digital currencies become broadly adopted, one of the main concerns is related to the safety of these systems. If privately issued digital currencies are used mainly for making retail payments, they do not necessarily pose any systemic risk to the financial system. Nevertheless, the failure of a major private digital currency scheme could potentially result in significant financial losses to users, a loss of confidence in these schemes, a disruption of retail payments and even considerable adverse economic effects. In addition, there could be a reputational risk for the regulators—including the central bank—who are seen as being responsible for oversight of the payment systems to ensure their safety. In that case, central banks and other public authorities would need to assess whether the existing oversight framework is adequate to address these concerns, and to improve the framework as required. Looking forward, if the risks related to digital currencies were to increase in a scenario where these digital currencies have become widely adopted and therefore the risks to the system have become more significant, the best course of action for central banks and public authorities would be to consider subjecting digital currencies to oversight. In this case, it is not necessary for a central bank to consider issuing its own digital currency.
Therefore, as far as the retail payment system is concerned, one possible reason for public authorities such as a central bank to issue a digital currency would be to promote efficiency.
A new payment system would be more efficient than existing alternatives if the social benefits from its introduction outweighed the social costs. Besides technological and economic factors affecting the costs and benefits, improvements—such as increasing protection of private data and providing easy access to new payment methods—would also enhance the benefits of these systems for customers and therefore the efficiency of the payment system overall.
As discussed above, it is in the context of efficiency that we discuss whether a central bank should issue its own digital currency. We propose a general framework to study this complex question.
1. Would a digital currency improve efficiency?
The first key question is whether a digital currency could improve the efficiency of payment systems in the first place. If not, there is really no need for a central bank to consider issuing a digital currency.2. Would privately issued digital currencies provide such efficiency improvements without government intervention?
Even if a digital currency could improve efficiency, another key question that a central bank needs to answer is whether the provision of such a currency could be left to the market. In other words, it is necessary to assess whether the private sector is likely to arrive at an efficient outcome without government intervention.Clearly, there are already a number of privately provided digital currencies today, such as Bitcoin and other cryptocurrencies. The real question is whether these digital currencies improve social efficiency to the full extent of what is technologically possible, and whether these digital currencies are broadly adopted by users. If both questions are answered with “yes,” then there is no need for a CBDC in the context of improving efficiency of the retail payment system. Nevertheless, there may still be a potential role for the central bank or government to establish rules and regulations and to monitor compliance. Rules and regulations would protect the safety of these systems. However, there would be no need for the central bank to issue digital currency directly.
Note: Bank of Canada staff discussion papers are completed staff research studies on a wide variety of subjects relevant to central bank policy,
produced independently from the Bank’s Governing Council. This research may support or challenge prevailing policy orthodoxy. Therefore, the
views expressed in this paper are solely those of the authors and may differ from official Bank of Canada views. No responsibility for them
should be attributed to the Bank.
