Is central bank digital currency the future?

In recent weeks the media focus on central bank digital currencies has become quite intense as many of the world’s central banks including ECB, BoE and BoJ all stated that they are exploring the possible uses of this technology. So what are the pros and cons and policy implications of CBDCs?

What is CBDC?

Central bank digital currencies are simply digital versions of legal tender of the central bank of each country. The immediate benefits are obvious. Cash in the form of paper money and coin is onerous to produce, count and maintain. In the advanced industrialized world where almost all economic transactions take place digitally cash is quickly becoming obsolete already.

Cash is inefficient

A move towards CBDC would eliminate the need for cash and would allow millions of unbanked citizens to have a safe, secure store of value. At a time when the vast majority of the population in the OECD world possesses a smartphone, the issuance of CBDC would be relatively easy to implement.

The use of CBDC eliminates anonymity

However, the idea of a digital currency is not without its downsides – the most serious one being the loss of anonymity. CBDC would be fully trackable which would allow the government to have unprecedented access to every citizen’s transaction history. One could make an argument that in the current environment where the vast majority of all economic transactions are digital already, such unfettered access already exists. However, the issuance of CBDC would formalize this ability to track every economic transaction and furthermore would effectively eliminate the choice of anonymity that cash currently offers.

CBDC provides a dizzying array of new policy choices

From a policy perspective the prospect of a CBDC provides almost a dizzying array of policy choices to monetary and fiscal authorities. First and foremost, the creation of digital tender would allow for much greater control and oversight over economic transactions and would eliminate almost all illegal and grey market transactions allowing for much more precise combat of criminal activity as well as much more efficient tax collection.

The move towards CBDC would also allow for policy actions that are simply not possible now such as negative interest rates on cash balances and perhaps the most radical notion of all the ability to put an expiration date on the currency itself. Such possible policy initiatives would allow for much greater behavioral control at the consumer level and could be used to encourage or discourage spending, thus providing much greater granulary over demand and supply in the economy. The leader in the CBDC space is the central Bank of China which has been experimenting with digital yuan in Beijing and Shanghai and plans to expand the pilot program to other jurisdictions. In China, where 87% of all payments are already settled via smartphones, the move towards digital currency should be relatively easy to implement and in a highly centralized society it will offer the government near complete control over their citizens’ economic lives.

CBDC – a matter of when not if

In the OECD world of democratic societies such absolute control over the ability to manipulate legal tender is likely to be resisted and central banks will likely have to adhere to some modicum of privacy regulation so that citizens are able to exercise some degree of autonomy over their financial assets.

Still the technological and policy implications of CBDC are simply too powerful for authorities to ignore and may even endanger the competitive stance of western economies if the technology is not quickly adapted. This is the reason why so many western central banks are now studying the idea and why adoption of the CBDC will become the norm in the decade to come.