CBDCs are a new form of digital cash intended to serve as a substitute for physical cash. They will be a liability of the central bank, which will maintain them in a centralized ledger. CBDCs should not be confused with cryptocurrencies, which either are pegged to an underlying asset or backed by a public blockchain.
Cryptocurrencies are not a viable form of digital cash for payments on a large scale, given the high computational and energy intensity of the validation process using distributed ledger technologies. However, they will continue to perform other functions. For instance, investors may perceive that cryptocurrencies can be a store of value (akin to precious metals) to hedge against the effects of central banks’ aggressive monetary easing.
Efforts to introduce CBDCs are gaining momentum, with as many as 86% of the world’s central banks exploring digital currencies. China has launched pilot trials in a number of cities, the ECB recently concluded a public consultation on a digital euro and will make a decision this summer, and the Boston Fed is set to release its initial research in the fall.
What explains this sudden concerted interest? We see three main reasons:
- Monetary sovereignty: Private payment networks have proliferated rapidly. As they gain market share, these networks can become the primary means of transaction for many users. The central banks’ concern is that money will circulate almost exclusively within the networks, posing a threat to central bank control of the monetary system.
- Financial stability: Any potential failure by a private provider of digital money could disrupt the payment system and lead to financial stability risks. While regulators have taken steps to mitigate these risks, they cannot eliminate them. In contrast, the central bank both creates and holds a CBDC, hence will be able to guarantee its reliability as a medium of exchange for transactions.
- Financial inclusion: The rise of private, narrow money networks risks excluding segments of the general public, e.g., the unbanked population. A CBDC, just like physical cash, can be made broadly available and may even foster greater financial inclusion.
With these objectives in mind, we think that central banks will implement consumer-facing retail digital currencies, accessible to the public through financial intermediaries and running on a centralized ledger system controlled by monetary authorities.