What If a Central Bank Issues Its Own Digital Currency?
A central bank could issue its own digital currency, commonly called a Central Bank Digital Currency (CBDC). A number of central banks have been exploring or implementing CBDCs, as noted in Auer, Cornelli, and Frost (2020).
A CBDC could have several advantages over stablecoins; one is safety. In contrast to a stablecoin, which is the liability of a private institution, a CBDC would be the liability of a central bank. Nevertheless, a stablecoin that is fully backed by balances in a central bank account would be (almost) as safe as a CBDC. Another advantage of a CBDC is that it can be designed to meet public policy objectives. For instance, a Central Bank Digital Currency (CBDC) could offer features that ensure equal access to citizens, facilitate direct payments from the government, or provide heightened privacy protection.
Despite the advantages, a central bank digital currency also has some serious risks for the economy and the financial system. If regular people can create accounts directly with the central bank, that could undermine the existing commercial banking system. Depending on how the electronic money is designed, it could be exploited by money launderers and hackers. If the government fails to protect the system from outages and cyber attacks, people could lose confidence in the lender of last resort. And more importantly, many detractors of central bank digital currencies say that as the digital assets are created by a central body, this introduces the possibility of people being “non-personed” by a bank or government.
Even so, a number of experts think central bank digital money has promise, and is likely inevitable. “The US strength in the international payments and financial services space is an American treasure that has tremendously benefited the country,” wrote Robert Baldwin, head of policy at the Association for Digital Asset Markets, in his testimony to the House Financial Services Committee. “The US must continue to innovate in this space so that it does not fall behind to pressure from international competition and digitization.”
China is among the furthest along in piloting a digital currency
China is among the furthest along in piloting a digital currency, giving the world’s second largest economy the opportunity to be the leader and standard setter for this critical digital infrastructure.
Yaya Fanusie, adjunct senior fellow at the Center for a New American Security, noted that China plays an influential role at the Bank for International Settlements, which is set to lead deliberations over central bank digital currency standards. Those standards could end up benefitting China’s goals and interests instead of the US’s. “The United States will need to increase its CBDC expertise and assert greater influence in the BIS and other international forums that guide CBDC development,” Fanusie testified.
It would also, however, open up the possibility to use the CBDC to back a stablecoin instead of government securities or bank deposits. Why would a private entity want to back a stablecoin with a Central Bank Digital Currency (CBDC)? One reason is that the stablecoin would be safer to end-users and thus more attractive than those backed with other assets.
Why attempt to compete with the Central Bank Digital Currency (CBDC)? A company might believe that it can build a more convenient and innovative form of money than the one available from the central bank. Central banks do not have a lot of experience developing and updating mass market products or interacting with retail consumers. By contrast, competition between private sector entities has spurred the availability of a vast array of convenient consumer products.
Central banks can support the development of digital currencies indirectly, by supporting the public provision of safe, privately issued digital currencies, or more directly, by issuing digital currencies themselves, among other possibilities. These approaches are not necessarily mutually exclusive, especially if there are separate reasons to issue a Central Bank Digital Currency (CBDC). In that case, central banks may need to think about how private sector entities could use the CBDC to support the development of their own stablecoins.
However, it is important to note that the very reason that many people are interested in cryptocurrency in the first place is that it is removed from centralised governance, and particularly out of the reach of authorities, thus providing a degree of privacy and security for it’s users, and with this in mind, it’s clear that the CBDC argument is going to continue to rage for some time.