Within a few years, retail central bank digital currency (CBDC) has morphed from an obscure fascination of technophiles and monetary theorists into a major preoccupation of central bankers. Pilot projects abound and research on the topic has exploded as private sector initiatives such as Libra/Diem have focused policymakers’ minds and taken the status quo option off the table.¹ 

In a new CEPR eBook (Niepelt 2021), academics and policymakers review what we know about the economic, legal, and political implications of CBDC, discuss current projects, and look ahead.

Download the eBook Central Bank Digital Currency: Considerations, Projects, Outlook here.

Considerations

The first part of the eBook focuses on specific aspects or implications of CBDC. Jonathan Chiu and Francisco Rivadeneyra discuss the consequences of CBDC for bank intermediation. They emphasise that CBDC might ‘crowd in’ rather than ‘crowd out’ bank intermediation, by disciplining banks in imperfectly competitive deposit markets; and that this effect may operate even without interest on CBDC. The authors note that bank deposits and CBDC would likely constitute imperfect substitutes and in a world with CBDC, banks might participate in the provision of CBDC-related services. They discuss channels through which this might moderate or exacerbate the impact of CBDC on bank profits.

Todd Keister and Cyril Monnet focus on information aspects of digital payment technologies. They explain how bundling, network effects, and consumers’ underinvestment in privacy give rise to market power on digital platforms and undermine risk-sharing. The authors argue that a CBDC that allows the purchaser’s identity to be hidden could help improve outcomes by giving consumers control over their data. In addition, CBDC would help preserve financial stability by providing useful aggregated payment information for central banks. They conclude that an appropriately designed CBDC would increase depositor confidence, rendering runs less likely.

Raphael Auer, Sebastian Doerr, Jon Frost, Leonardo Gambacorta, and Hyun Song Shin similarly emphasise the centrality of data in the context of digital payments. They emphasise that monetary authorities need to foster competition, ensure data privacy, and safeguard the integrity of the payment system. And they argue that CBDC can help attain these goals as long as it is integrated in a two-tier architecture, it is account-based, and it preserves an innovation friendly level playing field.

Corinne Zellweger-Gutknecht offers a legal perspective. Placing central bank money in its historic context, she argues that the mandate of central banks to issue cash implies a right – and a duty – to also issue CBDC as a digital equivalent and complement to notes and coins if declining cash circulation made such a complement necessary. She emphasises that the situation is different for CBDC as a monetary policy tool, as the introduction of CBDC with functionality beyond the one of cash would require a change of law.

Dirk Niepelt emphasises political risks. He argues that central banks can neutralize the effects of CBDC on bank balance sheets, funding costs, credit, and investment, but that political pressure may lead them to act differently. He estimates the increase in funding costs that banks might suffer in a (for them) worst-case scenario to be on the order of half a percent of GDP, and he cautions that CBDC might lead to further politicisation of banking and central banking. He also discusses other political risks in connection with the introduction of ‘Reserves for All’.

Linda Schilling, Jesús Fernández-Villaverde, and Harald Uhlig consider possible implications of CBDC for price stability. They argue that central banks can be subject to ‘spending runs’ where fear of inflation motivates consumers to spend (central bank) money, rendering the fear self-fulfilling. They emphasise that this run risk creates a trilemma if the central bank also engages in maturity transformation: while the threat of central bank induced inflation can deter runs, the goals of price stability, absence of spending runs, and maturity transformation cannot be reconciled. The authors also discuss time inconsistency problems and warn of dangers for central bank independence.

Antonio Fatás questions the transformative role of CBDC. He identifies two types of CBDC benefits: one from publicly providing a robust pillar of the monetary system, and the other from supplying an accessible, efficient, and resilient alternative to private digital money. He argues that account based CBDC could provide the monetary anchor, realising the first benefit, while inclusiveness, efficiency, and resiliency goals would be hard to reconcile due to conflicting implications for payment infrastructures or public-private-partnerships. He concludes that “CBDC is in no way a substitute for the needed reforms to the architecture of payments”.

Similarly, Stephen Cecchetti and Kermit Schoenholtz call for the policy objectives to be clarified. While acknowledging various potential benefits of CBDC, they caution that these benefits come with risks, especially when government institutions are weak. The authors emphasise that it is not sufficient for CBDC to generate positive net gains; after all, alternatives to CBDC may realsze the same benefits at lower cost. Accordingly, they conclude that such alternatives need to be assessed more carefully.

Markus Brunnermeier and Jonathan Payne focus on the bundling of money creation and financial services. They argue that CBDC could impair the synergies and valuable incentive effects of bundling deposit (money) creation and bank lending in today’s financial system. And they explain how CBDC as legal tender could undermine the commitment benefits of bundling FinTech token creation and smart contracts, at least in some markets. The authors caution that the implications of CBDC for financial market structure deserve careful attention.

Tobias Adrian and Tommaso Mancini-Griffoli offer an international perspective. They anticipate CBDC benefits from greater efficiency and resiliency of payment systems, financial inclusion, and smoother cross-border payments. They also anticipate risks due to bank disintermediation, central bank reputation loss, and ‘dollarisation’. The authors discuss measures to limit these risks and emphasise the need for a rules-based international monetary system that avoids a ‘digital divide’ between countries.

In the final chapter of the first part, Quentin Vandeweyer considers stablecoins as potential alternatives for CBDC. He notes three policy positions on stablecoins, which emphasise financial stability risks, innovation, and complementarities with CBDC; and he compares the contemporary debate about cash-reserve assets versus crypto-collateralised or algorithmic stablecoins with the debate about bank notes two centuries ago. Vandeweyer discusses the role of a two-tier CBDC in broadening access to central bank liquidity and concludes that stablecoins are here to stay but that an overhaul of the regulatory framework may be needed to fully realise their potential.

Projects

The second part of the eBook focuses on projects. Jonathan Chiu and Francisco Rivadeneyra report on the Canadian case. They explain how the Bank of Canada’s contingency plan builds on the question of what role publicly provided money should play, and how this role can be inferred from the multiple contemporary functions of cash. Against this background, they systematically assess the opportunities and risks of CBDC and point to open questions. They conclude that the “decision to issue a CBDC belongs ultimately to Canadians and their elected representatives”.

Martin Flodén and Björn Segendorf offer a Swedish perspective. They argue that the convertibility of privately issued krona into base money could soon be called into question, due to declining cash use; the digital payments landscape might lower the threshold for currency substitution and increase fragility; and the marginalisation of cash could undermine credibility. They describe the Riksbank’s responses as well as scenarios for the future, including building a national financial market infrastructure and giving FinTechs direct access to it. Like Chiu and Rivadeneyra, Flodén and Segendorf emphasise the need to involve decision makers outside of the central bank.

Katrin Assenmacher and Ulrich Bindseil report from Frankfurt. They describe motivations for and possible consequences of CBDC, with regards to both the payment system and macroeconomic stability. They argue that the design of a digital euro would entail a trade-off between usability for end-users on the one hand, and system wide stability on the other. And they predict that a digital euro would only be introduced if policymakers were highly confident about their ability to manage possible risks.

Three chapters focus on the US case. Christopher Waller questions the usefulness of a CBDC. He argues that cash will not disappear soon; the payment system works well; financial inclusion does not require CBDC; private sector initiatives such as stablecoins could suffice to compress bank markups; and CBDC need not spur innovation, deter the use of crypto-assets, or help the US preserve dollar supremacy, while it could generate new types of risk. He concludes that absent a clear market failure the government should not compete with private sector financial service providers.

David Andolfatto shares Waller’s scepticism, but he discounts fears that CBDC might disintermediate banks or promote runs. He cautions that adoption of CBDC should not be taken for granted and even if adoption were widespread, efficient cross-border payments would still require international cooperation. He also emphasises the market power of credit card companies and banks, but concludes that the most promising way forward may not be the introduction of CBDC but rather to promote entry, for instance by granting ‘narrow bank charters’ to new financial services providers.

Darrell Duffie emphasises bank market power and problems in the US payment system. He argues that a public–private CBDC pilot would generate benefits (even if Congress eventually decided against deployment) in the form of learning by doing, technological spillovers, competition, and US participation in international discussions. Among the main challenges of CBDC, he identifies the trade-off between privacy and enforced legality of payments; the threat of government stifling innovation; and operational risks, but not disintermediation or runs. Like Waller and Andolfatto, Duffie rejects international currency competition as a convincing motive for a digital dollar.

Andréa Maechler and Andreas Wehrli discuss the role of wholesale rather than retail central bank digital currency. They argue that securing the safety and integrity of payments in a DLT-based financial architecture requires a suitable integration of central bank money rather than stablecoins or other private payment instruments. The authors report on two approaches currently being tested in Switzerland: one building on the existing real-time gross settlement system, and the other using wholesale central bank digital currency.

Raphael Auer, Giulio Cornelli and Jon Frost conclude the second part of the eBook with an overview of ongoing CBDC projects. They report that most central banks view CBDC as a complement to – not a substitute for – cash that they would deploy relying on public–private partnerships rather than by directly engaging with retail users. The authors also report that there is less agreement concerning the importance of improved cross-border payments or the advantages of account-based versus token-based CBDC models, while most central banks agree in rejecting architectures based on permissionless DLT.

Outlook

Several contributors to the eBook also offered predictions. Most, but far from all, expect that a CBDC in a developed economy would resemble deposits in terms of user experience. But there is disagreement as to whether digital currencies would be interest-bearing and how strictly they would protect privacy. Almost everyone expects that private banks and service providers rather than the central bank would interact with end-users.

Many authors view CBDCs as potential threats to monetary sovereignty in emerging economies, depending on international cooperation as well as on CBDC design choices, for instance with respect to know-your-customer regulation or holding restrictions for foreigners. There is disagreement on whether the introduction of CBDCs would undermine the political support for cash.

Several authors fear that in the absence of CBDC, declining cash circulation could undermine trust in central bank money. They caution, however, that such an effect would only arise in the limit, once cash really disappears, and that price stability remains an equally or more important determinant of trust.

Conclusion

While consensus on the ‘right’ CBDC choices remains elusive, common perspectives are beginning to emerge. First, money, banking and payments are ripe for upheaval, with or without CBDC. Second, the key risk of CBDC is unlikely to be bank disintermediation – privacy, politics, and information may be more critical. Third, the use case for CBDC must be clarified, country by country; it may not exist, because of alternative, better solutions for the existing problems. And fourth, as the implications of CBDC go far beyond the remit of central banks, parliaments and voters should have the final say.