18 February 2022

ECB's Panetta: Central bank digital currencies: defining the problems, designing the solutions

I will argue that in a digital world CBDCs are necessary to preserve the role of central bank money as a stabilising force at the heart of the payments system and to safeguard monetary sovereignty.

It is a great pleasure to take part in this panel on central bank digital currencies (CBDCs).

Throughout history, money and payments have been constantly evolving. And this also holds true in the digital age. As we increasingly pay digitally and shop online, we rely less on cash. Our wallets are gradually moving from our pockets to smartphones and other electronic devices.

These changes have profound implications for the nature of money itself, raising the question of whether central banks should issue digital currencies for retail use.

Today I will argue that in a digital world CBDCs are necessary to preserve the role of central bank money as a stabilising force at the heart of the payments system and to safeguard monetary sovereignty.

But CBDCs will need to be carefully designed. To be successful, they will need to add value for users, support competition rather than crowd out private innovation, and avoid risks to financial intermediation.

Why we need central bank digital money

Our monetary system is based on the complementarity of private money with public money – which is available for retail payments in the form of banknotes.^[1]

Confidence in private means of payment is determined by our ability to convert private money into safe public money. This is because central bank money is a risk-free form of money that is guaranteed by the State: by its strength, its credibility, its authority.

Other types of money are liabilities of private issuers: their value is based on the soundness of the issuer and is underpinned by the promise of one-to-one convertibility with central bank money.^[2] Our readiness to hold private money such as bank deposits reflects the confidence that we can always go to a branch or a cash machine and convert our deposits into cash. The fact that we can do this tells us that our deposits are safe. It reassures us that we will be able to convert them into risk-free central bank money in the future, too.

Bank runs and financial crises start when confidence in the convertibility of private money evaporates.^[3] Without the anchor of sovereign money, people would constantly have to monitor the soundness of private issuers in order to assess the value of each form of private money. This would undermine confidence in the singleness of money and impair the functioning of the payments system.^[4]

History provides examples for this. In times when various forms of private money coexisted in the absence of sovereign money – such as the free banking era of the 19th century – the notes issued by banks often traded at variable prices^[5] and instability risks^[6] required dominant banks and clearinghouses to act as quasi-central banks^[7].

The consensus among central banks on the coexistence between public and private money was summarised 20 years ago as follows: “The composite of central and commercial bank money, convertible at par, is essential to the safety and efficiency of the financial system and should remain the basis of the singleness of the currency. In other words, central banks would accept neither an outcome in which central bank money crowds out private initiative, nor an outcome in which central bank money is phased out by a market mechanism.”^[8]

In the digital age, however, banknotes could lose their role as a reference value in payments, undermining the integrity of the monetary system.^[9] Central banks must therefore consider how to ensure that their money can remain a payments anchor in a digital world.

Some have suggested that innovative private payment solutions such as stablecoins could, if properly regulated, make CBDCs superfluous.^[10] However, confidence in stablecoins would also depend on the ability to convert them into central bank money,^[11] unless stablecoin issuers were allowed to invest the reserve assets in risk-free deposits at the central bank. But this would be tantamount to outsourcing the provision of central bank money, which would endanger monetary sovereignty.^[12] Moreover, in the absence of public money, stablecoins could exacerbate the “winner-takes-all” dynamics inherent in payment markets, with adverse consequences for the functioning of the payments system.^[13] And stablecoins’ potentially large investments in safe assets could affect the availability of these assets.^[14] This could in turn have an impact on market functioning and real interest rates, with undesirable implications from a monetary policy perspective.^[15]

Other threats to monetary sovereignty could emerge in the absence of a domestic digital currency.

If a foreign CBDC were to be widely adopted, this could lead to digital currency substitution^[16]. This risk would be higher for small countries with unstable currencies and weak fundamentals, especially if the CBDC were issued in a major economy.^[17] But it could eventually also affect leading currencies.^[...18]

^{more at E}CB

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