The Case for Central Bank Digital Currencies: Why it could soon be time to go bold.

• Author: Dombret, Andreas

The last dozen years have seen the emergence of digital currencies, starting with Bitcoin in 2009, a highly speculative asset with some currency characteristics that is privately issued and not connected to any central bank or government-issued currency. This was followed by Libra, invented and de facto controlled by one of the largest tech companies, which aimed at merging the advantages of being based on existing official currencies with the advantages offered by technology ("stablecoin"). More recently, several central banks are contemplating or already experimenting with issuing a digital currency themselves--a central bank digital currency, or CBDC--that would complement "account-based money" which exists as central bank money (physical cash issued by and reserves with the central banks) and private money (deposits at private credit institutions).

Pervasive digitization has reduced the leverage policymakers have over the choices made by economic agents about which currency they use, particularly in countries with less robust institutions and less stable currencies. While it is difficult to predict exactly what role digital currencies will play, it is quite certain that significant shifts will happen. Policymakers will want to ensure that the official monetary system is the most attractive one.

CBDCs might be a possible avenue for safeguarding the "public good" features of a monetary system brought to the broader economy. Especially in the retail area, these experiments are still in their early stages. More policy and technical work needs to be done, although many central banks have still not determined whether they will roll out CBDCs at all.

Taking a long-term view, here is an outline of what might be achieved in the next few years. We explain why central banks should go bold on CBDCs in the long term, as such an approach is the only one that will allow CBDCs to become viable, in particular as alternatives to physical cash and as co-existing alternatives to deposit money.

THE END OF PHYSICAL CASH?

The concept of money emerged several thousand years ago. From the beginning, money provided three basic functions: a unit of account, a means of transaction, and a store of value. An important reason for something to be called money or currency was that a particular type of money was accepted by convention, custom, or law as a means to account for and settle claims--legal tender.

Different kinds of specie were used: coins made of precious metal, paper money, or exotic items such as shells. They all have in common that they are scarce, either by natural constraints (the availability of precious metals), technology (security features of banknotes), and/or through legal safeguards, such as the monopoly to issue coins and notes protected by criminal law and the enforcement power of a government.

Reliance on the laws of physics comes with an important inconvenience. Cash has to be physically moved and stored. This is logistically expensive and comes with security risks. It is for this reason that in Europe the first banks emerged in mediaeval times as trans-European trade intensified. Merchants like the Fugger family, needing to pay for goods at a distance, branched out into banking, where moving around physical money is replaced by moving claims on money around with a stroke of a pen, or today through computers.

Deposit money comes with many advantages. From a macroeconomic perspective, it provides the means of money creation to private sector banks that did not issue base money in the first place, by way of leveraging and providing credit. The issuer of base money, today the central bank, can rely on a widespread banking system to contribute to money creation while itself determining the right amount and the conditions for credit. Practicality and convenience count.

For consumers, stocking the right amount of cash at the bank counter or the ATM and paying physically at the baker or the butcher shop is not convenient, which explains economies moving away from cash for daily use as soon as electronic alternatives became available. The financial system benefits because providing credit, deposit, and payment services is lucrative, albeit less so recently. And governments enjoy the universal traceability of non-cash transactions in enforcing tax or antimoney-laundering laws. Due to all of these factors, today the value of physical cash in circulation is marginal compared to the value of deposit money.

The advent of cryptocurrency leads to a new equilibrium. The laws of physics and rules that used to provide for scarcity and non-duplication are replaced by the laws of mathematics that ensure the same, however without the inconvenience that comes with physical goods.

In recent years, digitization has become pervasive, and in such a world, physical cash becomes anachronistic. Still, physical cash for now stays around for several reasons. First, the world has not yet arrived at broadly accepted alternatives...