Central banks meet digital currencies

Last year when the Swedish Central Bank published a survey^[1] on payment patterns among the population, it showed that the usage of cash is decreasing while digital payment services like Swish^[2] are rapidly increasing whereas debit/credit cards remain the most popular form of payment. Furthermore, by looking at the age of the users, the Riksbank noticed that younger generations have rapidly adopted digital payment solutions as their main form of payment. This together with the fact that more and more shops in urban areas aren’t accepting cash anymore^[3], shows us a clear trend for the future; the digitalization of money.

Traditional cash is printed and guaranteed by the central bank of its respective country and therefore fulfills a central stabilizing role in our modern economy. But with its usage rapidly declining, one question instantly arises. What happens when agents can’t withdraw cash (or pay with it) when they lose confidence in the whole banking system (i.e. during a financial crisis)? What safety nets will there be?

Those questions are increasingly being addressed by different central banks and scholars. Sweden plans the introduction of an “E-Krona” and the Bank of England is conducting research on the introduction of a similar solution; a central bank digital currency (CBDC). Other central banks like the SNB are more careful in their approach.

What will those new currencies look like then? Most certainly not like Bitcoin as its decentralized nature^[4] contradicts the central control that is governing cash supply or price. Take Sweden, the Riksbank is planning one of the two following solutions: allow private entities to open accounts at the central bank or emit tokens held within a card or an app^[5] by the user. A study^[6] published on the topic by the Bank of England described the key characteristics of such a system. It would have to be highly resilient (i.e. less than 5 minutes of downtime per year), secure against cyber-attacks, private (but not anonymous), instantly settling payments, interoperable with other CBDC’s, future-proof and interest bearing. These high standards will have to be entirely met as it might be the most important innovation since bank notes.

A CBDC accessible by all would have a major impact on how we pay and just like all reforms, it comes with its share of advantages and drawbacks. A digital currency issued by the central bank means a more direct impact of monetary policies than with the two-tier system we have today. Additionally, it would have a countercyclical effect as agents would prefer this currency over other assets in bad times. Furthermore, it would take back the sovereignty of the State over payment methods instead of relying on foreign credit card companies^[7]. Finally, it is also estimated that crime, money laundering and fiscal evasion will be sharply reduced as your transactions will no longer be anonymous and the State will be able to know who owns which unit of CBDC.

While some of those advantages seam appealing it is also necessary to consider the drawbacks of such a system. It will be more vulnerable to tampering and shutdowns than cash (think of wars or natural disasters that would shut down the “currency” of a whole country). Introducing an e-currency would also mean giving up a certain degree of privacy as the State would know your transaction history.

To conclude, while the technology and the implementation of CBDC’s are still in their early stages it is important for businesses, legislators and ultimately citizens to understand the path that is being laid out by central banks regarding the future of money in a digital world.

Bernhard Bieri