Interview
What’s Next for Central Bank Digital Currencies
- A Central Bank Digital Currency (CBDC) is a digital liability of the central bank denominated in sovereign currency, distinct from cryptocurrencies, cash, and central bank reserves.
- The design spectrum for CBDCs includes account-based vs. token-based models, varying levels of anonymity, interest-bearing vs. non-interest-bearing structures, and offline payment capabilities.
- Central banks are accelerating CBDC projects primarily to crowd out private digital currency alternatives that could pose financial stability risks.
- As of the report, two countries have launched CBDCs for public use, approximately 20 are conducting pilot projects, and many others are in major research phases.
- Current global design trends favor hybrid models intermediated by commercial banks rather than direct central bank access for the public.
- Most active projects utilize distributed ledger technology or centralized clearing systems, do not pay interest, and allow small-scale offline transactions.
- Proposed benefits of CBDCs include faster/cheaper payments, reduced crime and cash handling costs, financial inclusion, and strengthened monetary/fiscal policy.
- Skepticism regarding these benefits stems from the fact that traditional methods, such as subsidized bank accounts or the upcoming FedNow real-time payment system (expected 2023), can achieve similar outcomes.
- Many claimed benefits require a "radical" CBDC version that exceeds current central bank plans, such as the complete phase-out of cash.
- Emerging economy central banks prioritize financial inclusion and preventing monopolies by dominant private payment apps.
- Advanced economy central banks, including the Fed, focus on payment system safety, robustness, and future scalability to handle increased transaction volumes or micropayments.
- A primary risk for central banks is the potential for CBDCs to facilitate criminal activity through enhanced anonymity and stability compared to current cash or crypto.
- To mitigate crime risks, central banks are moving away from full anonymity, imposing caps on anonymous transactions, and tasking intermediaries with transaction monitoring.
- A second major risk is the disintermediation of commercial banks if the CBDC becomes too attractive, threatening the bank deposit base essential for financial stability.
- Strategies to prevent bank disintermediation include placing caps on CBDC holdings, applying penalty interest rates, or choosing not to pay interest on CBDCs.
- Alternative solutions involve recycling CBDC funds back to banks via auctions or providing central bank funding to intermediaries proportional to customer CBDC holdings.
- A more creative approach could allow commercial banks to set CBDC interest rates, with the central bank lending to them at that rate plus a risk premium.
- Central banks are generally more open to using CBDCs to disrupt incumbent payment networks (e.g., credit card companies) to lower fees and foster competition.
- Incumbent credit card networks retain advantages regarding widespread acceptance, established fraud detection investments, and consumer brand rewards.
- Reducing barriers for new competitors could be achieved by granting access to Fed clearing and having the CBDC platform absorb fixed costs like fraud detection.
- Initial "version 1.0" CBDCs are expected to be conservative with modest impacts on monetary and fiscal policy to minimize financial system disruption.
- Simple CBDCs could enable instantaneous fiscal stimulus distribution, though current FedNow infrastructure combined with Treasury data access could achieve similar results.
- A radical CBDC could allow policymakers to program variable tax rates or real-time interest rates based on economic data, potentially automating policy responses.
- While a radical CBDC could provide real-time economic data and variable interest rate tools, initial versions will likely not offer these advanced capabilities.