12/01/2021 | News release | Distributed by Public on 12/01/2021 06:20
Raphael Auer, Jon Frost, Michael Lee, Antoine Martin, and Neha Narula
In the past year, a number of central banks have stepped up work on central bank digital currencies (CBDCs - see map). For central banks, are CBDCs just a defensive reaction to private-sector innovations in money, or are they an opportunity for the monetary system? In this post, we consider several long-standing goals of central banks in their support and provision of retail payments, why and how central banks tackle these issues, and where CBDCs fit into the array of potential solutions.
CBDC Research and Pilot Projects around the World
Central banks have long endeavored to support safe, low-cost, and inclusive payments, to protect privacy, and to promote innovation. Why do these goals matter?
Central banks could support these goals in different ways. First, a central bank-in conjunction with other relevant authorities-could adjust the current regulatory framework to better enable solutions to emerge from the private sector. For example, the public sector could take actions to improve competition and efficiency in payment services (which lie squarely in the mandate of many central banks) to counteract the high cost of payments. They could also broaden access to digital central bank money, letting new entrants build payment services on their credit-risk-free payment infrastructure. These actions would require policy makers and legislators to adapt current laws and regulation.
Second, the public sector could improve the existing payment system. For example, in the United States, FedNow will support faster payments for retail use by providing financial institutions with a 24/7 instant payment system, allowing banks to provide safe and efficient payment services to their customers. FedNow could also spur innovation and bring down transaction costs associated with retail payments, and so make banking services more accessible to low-income users. However, since FedNow would require consumers to have access to commercial bank accounts, it would not necessarily help promote financial inclusion for unbanked consumers.
Third, central banks could issue a retail CBDC. This would grant direct access to digital central bank money to consumers and provide a means to transact and settle payments with central bank money. Many central banks are considering designs in which they run the system, but competing private sector providers offer retail CBDC services, such as wallets. Central banks are also considering methods for offline payments, dedicated devices and other approaches for CBDCs to meet the needs of the unbanked, and models to promote cross-border payments.
Issuing a CBDC would constitute a significant step for a central bank, since that may require a completely new payment infrastructure, possibly using new technologies. In contrast, the other approaches are more familiar to central banks as they represent incremental improvements in the regulatory framework and technical features of payment systems. However, by not issuing a CBDC, some central banks may eventually relinquish their roles in providing central bank money to the public and leave digital payments entirely to the private sector.
What are the unique merits of issuing a CBDC relative to the more standard solutions? Regarding privacy, central banks may fill the vacuum of low-cost privacy-preserving electronic payments by issuing a CBDC, which could benefit consumers by allowing them to monetize privacy. A CBDC may also be desirable if the technical design of the legacy system impedes innovation. Relative to the legacy system, a CBDC could help standardize and enable new features such as programmability (smart contracts) and fractionalisation (for machine-to-machine micropayments, for example).
While it is too early to tell whether CBDCs are the solution for all the challenges facing payment systems, they should be considered a potential solution. Because CBDCs are new and a range of approaches to implementation are being tried, central banks can learn more about the costs and benefits of CBDCs, relative to other approaches, by engaging in research and development. Answering these questions and uncovering new challenges would require a central bank to go far down the path of implementing a CBDC, whether that CBDC is ultimately adopted or not.
Raphael Auer is a principal economist for innovation and the digital economy at the Bank for International Settlements.
Jon Frost is a senior economist at the Bank for International Settlements.
Michael Lee is an economist in the Federal Reserve Bank of New York's Research and Statistics Group.
Antoine Martin is a senior vice president in the Federal Reserve Bank of New York's Research and Statistics Group.
Neha Narula is the director of the Digital Currency Initiative at the MIT Media Lab.
How to cite this post:
Raphael Auer, Jon Frost, Michael Lee, Antoine Martin, and Neha Narula, "Why Central Bank Digital Currencies?," Federal Reserve Bank of New York Liberty Street Economics, December 1, 2021, https://libertystreeteconomics.newyorkfed.org/2021/12/why-central-bank-digital-currencies/.
Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.