Over the past year, a number of central banks have stepped up their work on central bank digital currencies (CBDCs – see map). For central banks, are CBDCs just a defensive reaction to private sector monetary innovations, or are they an opportunity for the monetary system? In this article, we take a look at several long-standing goals of central banks in supporting and delivering retail payments, why and how central banks are approaching these issues, and where CBDCs fit into the range of potential solutions.
CBDC research and pilot projects around the world
Some key policy considerations in retail payments
Central banks have a long history of supporting secure, low-cost and inclusive payments, protecting privacy and promoting innovation. Why are these goals important?
- Payment fees. It costs money to pay money. Payment costs have generally fallen over time, but surprisingly not by much – credit card networks still routinely charge merchants a 3% service fee, and card revenues account for over 1% of GDP. in the United States and much of Latin America. High transaction costs can dampen economic activity and trade.
- Financial inclusion. Universal access to payment services has been a long-standing political goal, and central banks and other international authorities have been studying this issue for many years. Inclusion is a major societal concern both in developing economies and in some developed economies with large unbanked populations (the United States and the Eurozone, for example). With the growth of e-commerce, there is an increased need for easy and convenient access to secure digital payments as an alternative to cash.
- Consumer privacy. Along with the increasing digitization of economic activity, the adoption of digital payment has accelerated. Digital payments, including bank accounts, payment cards, and digital wallets, create a data trail. Consumer private information is aggregated and distributed for monetization. Recent research suggests that there are public good aspects to privacy; individuals may share too much data because they do not bear the full cost of not protecting their privacy when choosing their payment method. This is why the structural increase in digital payments since the COVID-19 pandemic can have negative side effects.
- Promote innovation. New, more convenient and secure payment methods not only benefit consumers, but can also spur innovative business opportunities. New technologies also offer the possibility of potentially automating certain financial practices through âsmart contractsâ, thus improving efficiency.
What is the rationale for central bank involvement in these issues?
- Payment fees. Central bank intervention may be desirable if the high payment costs result from a lack of competition. Traditionally, payment services have been powered by banks, which can access the central bank’s digital currency in the form of reserves. If, in fact, the limited access to the central bank’s digital currency contributes to limited competition, central banks might consider changing their policies to improve the functioning of the market.
- Financial inclusion. Will the private sector offer payment modalities that include unbanked populations? Private payment methods often don’t cater to the unbanked. For example, a survey reveals that in most economies, fintech payment services are more widely adopted by those who already use traditional financial institutions for similar services. A central bank can take a proactive approach to improve financial inclusion if the private sector, left alone, fails to provide universal access.
- Consumer privacy. Central banks provide physical cash which by nature guarantees consumer privacy. Physical money currently has no digital substitute that is also inexpensive and accessible. This may very well reflect the fact that innovations in private sector retail payments are driven by profit (for example, generating income through data acquisition or transaction fees). As a non-commercial party, central banks have no incentive to collect transaction data and, therefore, may be better able to internalize the social gains resulting from the facilitation of confidentiality.
- Promote innovation. Central banks support safe and efficient financial services and ensure that payment systems improve over time. Some features of smart contracts could benefit from implementation within the central bank’s settlement and payment systems. For example, a central bank is in a unique position to provide consistency guarantees for smart contracts, just as it already does for commercial bank money.
How can central banks achieve these goals?
Central banks could support these goals in different ways. First, a central bank, in collaboration with other competent authorities, could adjust the current regulatory framework to better allow solutions to emerge from the private sector. For example, the public sector could take steps to improve the competition and efficiency of payment services (which clearly fall within the mandate of many central banks) to counter the high cost of payments. They could also expand access to the central bank’s digital currency, allowing new entrants to build payment services on their payment infrastructure without credit risk. These actions would force policy makers and legislators to adapt existing laws and regulations.
Second, the public sector could improve the existing payment system. For example, in the United States, FedNow will promote faster payments for individuals by providing financial institutions with a 24/7 instant payment system, enabling banks to provide secure and efficient payment services to their customers. . FedNow could also spur innovation and reduce transaction costs associated with retail payments, making banking services more accessible to low-income users. However, since FedNow would require consumers to have access to commercial bank accounts, this would not necessarily help promote financial inclusion for unbanked consumers.
Third, central banks could issue a retail CBDC. This would give consumers direct access to central bank digital currency and provide a means to process and settle payments with central bank money. Many central banks are considering designs in which they manage the system, but competing private sector providers offer retail CBDC services, such as wallets. Central banks are also considering offline payment methods, 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 be an important step for a central bank, as it could require a whole new payment infrastructure, possibly using new technologies. In contrast, the other approaches are more familiar to central banks because they represent gradual improvements in the regulatory framework and the technical characteristics of payment systems. However, by not issuing CBDCs, some central banks may eventually abandon their role of providing central bank money to the public and leave digital payments entirely to the private sector.
What are the unique advantages of issuing a CBDC over more standard solutions? When it comes to privacy, central banks can fill the void 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 existing system hinders innovation. Compared to the existing system, a CBDC could help standardize and enable new features such as programmability (smart contracts) and splitting (for machine-to-machine micropayments, for example).
Are CBDCs the right answer?
While it is too early to tell if the CBDCs are the solution to all the challenges facing payment systems, they must be considered a potential solution. Since CBDCs are new and a range of implementation approaches are being tested, central banks can learn more about the costs and benefits of CBDCs, compared to other approaches, by engaging in research and development. Answering these questions and uncovering new challenges would require a central bank to go to great lengths in implementing a CBDC, whether or not that CBDC is ultimately adopted.
Raphael Auer is Senior 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 Research and Statistics Group of the Federal Reserve Bank of New York.
Antoine Martin is senior vice president of the research and statistics group at the Federal Reserve Bank of New York.
Neha Narula is the Director of the Digital Currency Initiative at MIT Media Lab.
How to cite this post:
Raphael Auer, Jon Frost, Michael Lee, Antoine Martin and Neha Narula, âWhy Central Bank Digital Currencies? Â», Federal Reserve Bank of New York Economy of the rue de la LibertÃ©, December 1, 2021, https://libertystreeteconomics.newyorkfed.org/2021/12/why-central-bank-digital-currencies/.
The opinions expressed in this article 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.