Over recent years we have witnessed profound changes in the retail payments systems and in the debates over the future of cash. The emergence of Bitcoin and other cryptoassets based on a Distributed Ledger Technology (DLT) opened the way to decentralized means of payment that are cross-border and outside the control of central banks. The main drawback of this type of tokens is their very high volatility. To overcome this problem a new type of cryptoassets emerged, the so-called stablecoins, whose value is anchored in fiat money, commodities or an algorithm that defines their supply. In 2019 Facebook put forward the idea of a stablecoin (Libra) that would facilitate cross-border payments among its users based on a basket of main currencies.

The Libra proposal has reignited the debate among central banks on whether they should consider issuing a type of CBDC. This idea had been circulating for several years, since the Bank of England published a seminal paper in 2016. Many central banks analysed the idea, partly because of the threat of competition from cryptoassets (so far only incipient), but also based on the intuition that a digital form of cash may overcome some of the traditional drawbacks of banknotes: they are costly to issue and withdraw, they are the main vehicle for tax evasion, crime and money laundering, and in some advanced societies they are disappearing, replaced by electronic forms of money like credit cards that are supplied by a few  private and very often foreign companies, which in the view of some authorities raises issues of excessive dependence on critical suppliers.

Some central banks, faced with these trends, analyzed the pros and cons of the issuance of digital cash. Most of them, however, did not go further that the exploratory phase, apparently because of the dilemma created by anonymity. If central banks decide to maintain the anonymity that is a key feature of cash (in the so-called “token” variant), it will imply creating a powerful instrument for illegal and crime-related transactions as well as tax evasion. If, on the contrary, CBDCs are identified (in the so-called “account” variant), this would be tantamount to open deposits to the general public in the central bank that would compete with commercial banks’ deposits, opening the way to a radical disruption of financial intermediation.

We illustrated the nature of this dilemma in a paper in 2017, based on the idea that CBDCs open the way to transform the nature of cash in three out of its four key features. Cash is peer-to-peer, universal, anonymous and non-yield bearing. CBDCs would continue to be peer-to-peer, but could be universal or restricted to a particular group of users (for instance, financial intermediaries if applied to the wholesale payment system), anonymous or identified, and can open the way to a yield-bearing type of cash.

Depending on how these features are combined different variants of CBDCs are possible, addressing different problems. The most disruptive of them is a model in which the central bank opens accounts to the population, including the possibility of paying interests. The least disruptive variant is a CBDC limited to wholesale interbank markets.

It is precisely the very disruptive nature of some of these options that led most central banks to leave aside the analysis of their feasibility… until the announcement of Libra. Their main concern had to do with their likely incompatibility with central bank independence. Central banks are already tasked with a complex set of functions, much more so after the global financial crisis. The broader their mandate the more complicated their accountability, which is the reason why their independence is questioned in a number of places, including the US and the Eurozone. If on top of what they are already doing, central banks are to open accounts to the whole population and/or deciding directly in the interest rate of deposits their legitimacy would be questioned, and it is very likely that their independence would be revised.

Central banks are already tasked with a complex set of functions, much more so after the global financial crisis

Part of the problem of central bank independence has to do with the use the central bank would make of the resources of CBDCs. In another paper we explored the implications of CBDCs on the asset side of the central bank balance sheet, which is often overlooked. If CBDCs replace banks’ deposits, the substantial increase in their liabilities needs to be matched by either (i) lending to the government, (ii) lending to banks or (iii) lending to the private non financial sector. Each of these options entails serious problems. In case (i) it clashes with the monetary financing prohibition that accompanies central bank independence and leads to the so-called fiscal dominance problem. In case (ii) it would imply that the central bank would back credit decisions taken by private banks, with huge potential moral hazard implications. And case (iii) is equivalent to a nationalization of credit.

Most of the central banks that analyzed the topic concluded that the risks of CBDCs exceed their potential gains. Only Sweden and China seemed to be considering seriously to go ahead. Sweden because cash is disappearing, and the electronic forms of money that are replacing it are provided by a few foreign companies. And China because the recent explosion in the role of Bigtech companies in retail payments is a source of uneasiness for the regulators, which seem to see the CBDC as a way to regain certain degree of control.

This was the situation when Libra was announced in June 2019. The possibility that Facebook, with its 2.5 billion users, issued a stablecoin that may compete with cash triggered a reaction among central banks, which on the one hand raised questions on the nature of Libra and its regulatory treatment and, on the other hand, reviewed their plans for CBDCs with a more positive tone. According to a BIS survey published in January 2020, nearly 40% of central banks consider likely or possible to issue a general purpose CBDC in the medium term (and more than 25% in the case of a wholesale CBDC). Although Libra was intended for cross-border payments like remittances, and therefore would not compete directly with cash (which is mostly used for domestic transactions, with a few exceptions), in practice the use cases may overlap, especially if Libra drops its basket feature (as suggested recently by its creators) and pegs instead to fiat money.

The debate since then has focused on (i) more pragmatic variants of CBDCs, based on private-public partnership instead of competition, and (ii) on the cross-border implications of the different modalities.

As regards the first topic, the IMF flagged the idea of a “synthetic” CBDC, which will be issued by the central bank, but in which the relationship with the customers will be retained by private companies (in principle banks or fintechs), which will be required to have a full backing of the positions in the central bank (100% reserves coverage). A number of questions arise in relation to this proposal: would the identity of the CBDCs holders be known by the central bank or only by the private intermediary? What would be the role of banks vis-à-vis fintechs or bigtechs, including access to central bank accounts? Will DLT be a feature of the system, either at the level of the central bank link with financial intermediaries or at the level of the link between the latter and the public (or both)?

Regarding the cross-border dimension, as the proposals get more concrete and the analysis goes more into the details the global spillovers of CBDCs have become more evident. This is closely related to the question of anonymity: if fully anonymous, it would be impossible to limit CBDCs to residents. In this case, the possibility of non-residents holding CBDCs opens a competition for global seigniorage much beyond the present situation. Today there is external seigniorage in the form of banknotes circulating abroad (overwhelmingly dollars), but this is limited by the logistic complications of banknotes travelling cross-border. With a digital form of cash the easiness of this circulation would be dramatically increased. A credible central bank issuing a digital form of cash would have a huge potential external demand, especially in countries with a tradition of dollarization, where the population tends to mistrust the local currency, which is the case in emerging and developing countries with weak institutions. These countries would have strong incentives to establish some form of capital controls if faced with the competition of digital cash issued in countries with a reserve currency like the dollar, euro or any other stable fiat currency with a credible central bank behind.

With a digital form of cash the easiness of this circulation would be dramatically increased

The recent announcement of a group of central banks that they will work together on potential cases for central bank digital currency (CBDC) in their home jurisdictions, under the umbrella of the BIS, reveals an awareness that this is an area where international cooperation is necessary. Two important central banks are missing in this group: the Fed, which has made clear that they have no intention to issue anything similar to a CBDC, because there is no obvious problem to fix in the US retail payment system (and probably also because they are happy with the status quo of the US dollar receiving most of the “external” seigniorage) and China, which has announced that their pilot on CBDC is soon to be launched. The global impact of the Chinese experiment is however less clear, to the extent that the renminbi is not fully convertible, and the potential for its global role is therefore limited.

In the next years we will probably see different types of cryptoassets, stablecoins and CBDCs proliferate and compete. The spillovers of national experiences are becoming more evident, since the technology behind them is inherently cross-border. This heralds a new form of competition in the global provision of money that we have not seen so far. Central banks will try to retain control of something as core to their mandate as cash in its different forms. And they will have strong incentives to cooperate to avoid a disorderly competition between them and also with private modalities existing or to be born. What form of digital money will prevail will depend on the attractiveness of the different modalities. The digital world tends to be a “winner takes all” type of markets. But in the case of cash national strategic interests are very strong, and regulation is a powerful weapon that different countries may use aggressively.

The reaction of central banks to the Libra announcement shows that this is a field in which they will not be passive observers. Whether central banks will react in a cooperative or in a competitive fashion is to be seen. The announcement of the agreement between the six central banks mentioned at the beginning of this article shows that cooperation will have an opportunity.