A refresh on money and its new frontier


Central Bank Digital Currency Have you ever stopped and wondered what money really is? Have you ever stopped and thought about which types of money you have knowledge of? All of us are sharing a world where money leads the way, yet most of us do not really have a sense of what it is and what it is not. The philosophy of money has definitely pervaded human societies for a while, in spite of our huge ignorance about the economy machine. We do not really know what money is; we have no idea of how the economy works; we only know that money allows us to get what we need as well as most of what we desire: we are living with a need for money and a desire for more and more of it. From Coins to CBDC Money is a mean generally defined in terms of the following four traditional functions it performs: (1) medium of final payments, (2) store of value, (3) standard of deferred payments and (4) unit of account. Therefore money makes our economic system work by allowing us (1) to participate as buyers and sellers; (2) to carry a safe and stable wealth over time; (3) to value debt and acquire goods and services with deferred payments, and (4) to have a common measure of the economic value of something. When a particular type of money is issued for a country[1] and is legally accepted for paying taxes and debt in that country, it is said to be the legal tender. So, while the € 10 bill is clearly legal tender in Europe and complies with the definition of narrow-money, we could debate on whether the Bitcoin - far from being legal tender for everyone - complies as well. Isn’t it too volatile to be considered as a true store of value and as a unit of account? Would you underwrite debt denominated in Bitcoin, despite its volatility? Is it a real medium of exchange for people or is it rather a financial asset for speculators? Regardless of potential doubts about its nature, Bitcoin has already been widely categorized as a cryto-currency[2]. Now that we have got an idea of what money is, we can take a step further and learn which types money can assume. The figure below presents a taxonomy of money in the form of a Venn-diagram referred to as the “money flower” [3]. It divides money in types based on the combination of four key properties: issuer (Central Bank (CB) or private), form (physical or digital), accessibility (limited or not)[4], and technology (account-based or token-based).

A key distinction between token and account-based money is the form of verification for transfers: token-based money relies critically on the ability of the payee to verify the validity of the payment object (with cash the worry lies on counterfeiting, while in the digital world concerns lie on “double spending”[5]); account-based money, on the other hand, depends fundamentally on the ability to verify the identity of the account holder (identity theft). To make it practical, you should have knowledge of four money types:

  1. Cash: issued by a CB in physical form, it is accessible to everyone every time and it is token-based by its physical nature.

  2. Bank deposits: issued by commercial banks in digital form, these are always accessible to anyone who can hold a bank account, and they are account-based.

  3. Central bank reserves: issued by the CB in digital form, they are account-based and accessible only by monetary intermediaries.

  4. Bitcoin: it is not issued by any CB, it has digital form, it is accessible always by everyone and it’s token-based.

Now that you have a frame for money types, you might have noticed that there is an unexplored money-family (dark grey area in the figure). Economists refer to this family as Central Bank Digital Currency (CBDC), which can be defined as “digital money issued by the central bank, other than reserves” and it would represent an additional CB liability. As you can notice in the money flower, CBDC could be for wholesale-only or for general purpose. The former would somehow represent a renewed version of CB reserves, while the latter would definitely play as a new money standard halfway between cash and reserves. In Sweden, economists are working on the e-krona[6] - the Swedish possible future central bank digital currency - in order to overcome the peculiar problem of scarce cash usage in the nation. The e-krona will be widely accessible and usable in both token and account form. Given the design they opted for, some economists refer to it as “digital cash”. In addition to the four core properties highlighted above, there are other design features that the CBDC can in principle bear: availability (24/7 or limited), anonymity, transfer mechanism (decentralized or centralized), interest-bearing, limits or caps. The e-krona has been tested as a 24/7 available, centralized and non-anonymous payment mean, without interests and limits[7]. Feasibility and relevance for Policy Feasibility. According to the Committee on Payments and Market Infrastructures (CPMI), CBDC implementation is a real challenge because of (1) legal, (2) technological and (3) reputational issues: (1) many reforms would have to be introduced to make CBDC work and much time would be required for their implementation; (2) technologies like Distributed Ledger Technology (DLT) are still relatively untested and in turn not fully reliable in a central bank context; (3) in case of flop or excessive involvement with the private sector, CB reputation could be undermined. Pros? CBDC is supposed to enlarge financial inclusion; to promote a safer and efficient payments system and support monetary policy. To what extent monetary policy and financial stability will be affected by the CBDC depends on how large its demand will be, and demand depends in turn on how the CBDC is designed. For instance, a widely accessible interest-bearing CBDC can represent a useful additional policy tool to strengthen the pass-through of policy rates and to alleviate the zero lower bound constraint. The interest it bears can function as an instrument to control CBDC demand and make it more or less intrusive. Moreover, a CBDC like e-krona would be an excellent complement to cash and in turn, a needed tool to make Swedish monetary policy more effective and ensure that the general public retains access to a state-guaranteed means of payment. Cons? More than an efficient payment vehicle, CBDC will end up functioning as a store of value in unforeseen ways under certain circumstances. For instance, if granted access, residents in high-inflation countries may turn to CBDC issued by a low-inflation country (as they do nowadays with cash). More importantly, in times of financial stress, people are likely to consider CBDC safer than bank deposits, with possible side effects on financial stability (bank runs). In other words, CBDC could jeopardize banks' soundness by undermining the attractiveness of deposits, which are the main financing source for the banking sector. Will we see something like that soon? Mario Draghi expressed his vision about the desirability of CBDC for the EU in a public letter. After considering the points we discussed before, he declared that the ECB will not issue CBDC in the near future because (1) European demand for cash is growing, (2) MP is still well functioning and (3) digital payments are already evolving fast in the private sector.

[1] It is not said that the legal tender currency has to be produced/printed/issued within the border of the user nation. In the past, some nations (like Portugal) had to commission the Bank of England to print Portuguese currency because of the BoE’s monopoly in the production of high quality banknotes.

[2] It has been defined as a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets in a decentralized way (usually using a Block-chain technology).

[3] Bech and Garratt (2017).

[4] Note that accessibility distinguishes between money that is available everywhere to everyone and money that is restricted to certain agents or jurisdictions.

[5] With digital currency, there is a risk that the holder could make a copy of the digital token and send it to another party while retaining the original, so the falsifier can spend twice. Double-spending concerns uniquely digital currencies because digital information can be reproduced relatively easily.

[6] https://www.riksbank.se/en-gb/payments--cash/e-krona/

[7] https://www.riksbank.se/en-gb/payments--cash/e-krona/e-krona-reports/e-krona-project-report-2/

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