Central bank digital currencies risk becoming a gigantic flop
The discussion about central bank digital currency (CBDC) has gained an impressive momentum. Auer et al. (2020) report that many central banks have published retail or wholesale CBDC work and that in speeches of central bank governors and board members about CBDC there have now been more speeches with a positive than a negative stance. The ECB has recently published a comprehensive report on ‘a digital euro’ (ECB 2020).
These activities have led to a growing literature, with a focus on the macroeconomic dimensions of CBDCs. Key topics are the effects of CBDCs on commercial banks, especially the risk of disintermediation, and on monetary policy and financial stability (Carapella and Flemming 2020, Brunnermeier and Niepelt 2019, Fernández-Villaverde et al. 2020, Andolfatto 2018).
In contrast, the microeconomic aspects of CBDCs have received relatively little attention. Our study (Bofinger and Haas 2020) provides a microeconomic analysis of CBDC, which in our view is of central importance for a comprehensive discussion of CBDCs. Specifically, two questions are at stake:
- What is the market failure that would justify central banks entering business areas that have so far been operated by commercial banks and private retail payment system providers?
- Are the options discussed so far by central banks attractive enough for CBDCs to compete successfully with the products offered by private providers?
Finally, the microeconomic analysis shows that there is no such thing as a CBDC per se, but rather a variety of different design options. Therefore, a macroeconomic analysis can only make sense if we have first clarified what we mean by CBDC.
CBDC design options
A systemic perspective is required for a comprehensive taxonomy of CBDC design options. From the systemic perspective, CBDC concepts can be presented in two separate but interrelated ways. CBDCs can be discussed from the perspective of:
- new payment or settlement objects made available by central banks, and/or
- new payment infrastructures or systems operated by central banks.
A CBDC can thus be understood as a purely monetary object, i.e. a deposit with the central bank that is used within the framework of existing real-time gross settlement (RTGS) payment systems. However, it can also be understood as an independent payment system that operates in parallel to the existing system using deposits held with the central bank. The systemic perspective also opens the view for solutions where central banks create new retail payment systems which would not necessarily require deposits that are held with central banks.
Table 1 Options for digital central bank projects
A further differentiation arises in the case of CBDC objects. Here, a distinction must be made between account-based and token-based CBDCs. In addition, one can also differentiate between central bank balances, which can be used primarily as a means of payment, and balances which can be used primarily as a store of value. Finally, one can differentiate between retail CBDCs designed for private households and wholesale CBDCs designed for firms or for payment service providers.
Table 2 Options for CBDC objects
For our microeconomic evaluation of CBDC design options we use two criteria:
- Allocative efficiency: Any government interference with the market process requires the diagnosis of market failure (Carletti et al. 2020). The burden of proof lies with the central banks. They have to show that the objectives which they pursue with CBDCs are currently not satisfactorily met by the private providers. And even if public goods like financial stability or stability of the payment system are not optimally met, it is not obvious that CBDC is the adequate solution.
- Attractiveness for users: If CBDCs are designed as new payment objects that are used within existing payment systems, the user perspective implies that CBDCs must compete with existing payment objects (above all cash and traditional bank deposits). If CBDCs constitute new payment systems, their acceptance by private users must be analysed within the context of the existing payments ecosystem. For the reputation and credibility of central banks, it is important that any CBDC solution is attractive enough for potential users to adopt it.
A narrow CBDC approach is the provision of CBDC objects as means of payment that are used within the existing payment systems, above all the real-time gross settlement systems operated by central banks. As the model by Bindseil (2020) shows, account-based CBDCs can be designed in a way that they are mainly suitable as a payment object. But from the allocative perspective there is no obvious market failure that could justify the provision of an ordinary bank deposit by a central bank. From a user perspective, having a direct account with the central bank could be attractive because of its absolute safety. But as bank deposits below €100,000 are protected by the deposit insurance schemes, holding smaller amounts of CBDCs – Bindseil (2020) speaks of a limit of €3,000 – is not an obvious reason to switch from a traditional bank account to a central bank account. In addition, it is unlikely that central banks would be able to offer the same spectrum of services that are associated with a private bank account. And if they decided to do so, this interference with private banks could hardly be justified by a market failure.
The case for a token-based CBDC that could serve as a digital substitute for cash is also not obvious. While the allocative perspective could justify that central banks provide a digital substitute for cash for which they already have a monopoly, the need to comply with anti-money laundering (AML) regulations sets rigid quantitative limitations for such products. Accordingly, from a user perspective the demand for a token CBDC will be very low as they would only provide an imperfect substitute for cash, which today is especially attractive for payments in the shadow economy and as a store value in periods of financial instability.
An option that has received little attention so far is a CBDC that is designed solely as a store of value. Such a CBDC could only be used for payments to and from the commercial bank account of its holder. From the allocative perspective, the supply of such a CBDC could be justified by the need of (nominally) safe assets which can only be provided by central banks. The demand for a store-of-value CBDC would come from firms and large investors with bank deposits of more than €100,000, which would be bailed-in in the case of a bank restructuring. From the user perspective, this demand would depend on the interest rate for such deposits. Central banks could auction store-of-value deposits which would give them a perfect control over their amount. While there could be a high demand for such a CBDC, central banks do not seem to be interested in this option, as they fear that this could lead to a strong disintermediation of the banking system (Bindseil 2020).
Store-of-value CBDCs could also be designed as collateral for large payment service providers. In China, Alipay is required to hold deposits with the central bank. Libra/Diem (2020, p.11) has expressed the “hope (…) that as central banks develop central bank digital currencies (CBDCs), these CBDCs could be directly integrated with the Libra network, removing the need for Libra Networks to manage the associated Reserves (…)”. This approach would prevent the Libra/Diem system from getting disconnected from central banks and their control over the monetary system. From an allocative perspective, such central bank intervention can be justified as it would de facto include payment service providers under the umbrella of the central bank’s reserve requirements and hence improve financial stability.
More ambitious CBDC models, like the Swedish e-krona (Sveriges Riksbank 2018), envisage a stand-alone payment system within which new CBDC objects can be transferred. For the attractiveness of CBDC bank deposits this is not necessarily an advantage. Without a specific payment system, CBDC deposits could be used like a commercial bank deposit. With a stand-alone payment system, CBDC deposits could only be used for payments to other CBDC accounts. The lack of interoperability constitutes a major drawback of such CBDC solutions. Especially in a small country like Sweden, the domestic focus is another major disadvantage.
Therefore, if central banks want to develop a serious answer to the dynamic activities of global payment service providers, they must rethink their whole approach to CBDCs. The benchmark is set by PayPal which is the ‘elephant in the room’ of global payments. It shows that instead of national schemes that can only operate with the national currency and can only make transactions with system-specific accounts, the solution must be supranational with a multicurrency operability and an openness to payment objects that are not system-specific.
But even if central banks realise that their task is not to develop a digital substitute for cash but a digital alternative for global payment systems, it will not be easy to achieve the high level of sophistication and the broad spectrum of services, especially for e-commerce, of such payment systems. But in contrast to narrow CBDC models, from an allocative point of view there would be an obvious justification for supranational retail payment networks operated by central banks.
In sum, we argue that there is no obvious justification for digital cash substitutes from the point of view of allocative efficiency. In addition, from a user perspective, the narrow solutions that are discussed by central banks so far do not seem attractive enough to compete successfully with private bank deposits and private retail payment systems like PayPal. The key advantage of CBDC, its absolute safety, is irrelevant for retail payments. These findings mainly concern advanced countries with a large share of the population having access to bank accounts. For emerging and developing economies, such CBDC solutions could be a suitable tool to approach the problem of a large share of people without access to bank accounts.
However, there is a huge potential for CBDCs as a store of value for retail payment service providers, like Libra/Diem. Astonishingly, central banks have so far not discussed this option, although it would help them to maintain control over private retail payment networks outside the existing bank-based payment system that relies on central bank reserves and the existing central bank settlement systems.
Finally, a clear market failure can be identified for global retail payment networks which are based on monopolistic or oligopolistic structures. However, the central banks’ response would then have to be supranational rather than national. Moreover, successful networks such as PayPal show that such systems are not tied to a system-specific currency or system-specific payment objects.
Thus, if central banks stick to their current approach, the risk is high that CBDCs will become a gigantic flop. This would be anything but beneficial for the reputation of central banks.
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