## ftnea2019001

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**Canonical URL:** [ftnea2019001](https://www.imf.org/-/media/files/publications/ftn063/2019/english/ftnea2019001.pdf)

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---

### Overview and purpose
- Offers a conceptual framework to categorize new digital monies, identify risks, think through implications, and offer policy options for central banks to consider.
- Focuses on interplay between new forms of money and the banking sector, emphasizing financial stability and consumer protection; notes other risks (financial integrity, monetary policy and capital flows, antitrust) are mentioned but not core.
- Limits scope and does not venture into the normative realm.

### Key messages and findings
- The two most common forms of money today—cash and bank deposits—will face tough competition and could be surpassed by e-money and stablecoins.
- E-money is economically similar to a private investment fund guaranteeing redemptions at face value: "If 10 euros go in, 10 euros must come out." The issuer must be able to honor this pledge.
- Adoption of certain new models may be extremely rapid due to convenience, network effects, and online integration; some new digital monies could become unrivaled means of payment even if not the best store of value.
- Banks will feel pressure from e-money but can respond by offering more attractive services or similar products; the traditional banking model is unlikely to disappear, though disruption is likely.
- Central banks will play an important role: rules they set will affect adoption of new digital monies and pressure on commercial banks.
- Allowing selected e-money providers access to central bank reserves under strict conditions is one policy option; partnering with e-money providers could effectively provide "central bank digital currency (CBDC)" to the public—described as "synthetic CBDC."

### Conceptual framework: the "money tree"
- Taxonomy with four attributes to classify means of payment:
  - Type: claim or object.
  - Value: fixed value redemptions (debt-like) or variable value redemptions (equity-like).
  - Backstops (for fixed-value claims): government backstops versus private backstops.
  - Technology: centralized or decentralized settlement; decentralized can be "permissioned" or "permissionless."
- Distinction highlights operational and legal differences (e.g., object-based cash requires no information exchange; claim-based payments require ownership recognition, backing, and registration).

### Classification: five different means of payment
- Central bank money
  - Object-based (cash), denominated in local unit of account, decentralized settlement among transacting parties.
  - Digital counterpart debated as CBDC; CBDC would likely not be anonymous, could protect users' data, could be validated centrally or decentrally, and could offer interest.
- Cryptocurrency
  - Object-based, denominated in its own unit of account, minted by nonbanks, often issued on permissionless blockchains.
  - Subtypes: "public coins" (e.g., Bitcoin, Ethereum) and "managed coins" (algorithmically stabilized value coins).
- B-money
  - Claim-based, covers commercial bank deposits, debt-like instruments redeemable upon demand at face value, transfers typically centralized.
  - Redemption guarantees backstopped by government policy: regulation, central bank liquidity provision, and deposit insurance where credible.
- E-money
  - Claim-based, redeemable in currency at face value upon demand, debt-like but with private backstops (prudent management and legal asset protections).
  - Examples include Alipay, WeChat Pay, Paytm, M-Pesa; banks can also issue e-money for clients without deposit insurance.
  - Blockchain-based e-money ("fiat tokens") examples include Gemini, Paxos, TrueUSD, USD Coin by Circle and Coinbase.
  - Term "stablecoin" is vague and overlaps with managed coins.
- I-money (investment money)
  - Claim-based with variable value redemptions into currency; equity-like instrument backed by assets such as gold or portfolios.
  - Examples include Digital Swiss Gold (DSG) and Novem.

### Stability of e-money: risks and comparative position
- Core question: Can e-money be as stable as competing forms of money? Stability measured in nominal terms relative to domestic currency unless otherwise noted.
- Comparative findings:
  - Cryptocurrency: "standard deviation of day-on-day changes in Bitcoin prices is approximately 10 times higher than in most G7 currency pairs, and even a little higher than in the Venezuelan Bolivar to U.S. dollar exchange rate."
  - Central bank money: perfectly stable in nominal terms; value underpinned by government solvency in modern fiat systems.
  - I-money and B-money: risk depends on underlying asset safety and liquidity; government backstops are central to b-money safety.
  - E-money: stability of value comes from guaranteed redemption at face value, but lacks government backstops characteristic of b-money and thus must privately generate means to honor redemptions (strong balance sheet, legal structures).
- Identified risk types for e-money:
  - Liquidity risk: lag before redemption requests can be met; depends on market liquidity of assets held by the e-money issuer.
  - Default risk: issuer defaults, leaving client funds at risk of seizure by other creditors.
  - Market risk: losses on assets held by the e-money provider that can exceed capital and put redemptions at risk.
  - Foreign exchange rate risk: where claims are denominated in a currency other than the domestic unit of account (example: Libra denominated in a basket of currencies).
- Parallel with CNAV funds: both pledge customers will at least get their money back; CNAV funds do not typically have legal obligation to cap investor losses—runs can occur.

### Measures to enhance e-money stability and protect client funds
- Institutional and design options:
  - Invest in safe and liquid assets such as short-term government paper; central bank reserves are the safest and most liquid and can be held directly or indirectly through a specialized bank or a special purpose vehicle with a bank license.
  - Contain creation of e-money so total issued is always lower or equal to value of client funds received; avoid over-issuance.
  - Ensure assets held are not encumbered and ideally segregated from the issuer’s balance sheet to protect client funds in case of bankruptcy.
  - Hold sufficient capital to offset losses and allow full redemption of client funds.
  - Strengthen regulation of e-money issuers quickly where necessary to protect customers and avoid risks to financial stability.
- Current practices and caveats:
  - Most popular assets held by e-money providers to date are bank deposits, which offer redemption on demand at face value but are subject to bank default risk.
  - E-money issuers are wholesale creditors; their funds are generally not protected by deposit insurance.
  - Client funds may be transferred to trusts to segregate funds from issuer balance sheets; legal protection varies across jurisdictions and may not be watertight.

### Adoption dynamics: why e-money could spread rapidly
- Stability in the unit of account is necessary for wide adoption but not sufficient; convenience and other attributes can compensate.
- Six drivers of rapid adoption:
  - Convenience: integration into digital lives and user-centered design.
  - Ubiquity: faster and cheaper cross-border transfers in some cases.
  - Complementarity: enables programmable delivery-versus-payment and tokenized assets.
  - Transaction costs: transfers nearly costless and immediate.
  - Trust: in some countries users trust telecommunications and social media companies more than banks.
  - Network effects: as merchants and peers adopt e-money, its value to users rises.
- Empirical and illustrative points:
  - "Ninety percent of Kenyans over age 14 pay with M-Pesa."
  - Value of e-money transactions in China (WeChat Pay and Alipay) surpass those worldwide of Visa and Mastercard combined.
  - Social adoption analogies: WhatsApp adoption faster than Gmail; WhatsApp past "the 1.5 billion users mark."

### Case examples and emerging instruments
- Libra
  - Announced June 18, 2019; appears backed by a portfolio called Libra Reserves composed of bank certificates of deposit and short-term government paper.
  - Libra coins could be exchanged into fiat currency at any time for their share of the going value of the underlying portfolio, "without any price guarantees"—distinguishing Libra from e-money.
  - Transfer of Libra would be essentially shares of Libra Reserves (potentially without a legal claim) and would comprise a payment.
- Private investment funds and tokenization
  - Private funds offering relatively safe and liquid investments have grown rapidly but do not yet offer widespread means of payment.
  - Shares in private investment funds could become i-money if tokenized; tokenized coins can be traded directly at low cost and constitute payments denominated in the underlying portfolio.
  - Regulatory restrictions may apply because transfer of i-money entails transfer of ownership of securities.

### Implications for the banking sector: three scenarios
- Scenario 1 — Coexistence (most likely)
  - E-money and b-money will coexist; banks’ strengths (captive users, distribution networks, cross-selling) matter.
  - E-money providers may recycle client funds to banks as certificates of deposit.
  - Risks to banks: substitution of cheap retail funding for expensive, runnable wholesale funding; loss of client relationships and transaction data; concentration of funding in a few large banks.
  - Bank responses: offer higher deposit interest; improve services; acquire startups; issue longer-term debt or equity.
  - Payments competitiveness: banks can match payment quality via innovations and central-bank–rolled "fast payment" systems (example: TIPS).
- Scenario 2 — Complementarity
  - E-money can draw poor households and small businesses into the formal economy; example: Kenya—credit growth increased steadily after 2008 as e-money was adopted.
  - Partnership model: e-money providers estimate creditworthiness and sell findings or intermediate funding to banks.
  - Some e-money providers may migrate to banking attracted by margins from maturity transformation.
- Scenario 3 — Takeover (least likely but consequential)
  - Radical transformation where payment-purpose deposits migrate to e-money and banks rely on wholesale funding; credit intermediated increasingly by markets.
  - Questions remain:
    - How much liquidity would be locked in e-money and unavailable for private-sector lending?
    - Would only liquidity buffers migrate or more (including uninsured deposits)?
    - Could monetary policy offset the effect?
    - Would credit be rationed or more expensive?
    - Could specialized funds offer and hold nonstandard/illiquid loans?
    - What portion of loans could be securitized and mutualized?
    - Could monitoring and screening be provided by funds, agencies, or technology?

### Risks of rapid e-money adoption and regulatory considerations
- Regulatory frameworks generally exist but "need to be revised and strengthened."
- Large fintech and big tech firms might be designated and regulated as being globally systemic.
- Guiding principle: regulation should be proportionate with the risks and types of services offered.
- Consumer protection and financial stability risks:
  - Runs on e-money with features of CNAV funds.
  - Privacy risks.
  - Risks to monetary policy transmission and seignorage following a drop in currency demand.
  - Risks to market contestability and financial integrity.
  - Risks to policymaking if data are lost.
- Financial integrity challenges in decentralized systems increase need for international cooperation to avoid regulatory arbitrage.

### Central bank policy options, reserves access, and sCBDC
- Allowing e-money providers to hold central bank reserves (examples: Reserve Bank of India, Hong Kong Monetary Authority, Swiss National Bank; China requires large payment providers to hold client funds at the central bank) would:
  - Transform such providers into narrow banks (cover 100 percent of liabilities with central bank reserves and do not lend to the private sector).
  - Reduce liquidity and market risk for e-money and attenuate default risk if reserves are protected from other creditors when the e-money provider goes bankrupt and e-money is issued one for one for reserves.
  - Enhance oversight of issuance and interoperability of payments.
- Run risk considerations:
  - If client funds backing e-money were held as wholesale funding for banks, runs could reverse.
  - If client funds were held as reserves at the central bank, uninsured deposits might migrate from banks to e-money providers.
  - Central bank lending could counter transient bank runs, but rapid disintermediation risk should be taken seriously.
- Advantages of central bank reserve access:
  - Stability: eliminates liquidity and market risk; reduces likelihood of costly runs and devaluations.
  - Interoperability and competition: contemporaneous transfers on central bank books ensure newly held e-money is fully backed and redeemable.
- Synthetic CBDC (sCBDC)
  - Definition: a public-private partnership where the central bank offers settlement services and access to central bank reserves to e-money providers while private providers retain customer-facing functions under regulation.
  - Advantages: far cheaper and less risky for central banks than full-fledged CBDC; preserves private-sector innovation and central bank trust/efficiency.
  - Constraints: public must understand limited central bank responsibility to avoid reputational risk; central bank need not perform customer due diligence or operate wallets under sCBDC.
  - Policy levers: central banks could pay interest on reserves held by e-money providers; the wedge between interest on e-money provider reserves and that paid to commercial banks could be a policy variable; interest on e-money could be brought into negative territory to address effective lower bound constraints.

### Interoperability, competition, licensing, and limits of alternatives
- Central banks could require technological standards for interoperability of e-money wallets to enhance competition.
- Allowing e-money providers access to central bank reserves would spur innovation, enable trading of blockchain-based assets, and facilitate cross-border payments.
- Alternatives (custodian accounts, bank deposits) may be less effective: client funds may not transfer immediately after sale of e-money, limiting interoperability.
- Risk of large e-money monopolies:
  - Network effects, data rents, and sunk costs could create near-natural monopolies.
  - Policy option: prefer domestic e-money providers under direct supervision by offering them means to issue safe, liquid money and retain seignorage revenue (subject to whether central bank pays interest on reserves).
- Licensing and supervision:
  - Central banks could set strict licensing conditions, supervision, and oversight; selected providers responsible for customer screening, transaction monitoring and reporting, and security of wallets and customer data.
- Limits of keeping e-money providers out of reserves:
  - e-money providers would remain in shadow-banking realm; countries may find it difficult to impose appropriate regulation such as disclosure, capital, and liquidity buffers.

### Unanswered questions and broader implications
- Key open questions remain about access, eligibility, safeguards, and how choices will shape outcomes.
- Broader considerations relevant to CBDC and sCBDC debates include financial inclusion, cost efficiency, safety of the payments system, consumer protection if cash disappears, and settlement services provided by large private sector players—many of which lie outside the scope of this note.

*Source: ftnea2019001 - Section 4 (IMF FINTECH NOTES, July 2019).*

### Section 1

### THE RISE OF DIGITAL MONEY

### Overview and purpose
- Offers a conceptual framework to categorize new digital monies, identify risks, think through implications, and offer policy options for central banks to consider.
- Focus is mostly on the interplay between new forms of money and the banking sector, emphasizing financial stability and consumer protection.
- Notes that other risks—financial integrity, monetary policy and capital flows, and antitrust—are mentioned but are not the core of the discussion.
- Emphasizes that the paper limits scope and does not venture into the normative realm.

### Key messages and findings
- The two most common forms of money today—cash and bank deposits—will face tough competition and could be surpassed by e-money and stablecoins.
- E-money is economically similar to a private investment fund guaranteeing redemptions at face value: "If 10 euros go in, 10 euros must come out." The issuer must be able to honor this pledge.
- Adoption of certain new models may be extremely rapid: convenience, network effects, and online integration could make some new digital monies unrivaled as means of payment even if they are not the best store of value.
- Banks will feel pressure from e-money but can respond by offering more attractive services or similar products; the traditional banking model is unlikely to disappear, though disruption is likely.
- Central banks will play an important role: rules they set will affect adoption of new digital monies and pressure on commercial banks.
- Allowing selected e-money providers access to central bank reserves under strict conditions is one policy option; partnering with e-money providers could effectively provide "central bank digital currency (CBDC)" to the public—described as "synthetic CBDC."

### Conceptual framework: the "money tree"
- Proposes a taxonomy with four attributes to classify means of payment:
  - Type: either a claim or an object.
  - Value: fixed value redemptions (debt-like) or variable value redemptions (equity-like).
  - Backstops (for fixed-value claims): government backstops versus private backstops.
  - Technology: centralized or decentralized settlement; decentralized can be "permissioned" or "permissionless."
- Distinction highlights operational and legal differences (e.g., object-based cash requires no information exchange; claim-based payments require ownership recognition, backing, and registration).

### Five different means of payment (classification)
- Central bank money
  - Object-based (cash), denominated in local unit of account, decentralized settlement among transacting parties.
  - Digital counterpart debated as CBDC (central bank digital currency); CBDC would likely not be anonymous, could protect users' data, could be validated centrally or decentrally, and could offer interest.
- Cryptocurrency
  - Object-based, denominated in its own unit of account, minted by nonbanks, often issued on permissionless blockchains.
  - Subtypes: "public coins" (e.g., Bitcoin, Ethereum) and "managed coins" (algorithmically stabilized value coins, e.g., proposed models such as Basis).
- B-money
  - Claim-based, covers commercial bank deposits, debt-like instruments redeemable upon demand at face value, transfers typically centralized.
  - Redemption guarantees are backstopped by government policy: regulation, central bank liquidity provision, and deposit insurance where credible.
- E-money
  - Claim-based, redeemable in currency at face value upon demand, debt-like but with private backstops (prudent management and legal asset protections).
  - Prominent examples include Alipay, WeChat Pay, Paytm, M-Pesa; banks can also issue e-money for clients without deposit insurance.
  - Blockchain-based e-money ("fiat tokens") examples include Gemini, Paxos, TrueUSD, USD Coin by Circle and Coinbase.
  - The term "stablecoin" is widely used but is vague and overlaps with managed coins.
- I-money (investment money)
  - Claim-based with variable value redemptions into currency; equity-like instrument backed by assets such as gold or portfolios.
  - Examples of gold-backed i-money include Digital Swiss Gold (DSG) and Novem.

### Implications for the banking sector
- Three scenarios considered for the impact of digital money adoption on banks:
  - Digital monies as complements to banks.
  - Digital monies as substitutes, but banks successfully compete for deposits.
  - Massive deposit outflows transform banks into private investment funds (following severe disintermediation).
- Today’s payment entrants could become banks and extend targeted credit based on proprietary information.
- Even if banks adapt by offering similar products, policymakers should be prepared for disruption in the banking landscape.
- Regulatory and supervisory frameworks will influence whether banks retain their central role in money creation and credit intermediation.

### Central bank policy options and trade-offs
- Central banks could allow selected e-money providers access to central bank reserves under strict conditions—this raises risks but also advantages.
- Partnering with e-money providers could be an effective model to introduce CBDC to the public at large (termed "synthetic CBDC").
- Important open questions remain before concrete policies can be designed; choices on access, eligibility, and safeguards will shape outcomes.

### Additional analytical observations
- Claim-based systems reduce physical risks but require complex infrastructure and legal recognition of claims.
- Fixed-value claims facilitate price agreement in the unit of account but create obligations on issuers comparable to debt instruments.
- Variable-value claims expose users to market value fluctuations and mirror equity-like instruments.
- Technology choices (centralized vs. decentralized; permissioned vs. permissionless) affect cross-border reach, settlement finality, and governance.

*The Rise of Digital Money, Tobias Adrian and Tommaso Mancini-Griffoli, July 2019.*

### Section 2

### ftnea2019001 - Section 2

### Overview and conceptual framing
- Discusses whether i-money and e-money qualify as “money” under economists’ and legal perspectives: money as a stable store of value, widespread means of payment, and unit of account.
- Notes absence of a generally accepted legal definition; most legal definitions emphasize ready exchange into currency, denomination in a unit of account, and widespread acceptance as a means of payment.
- Observes a likely continuum of i-monies depending on assets backing them; those backed by the safest and most liquid assets and widely accepted could be considered a form of money.
- Highlights that some e-money providers pledge 1 for 1 convertibility into fiat currency on websites and white papers, but not all necessarily issue legally binding guarantees of redemption at face value; models remain to be tested in stressed markets.

### Taxonomy of digital monies (summary of attributes)
- Table 1 (summarized in text) classifies forms of digital money across four elements of the conceptual framework:
  - Types listed: CBDC, Cryptocurrency, B-money, E-money, I-money.
  - Categories: Object vs. Claim; Value conventions (Unit of account / Other / Fixed value redemptions / Variable value redemptions); Backstop (n/a, Government, Private); Technology (Centralized & blockchain / Blockchain).
- Explicit positionings in prose:
  - Cryptocurrency: object; high volatility; potentially high capital gains.
  - Managed coins: lower volatility by design but stability depends on credibility of stabilization mechanisms.
  - Central bank money (cash or CBDC): perfectly stable as a store of value in nominal terms; underpinned by government solvency in real terms.
  - B-money (bank deposits, central bank liquidity): safety enhanced by government backstops.
  - I-money (equity-like instruments): inherits risk of underlying assets; risk varies with composition (e.g., Treasury bills vs. stock shares).

### Stability of e-money: risks and comparative position
- Core question: Can e-money be as stable as competing forms of money? Stability measured in nominal terms relative to domestic currency unless otherwise noted.
- Comparative findings:
  - Cryptocurrency: "standard deviation of day-on-day changes in Bitcoin prices is approximately 10 times higher than in most G7 currency pairs, and even a little higher than in the Venezuelan Bolivar to U.S. dollar exchange rate."
  - Central bank money: perfectly stable in nominal terms; value underpinned by government solvency in modern fiat systems.
  - I-money and B-money: risk depends on underlying asset safety and liquidity; government backstops are central to b-money safety.
  - E-money: stability of value comes from guaranteed redemption at face value, but lacks government backstops characteristic of b-money and thus must privately generate means to honor redemptions (strong balance sheet, legal structures).
- Identified risk types for e-money (in addition to operational/cyber risk):
  - Liquidity risk: lag before redemption requests can be met; depends on market liquidity of assets held by the e-money issuer.
  - Default risk: issuer defaults, leaving client funds at risk of seizure by other creditors; default can occur due to losses on other business activities or inability to meet debt obligations.
  - Market risk: losses on assets held by the e-money provider that can exceed capital and put redemptions at risk.
  - Foreign exchange rate risk: where claims are denominated in a currency other than the domestic unit of account (example: Libra denominated in a basket of currencies).
- Parallel drawn between e-money and constant net asset value (CNAV) funds: both pledge customers will at least get their money back; but CNAV funds do not typically have legal obligation to cap investor losses—runs can occur (example: money market funds “broke the buck” after Lehman bankruptcy).

### Measures to enhance e-money stability and protect client funds
- Institutional and design options to minimize risks:
  - Invest in safe and liquid assets such as short-term government paper; central bank reserves are the safest and most liquid and can be held directly or indirectly through a specialized bank or a special purpose vehicle with a bank license.
  - Contain creation of e-money so total issued is always lower or equal to value of client funds received; avoid over-issuance.
  - Ensure assets held are not encumbered (not pledged as collateral) and ideally segregated from the issuer’s balance sheet to protect client funds in case of bankruptcy.
  - Hold sufficient capital to offset losses and allow full redemption of client funds.
  - Strengthen regulation of e-money issuers quickly where necessary to protect customers and avoid risks to financial stability.
- Current practices and caveats:
  - Most popular assets held by e-money providers to date are bank deposits, which offer redemption on demand at face value but are subject to bank default risk.
  - E-money issuers are wholesale creditors; their funds are generally not protected by deposit insurance.
  - Client funds may be transferred to trusts to segregate funds from issuer balance sheets; trusts can protect client funds but legal protection varies across jurisdictions and may not be watertight everywhere—legal proceedings could delay fund re-appropriation.
  - Other legal structures may be more effective than trusts depending on country.

### Adoption dynamics: why e-money could spread rapidly
- Stability in the relevant unit of account is necessary for wide adoption, but not sufficient; convenience and other attributes can compensate for lesser stability.
- Six reasons e-money adoption may grow rapidly:
  - Convenience: better integration into digital lives; issuers understand user-centered design and social media integration.
  - Ubiquity: cross-border e-money transfers can be faster and cheaper than cash and bank deposits (subject to market-maker and redemption hurdles).
  - Complementarity: blockchain-based e-money could enable seamless delivery-versus-payment for tokenized assets, avoid manual back-office tasks, and be extended by developer communities (e.g., programmable restrictions on what e-money can purchase).
  - Transaction costs: transfers in e-money are nearly costless and immediate, often more attractive than card payments or bank-to-bank transfers, especially across borders.
  - Trust: in some countries users trust telecommunications and social media companies more than banks.
  - Network effects: as merchants and peers adopt e-money, its value to prospective users rises; network effects can amplify modest objective advantages into rapid, widespread adoption.
- Empirical and illustrative points:
  - "Ninety percent of Kenyans over age 14 pay with M-Pesa."
  - Value of e-money transactions in China (WeChat Pay and Alipay) surpass those worldwide of Visa and Mastercard combined.
  - Social network analogies:
    - WhatsApp adoption was "one-third faster than that of Gmail."
    - WhatsApp is "well past the 1.5 billion users mark" and surpassed Gmail in user-base.
  - Behavioral and social aspects: payments are social interactions; features like emojis, messages, photos, and customer ratings enhance the social appeal of e-money compared with debit card payments.

### Case example and emerging instruments
- Libra (example of i-money backed by a portfolio of assets):
  - Announced June 18, 2019; details still to be released in the source text.
  - Appears to be backed by a portfolio called Libra Reserves composed of bank certificates of deposit and short-term government paper.
  - Libra coins could be exchanged into fiat currency at any time for their share of the going value of the underlying portfolio, "without any price guarantees"—this sets Libra apart from e-money.
  - Transfer of Libra would be essentially shares of Libra Reserves (potentially without a legal claim) and would comprise a payment.
  - The source notes it does not advance a definite view as to whether Libra should be considered a security from a regulatory standpoint.
- Private investment funds and tokenization:
  - Private funds (money market funds, exchange-traded funds) offering relatively safe and liquid investments have been growing rapidly but do not yet offer widespread means of payment.
  - Shares in private investment funds could become i-money if tokenized; tokenized coins can be traded directly at low cost and constitute payments denominated in the underlying portfolio valued at the portfolio’s going worth in any currency.
  - Regulatory restrictions may apply because transfer of i-money entails transfer of ownership of securities, potentially limiting cross-border transactions.

*International Monetary Fund | July 2019*

### Section 3

### Effects of E-money on the Banking Sector

### Risks of Rapid E-money Adoption
- Regulatory frameworks generally exist but "need to be revised and strengthened."
- Large fintech and big tech firms offering financial services might be designated and regulated as being globally systemic.
- Guiding principle: regulation should be proportionate with the risks and types of services offered.
- Consumer protection and financial stability risks:
  - Runs on e-money with features of CNAV funds.
  - Privacy risks.
  - Risks to monetary policy transmission and seignorage following a drop in currency demand.
  - Risks to market contestability and financial integrity.
  - Risks to policymaking if data (for example on cross-border capital flows) are lost.
- Market contestability risk drivers:
  - Strong network effects favoring first movers.
  - Large fixed costs to establish operations at scale.
  - Exponential benefits of access to very large datasets enabling near-randomized trial–like inference of client behavior and peer effects.
  - Potential extension of monopoly position into related services leveraging the same dataset.
- Monetary policy transmission risk example:
  - Currency substitution in countries with weak institutions and high inflation: merchants and households may hold e-dollars and price goods in dollars, undermining central bank control.
- Financial integrity challenges with decentralized technologies:
  - Issuers and partners remain liable for AML/CFT obligations: identifying customers, monitoring transactions, reporting suspicious transactions, respecting UN or country-specific sanctions lists.
  - Decentralized verification with many fragmented entities (crypto-exchanges, governance bodies, wallet providers, client fund managers, market makers) makes enforcement difficult.
  - Increased need for international cooperation to avoid regulatory arbitrage and dilution of regulation.

### Scenario 1: Coexistence
- Key assessment: the most likely scenario is coexistence; "e-money and b-money will coexist; the battle will wage on."
- Banks’ strengths:
  - Captive users and strong distribution networks.
  - Ability to cross-sell financial services (overdraft protection, credit lines).
- Possible e-money provider funding behavior:
  - Recycle client funds to banks as certificates of deposit or other short-term funding (see Figure 4).
- Risks to banks under deposit substitution:
  - Swap cheap, stable retail funding for expensive, runnable wholesale funding.
  - Loss of client relationships and valuable transaction data.
  - Concentration of e-money provider funding in a few large banks, increasing funding strain/volatility for smaller banks.
- Bank responses:
  - Offer higher interest on deposits.
  - Improve services to retain deposits (including acquisitions of promising startups).
  - Find other funding sources (longer-term debt or equity).
- Interest rate dynamics:
  - E-money providers must hold very liquid assets and thus could offer approximately overnight money market rates.
  - Banks may be able to offer higher interest than e-money providers and conservative i-money providers (note: "Libra has announced that it will not offer any interest to users").
  - Higher deposit rates could be met with greater operational efficiency, lower profits, and potentially slightly higher lending rates.
- Payments competitiveness:
  - Banks can rival payment service quality domestically via innovations (touchless cards, phone-based apps like Venmo, Zelle, Apple Pay Cash).
  - Central-bank–rolled "fast payment" systems (example: TIPS—TARGET instant payment settlement) allow near real-time retail settlements at negligible cost.
  - Examples of bank/consortium responses: Swish (Sweden), JPM Coin.
- Central bank role in transition:
  - Provide temporary liquidity if banks lose deposits rapidly, though central banks will be reluctant to extend this crutch for too long due to balance sheet growth and difficult lending decisions.
  - Banks can alternatively issue longer-term debt or equity.

### Scenario 2: Complementarity
- E-money can complement commercial banks, already observable in some low-income and emerging market economies.
- Potential benefits:
  - Draw poorer households and small businesses into the formal economy.
  - Familiarize users with technologies and encourage migration from payments to credit, savings instruments, accounting services, and financial advice provided by banks.
  - Example: Kenya—credit growth increased steadily for several years as e-money was rapidly adopted after 2008.
- Partnership model:
  - E-money providers leverage data to estimate creditworthiness and sell findings or intermediate funding to banks for more efficient credit allocation.
  - Some large e-money providers may migrate to the banking business, attracted by margins from maturity transformation.

### Scenario 3: Takeover
- Description: radical transformation where banks mostly rely on wholesale funding and credit is increasingly intermediated by markets—the least likely scenario but a contingency to consider.
- Mechanics:
  - Payment-purpose deposits migrate to e-money and may be held abroad, in government bonds, or in central bank money.
  - Savings could be channeled to mutual funds, hedge funds, capital markets, or remain in banks that rely on wholesale funding.
- Consequences:
  - Greatly limits fractional banking; fractional banks hold only a fraction of deposits as liquid assets and lend the rest.
  - Questions and uncertainties (empirics scarce):
    - How much liquidity would be locked in e-money and unavailable for private-sector lending?
    - Would only liquidity buffers migrate or more (including uninsured deposits)?
    - Could monetary policy offset the effect?
    - Would credit be rationed or become more expensive because mutual and hedge funds must receive funding before extending loans?
    - Could specialized funds offer and hold nonstandard/illiquid loans (mortgages) and lock in funding long enough to support credit during stress?
    - What portion of loans could be securitized and mutualized?
    - Could monitoring and screening functions be taken up by funds, specialized agencies with skin in the game, or technology (artificial intelligence and big data analytics)?
    - Interaction with shadow banking: would flows move from shadow to e-money providers, potentially enhancing welfare?
- Transition risk: potentially rocky and urgent empirical investigation is needed to assess costs and risks of a world with more e-money.

### The Role of Central Banks and Synthetic CBDC
- Current central bank stance:
  - Central banks have historically favored fractional banks by supervising banks and offering liquidity.
  - Central banks settle interbank payments via central bank reserves held in bank accounts to remove credit risk and ensure interoperability across banks.
  - Interoperability levels the playing field between banks.
- Proposal: e-money providers holding central bank reserves
  - Some central banks already offer special-purpose licenses allowing nonbank fintech firms to hold reserve balances subject to approval (Reserve Bank of India, Hong Kong Monetary Authority, Swiss National Bank).
  - Bank of England is discussing similar prospects.
  - China requires large payment providers (Alipay and WeChat Pay) to hold client funds at the central bank as reserves.
  - Allowing e-money providers to hold central bank reserves would transform them into narrow banks (cover 100 percent of liabilities with central bank reserves and do not lend to the private sector; they merely facilitate payments).17
- Effects on fractional banks:
  - Would lose wholesale funding from e-money providers.
  - Banks could still compete via service offerings and some e-money providers might persist in funding banks or evolve into banks themselves (link to Scenarios 1 and 2).
- Run risk considerations:
  - Could there be massive runs from bank deposits into e-money in crises?
    - If client funds backing e-money were held as wholesale funding for banks, runs could reverse (from e-money to b-money) as clients seek deposit insurance.
    - If client funds were held as reserves at the central bank, run risks cannot be discounted; uninsured deposits might migrate from banks to e-money providers.
  - Attenuating points:
    - Systemic bank runs in many countries are associated with runs to foreign currencies and would occur irrespective of e-money.
    - Existing safe and liquid assets (e.g., Treasury-only funds) did not see massive inflows during the global financial crisis.
    - Bank runs can be countered by central bank lending if effects are temporary, balancing inflows to central bank reserves.
  - Conclusion: the risk of rapid disintermediation should be taken seriously.

### Potential Advantages of Central Bank Reserve Access for E-money Providers
- Stability:
  - E-money backed by central bank reserves can eliminate liquidity and market risk and attenuate default risk, reducing the likelihood of costly runs and devaluations that undermine payments system confidence and financial stability.
  - Facilitates oversight of issuance when client funds are dispersed across many banks.
  - With appropriate legal structures and regulatory reforms, e-money could be credibly redeemable at par for domestic currency.
- Interoperability and competition:
  - Central banks could ensure interoperability of payments and protect consumers from e-money monopolies.
  - Contemporaneous transfers of client funds across e-money providers’ trust accounts would be seamless if carried out on the central bank’s books, ensuring newly held e-money is fully backed and redeemable.

*Source: ftnea2019001 - Section 3, "Effects of E-money on the Banking Sector."*

### Section 4

### ftnea2019001 - Section 4

### Interoperability, competition, and access to central bank accounts
- Central banks could require e-money providers with access to their accounts to adopt technological standards allowing e-money wallets to “talk to each other,” enhancing interoperability and competition.
- Allowing e-money providers to hold central bank reserves would spur:
  - innovation,
  - enable the trading of blockchain-based assets,
  - facilitate cross-border payments (topic taken up in Adrian (2019)).
- Several advantages from offering e-money providers access to central bank reserves could be achieved through other means, but many of those means remain incomplete and potentially less effective (for example, client funds in custodian accounts or bank deposits might not be immediately transferred following the sale of e-money from one provider to another, thus limiting interoperability).

### Risk of large e-money monopolies and domestic policy responses
- Central banks and regulators might not be able to contain the growth of large e-money monopolies:
  - Could be large international firms operating as nearly natural monopolies given network effects, rents from access to data, and the sunk costs required for entry.
- Policy option: give preference to domestic e-money providers operating under direct supervision by:
  - offering them the means to issue money that is perfectly safe and liquid, and thus potentially more attractive than the foreign offering;
  - retaining seignorage revenue, to the extent the central bank did not pay interest on reserves held by e-money providers.
- Footnote 18 clarifies: If central banks did pay interest on reserves, and if competition forced providers to transfer this interest income to e-money holders, then seignorage can be thought of as being rebated to the population. Seignorage here is defined as the profits made by the central bank by issuing liabilities at a rate lower than that received on assets.

### Monetary policy transmission and interest on reserves
- Monetary policy transmission could be more effective for two reasons:
  - By offering an attractive means of payment in domestic currency, substitution into foreign currency (“dollarization”) provided by global e-money providers is less likely.
  - Central banks could pay interest on the reserves held by e-money providers, more directly transmitting monetary policy rates to consumers and putting greater pressure on banks to offer rates on deposits closer to the policy rate to avoid losing customers.
- The interest paid to e-money providers could differ from the interest paid to commercial banks on reserves, and the wedge between the two rates could be a policy variable in and of itself (footnote 19).
- Interest on e-money could be brought into negative territory, which would:
  - alleviate the constraint of the effective lower bound;
  - counter the risk that zero-yielding e-money would allow households and firms to circumvent negative rates on bank deposits.

### Licensing, supervision, and consumer protection
- Central banks could establish clear conditions to grant licenses to e-money providers, including strict supervision and oversight by the central bank or other authority.
- Selected providers would be responsible for:
  - appropriate customer screening,
  - transaction monitoring and reporting in accordance with know-your-customer and anti-money-laundering regulation,
  - security of wallets and customer data.
- Control over who can receive and hold e-money may help limit its spread beyond a country’s borders.

### Limits of alternatives and shadow-banking concerns
- If e-money providers are kept out of central bank reserves, many regulatory advantages would be lost:
  - e-money providers would remain in the less regulated shadow-banking realm;
  - countries may find it difficult to impose appropriate regulation such as requiring disclosure of risks to clients, and sufficient capital and liquidity buffers.
- Historical lesson: CNAV funds after Lehman showed that full disclosure of risks may not be well understood by clients.

### Synthetic Central Bank Digital Currency (sCBDC)
- Allowing e-money providers to hold central bank reserves leads to an immediate consequence: the creation of central bank digital currency, because:
  - if e-money providers can hold and transact in central bank reserves,
  - if these reserves are protected against other creditors when the e-money provider goes bankrupt,
  - and if e-money is issued one for one for reserves,
  - then e-money holders can essentially hold and make transactions in a central bank liability — the essence of CBDC.
- The full-fledged CBDC model (central bank as major operator) would make central banks responsible for:
  - performing customer due diligence,
  - offering or vetting wallets,
  - developing or selecting the underlying technology,
  - offering a settlement platform,
  - managing customer data,
  - monitoring transactions,
  - interacting with customer requests, complaints, and questions.
- These functions entail risks of glitches and cyberattacks, significant costs, and reputational risk for the central bank.

### sCBDC as a public-private partnership model
- Proposed alternative: “synthetic CBDC,” or “sCBDC,” a public-private partnership in which:
  - the central bank offers settlement services to e-money providers, including access to central bank reserves;
  - all other functions remain the responsibility of private e-money providers under regulation.
- Rationale and advantages:
  - sCBDC is a far cheaper and less risky model of CBDC for central banks relative to the full-fledged model;
  - preserves the comparative advantage of the private sector to innovate and interact with customers, and of the central bank to provide trust and efficiency.
- Conditions and constraints:
  - the public must understand the limited responsibility of the central bank and not see sCBDC as an entirely central-bank-branded product, to avoid reputational risk.
  - As with commercial banks today, fraud or technical glitches related to a person’s debit card are not blamed on the central bank, even though commercial banks have access to reserves.
- Footnote 20 clarifies: The term “synthetic” does not imply that the underlying assets—in this case reserves—are not needed, but that CBDC as a form of money can be recreated using different building blocks.

### Unanswered questions and broader implications
- Whether sCBDC will be the central bank money of the future, and whether it will rival b-money and potentially i-money, depends on:
  - decisions by central bankers, regulators, and entrepreneurs.
- Many broader considerations (financial inclusion, cost efficiency, safety of the payments system, consumer protection if cash disappears, and settlement services provided by large private sector players) are relevant to the CBDC debate but lie outside the scope of this section.

*Source: ftnea2019001 - Section 4 (IMF FINTECH NOTES, July 2019).*

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_Source: https://www.imf.org/-/media/files/publications/ftn063/2019/english/ftnea2019001.pdf_