## sdn1808 ## Source details **Canonical URL:** [sdn1808](https://www.imf.org/-/media/files/publications/sdn/2018/sdn1808.pdf) ## Other formats - [Markdown version](/-/media/files/publications/sdn/2018/sdn1808.pdf.md) - [Structured JSON version](/-/media/files/publications/sdn/2018/sdn1808.pdf.json) --- ### EXECUTIVE SUMMARY — overview and approach - Digitalization is reshaping economic activity, shrinking the role of cash, and spurring new digital forms of money; central banks are considering whether and how to adapt via central bank digital currency (CBDC)—a widely accessible digital form of fiat money that could be legal tender. - The note proposes a conceptual framework to assess CBDC adoption from users’ and central banks’ perspectives, abstracting from cross-border considerations by assuming CBDC is for domestic use only. - It discusses CBDC designs, explores potential benefits and costs with emphasis on monetary policy, financial stability, and integrity, and surveys central bank research and pilots. ### Key takeaways on impact and critical design features - Impact hinges on design and country-specific characteristics; critical features include anonymity (traceability), security, transaction limits, and interest paid. - CBDC could strengthen payment-system benefits and encourage financial inclusion, but demand depends on attractiveness of alternatives. - CBDC faces operational risks from disruptions and cyberattacks; further analysis of technological feasibility and operational costs is needed. - Conclusion: too early to draw firm conclusions on net benefits; central banks should consider country circumstances and alternative solutions. ### CBDC design types and technical notes - Token-based CBDC (transfer of an object): - Could extend attributes of cash to digital form; provide varying degrees of anonymity and immediate settlement. - Could curtail private anonymous payment development but increase risks to financial integrity; size limits on payments and holdings would reduce but not eliminate concerns. - Verification and settlement can be centralized or decentralized; DLT possible but currently short on scalability, energy efficiency, and payment finality. DLT could run on a closed (“permissioned”) network managed by the central bank, though other centralized settlement technologies may be more efficient. - Account-based CBDC (transfer of claims on accounts): - Payments resemble current commercial bank transactions but with accounts at the central bank; exchanges require substantial verification (payer authority, sufficient funds, payee authenticity). - Could increase risks to financial intermediation, raise funding costs for deposit-taking institutions, and facilitate bank runs during distress. - Careful design and accompanying policies can reduce but not eliminate these risks. ### User perspective, competitive landscape, and demand implications - Competing monies (four categories): cash; commercial bank deposits; narrow finance (stored value facilities and narrow banks); and cryptocurrencies. - Comparative findings: - Cash: immediate settlement, no default/cyber risk, full anonymity; high transaction costs, vulnerable to theft, no interest. - Commercial bank deposits: historically facilitated by debit card networks; recent wrapper technology and central-bank-provided fast-payment solutions have greatly improved attractiveness. - Fast-payment examples and timing cited in the source (select jurisdictions and services noted in the original text). - Narrow finance: - Stored value facilities (examples cited in the source). - Narrow banks: funds invested only in highly liquid and safe government assets, allowing payments via liabilities. - Cryptocurrencies: not liabilities of institutions, unbacked, often volatile; transactions settled via decentralized DLT. - CBDC relative position: - Would not strictly dominate alternatives; closely competes with evolving commercial bank deposits and e-money. - Stands out on anonymity and default risk; on par with fast payments for acceptance, settlement risk, and transaction cost (with good interfaces); likely superior on default risk in many jurisdictions. - Flexible features (interest, theft protection, scalability, anonymity) trade off against each other; full anonymity likely only with strict low holding/payment limits, undermining scalability. - If CBDC paid the policy rate, it would be as attractive as narrow finance solutions, though commercial banks could still offer higher deposit rates. - Demand implications: - May be low in advanced economies (except as cash replacement); could be attractive where banking penetration is limited and settlement platforms unreliable. - CBDC would compete mostly with cash for small-value transactions with some anonymity and could potentially replace paper bills over time. ### Central bank objectives, social criteria for money, and cash dynamics - Central bank public-policy goals to preserve: financial integrity, financial stability, and monetary policy effectiveness; these support money’s three functions (means of payment, store of value, unit of account). - Monetary policy constraints: - CBDC is unlikely to assure price stability in all circumstances. - Policy rates cannot be brought significantly below zero without risking a massive shift into cash; only widespread long-term CBDC adoption with cash elimination would allow deep negative rates if CBDC charged negative rates and cash did not coexist. - Alternative measures to allow deeply negative rates have questionable feasibility and do not necessarily require CBDC. - Financial inclusion and access: - CBDC could ensure equal access to payments and favor inclusion, but other solutions (fast payments, subsidized distribution, private-sector solutions) may be more efficient depending on barriers. - Cash trends and key statistics: - Cash in circulation as a share of GDP is currently half its value 10 years ago, representing merely 6 percent of central bank liabilities and 2 percent of the money supply. - In payment-volume examples: cash share of payments is 82 percent by volume in Austria (63 percent by value), but 46 percent in the United States (23 percent by value). ### Security, consumer protection, and market power considerations - Private issuers of money may under-invest in security and not internalize social costs of systemic disruptions (cyberattacks, negligence). - Central banks more likely to invest in security but cyber risks remain; CBDC could offer a backup in some disruption scenarios, though both digital money and cash have vulnerabilities in large-scale catastrophic events. - Consumer-protection risk: disappearance of cash could increase private-provider market power; CBDC (or low-cost fast payments) could restore competitive constraints if antitrust and data protections are insufficient. ### Privacy versus financial integrity - Trade-off between privacy (cash anonymity) and financial integrity (AML/CFT); most cash in circulation concentrated in the top two denominations and often associated with illicit use or store of value. - Eliminating cash would undermine privacy and may not improve financial integrity as illicit transactions may migrate to other monies; removing high-denomination bills is more appealing to curb illicit use. - CBDC design can strengthen integrity via transaction size limits or strong identity authentication and recording, but risks exist (trust in privacy safeguards, central bank responsibility for compliance failures, real-time scrutiny limits). - Fully anonymous CBDC with large-value transactions would undermine financial integrity relative to cash and current noncash systems; any CBDC design should accommodate effective AML/CFT measures. ### Financial stability and banking intermediation — scenarios, mechanisms, and policy options - Baseline: CBDC characteristics similar to bank deposits—traceability and protection from theft/loss. - Two scenarios analyzed: - Scenario 1 — Tranquil period (risk of disintermediation): - Some depositors may switch to CBDC; banks may raise deposit rates, compressing interest margins and possibly raising lending rates, reducing loan demand. - Banks with greater market power can pass deposit-rate increases to loan rates more easily; banks with less market power may face larger contraction in deposit and loan volumes. - Banks can replace lost deposits with wholesale funding (commercial paper, bonds, equity), which may be more expensive and less stable; implications: - Implication 1: Bank funding cost likely to rise because deposit insurance and implicit guarantees lower deposit costs; switching away from deposits could reduce profits or raise lending rates. - Implication 2: Market discipline could change depending on insured/uninsured depositors leaving; diminished discipline could encourage risk-taking. - Implication 3: Funding could become less stable because wholesale funders are more volatile; banks might hold more liquid assets or cut lending. - Heterogeneous impacts: greater disintermediation where banks have large retail-deposit shares or nonbank lenders are prevalent. - Central bank responses: limit CBDC holdings per individual; discourage convertibility from deposits to CBDC (fees); lend diverted funds back to banks (expanding central bank balance sheet and credit risk); allow banks to manage CBDC wallets to maintain customer relationships. - Scenario 2 — Systemic stress (run risk): - CBDC could facilitate runs by offering a safe, liquid alternative. - Muting factors: CBDC would not facilitate idiosyncratic runs between banks (electronic movement of funds across banks already exists); in currency/sovereign crises funds leave all local assets including CBDC. - If very safe/liquid alternatives already exist, CBDC may matter less. - CBDC could help central banks ease liquidity pressures and contain runs by facilitating provision of reserves and cash replacement—particularly useful in geographically vast countries where moving cash is costly. - Empirical context: central banks provided liquidity assistance in almost 96 percent of the 151 crisis episodes studied by Laeven and Valencia (2018). ### Deposit insurance, liquidity provision, and monetary policy transmission - Deposit insurance can alleviate run risks associated with CBDC introduction. - In the Laeven and Valencia (2018) sample: median peak liquidity provision was 15.3 percent in countries with deposit insurance; it was 22.4 percent of deposits for countries without it. - Recommendation: Countries adopting CBDC should have a deposit insurance scheme to lower the probability of runs. - Effectiveness depends on fiscal backstop credibility and coverage extent. - Monetary policy transmission: - CBDC introduction is unlikely to significantly affect main transmission channels under plausible designs; may even strengthen transmission via increased financial inclusion. - Channel-specific notes: - Basic interest-rate channel: may strengthen, especially if CBDC is interest bearing. - Bank lending channel: could strengthen if CBDC increases banks’ wholesale funding share. - Credit channel: unlikely to be markedly affected. - Exchange-rate channel: unlikely to be affected. - Preconditions and operational adjustments: - Central banks must remain able to affect market interest rates relevant to these channels, affect term spreads via communication, and control interest rates on reserves while banks demand reserve balances. - CBDC could displace cash and partially drain reserves; central banks can replenish reserves via liquidity-injecting open market operations and consider a floor system (paying interest on reserves) to stabilize rates. - Extreme stress case (banks no longer intermediate payments): - If banks lose payment-intermediation business and demand for reserves disappears, monetary policy can remain effective by paying interest on CBDC, which would put a floor on interest rates if CBDC is provided without limit. ### Central bank research, pilots, and prevailing design choices - Extent of exploration: several central banks in advanced and emerging markets are considering retail CBDC; a subset are actively exploring retail CBDCs (jurisdictions summarized in the source). - Motivations: - Advanced economies: declining cash use, countering private money growth, reducing cash-management costs. - Emerging markets: fostering financial inclusion, reducing cash distribution costs and risks. - Monetary policy at the zero lower bound was not cited as a rationale by central banks surveyed. - Design trends: - Most central banks contemplate account-based CBDC with various anonymity levels; some token-based solutions exist. - Examples in the source: Eastern Caribbean Central Bank and the People’s Bank of China considering both account- and token-based approaches; People’s Bank of China considering fully anonymous token-based wallets with low payment limits. - Many central banks avoid fully anonymous CBDC to meet Financial Action Task Force requirements. - Availability and offline capability: - Several central banks indicated CBDC should be available 24/7, mimicking cash. - Canada, China, and Sweden are investigating offline capability via preloaded tokens and encrypted messaging to point-of-sale terminals, with limits on such transactions. - Interest-bearing CBDC: - None of the central banks surveyed are seriously considering interest-bearing CBDC because of concerns about financial intermediation, lending contraction, and bank balance-sheet volatility. - Sweden’s proposed e-krona will have built-in ability to pay interest if decided. - Infrastructure and costs: - Marginal costs of managing physical cash are likely higher than CBDC, but high up-front fixed costs may favor CBDC adoption in larger economies. - Most central banks plan to outsource CBDC development and maintenance under close supervision; some consider cost-sharing with third parties. - Offline resilience caveat: digital money remains susceptible to catastrophic events that could knock out communications and power for extended periods (historical example cited in the source). ### Findings, concluding messages, and policy guidance - CBDC could be the next milestone in money’s evolution; it is a digital form of existing fiat money, issued by the central bank and intended as legal tender, implementable with a variety of technologies. - Three-step framework to assess CBDC value: - Identify user evaluation criteria for forms of money. - Establish central-bank public-policy goals for money. - Lay out competitive landscape of existing and evolving monies. - No universal case for CBDC adoption: - Demand depends on attractiveness of alternatives. - In advanced economies, CBDC may replace cash for small-value, pseudo-anonymous transactions. - In low-penetration and inefficient-settlement jurisdictions, demand may be greater. - Key findings (paragraph 68 highlights): - CBDC may reduce societal cash costs. - May improve financial inclusion where private solutions fail. - Could bolster payment-system security and consumer protection where regulation is insufficient. - Regulation and novel payment solutions remain compelling alternatives to CBDC. - Risks and mitigants: - Monetary policy: unlikely to be significantly affected; may benefit from inclusion. - Financial integrity: CBDC may enhance integrity in some situations but entail risks if poorly designed. - Banking sector: CBDC could raise deposit-taking funding costs and intensify run risk; design choices and policies can mitigate concerns. - Operational/reputational: malfunctions and cyberattacks remain challenges. - Recommended research agenda and cross-border questions: - Practical access: tourist and foreign access to CBDC. - Compliance and standardization: cross-border KYC and AML/CFT implications. - Currency substitution and safe-haven flows: exposure of weak-institution countries if reserve-currency CBDC access available. - Central bank cooperation and risk allocation for cross-border CBDC usage. - Research should proceed resolutely given deep, difficult, and far-reaching implications. *CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY (SDN1808), International Monetary Fund* ### EXECUTIVE SUMMARY __________________________________________________________________________ 4 ### EXECUTIVE SUMMARY ### Overview - Digitalization is reshaping economic activity, shrinking the role of cash, and spurring new digital forms of money. Central banks have been pondering whether and how to adapt. One possibility is central bank digital currency (CBDC)—a widely accessible digital form of fiat money that could be legal tender. - This discussion note proposes a conceptual framework to assess the case for CBDC adoption from the perspective of users and central banks. It abstracts from cross-border considerations by assuming that CBDC is for domestic use only. - The note discusses possible CBDC designs, and explores potential benefits and costs, with a focus on the impact on monetary policy, financial stability, and integrity. It also surveys research and pilot studies on CBDC by central banks around the world. ### Key takeaways on impact and critical design features - The impact of CBDC introduction will hinge on its design and country-specific characteristics. Critical features will be anonymity (the traceability of transactions), security, transaction limits, and interest earned. The role of cash and commercial bank deposits in payments will also matter. - CBDC could strengthen the benefits and reduce some of the costs and risks to the payment system and could help encourage financial inclusion. However, demand will not necessarily be very high and will depend on the attractiveness of alternative forms of money. - There are other payment solutions to help central banks more fully achieve their goals relative to money. CBDC will have to contend with operational risks arising from disruptions and cyberattacks. - Overall, it is too early to draw firm conclusions on the net benefits of CBDC. Central banks should consider their specific country circumstances, paying careful attention to the risks and relative merits of alternative solutions. Further analysis of technological feasibility and operational costs is needed. ### Token-based CBDC (token = transfer of an object) - Token-based CBDC—with payments that involve the transfer of an object (namely, a digital token)—could extend some of the attributes of cash to the digital world. - Token-based CBDC could provide varying degrees of anonymity and immediate settlement. - It could thus curtail the development of private forms of anonymous payment but could increase risks to financial integrity. - Design features such as size limits on payments in, and holdings of, CBDC would reduce but not eliminate these concerns. - Technical note: verification of tokens and settlement could be centralized or decentralized. Decentralized settlement is possible via distributed ledger technology (DLT), but DLT currently falls short in scalability, energy efficiency, and payment finality. DLT could be used over a closed (“permissioned”) network managed by the central bank, though other centralized settlement technologies may prove more efficient. ### Account-based CBDC (transfer of claims on accounts) - Account-based CBDC—with payments through the transfer of claims recorded on an account—could increase risks to financial intermediation. - It would raise funding costs for deposit-taking institutions and facilitate bank runs during periods of distress. - Careful design and accompanying policies should reduce, but not eliminate, these risks. - Account-based CBDC transactions would resemble today’s transactions between commercial bank depositors, except accounts would be held with the central bank; exchanges would require substantial verification (payer authority, sufficient funds, payee authenticity). ### Monetary policy transmission and other central bank objectives - CBDC is unlikely to affect monetary policy transmission significantly, although operations may need adaptation. - Transmission could strengthen if CBDC spurs greater financial inclusion. - Interest-bearing CBDC would eliminate the effective lower bound on interest rate policy, but only with constraints on the use of cash. - Central banks must weigh CBDC design against social criteria for money: price stability as a unit of account; universal availability, verifiability, efficiency, consumer protection, and minimal taxpayer cost as a means of payment; and secure store of value while allowing efficient allocation of resources. - One important user criterion highlighted is the ability to make anonymous transactions; anonymity can serve privacy and limit customer profiling, and is tied to recognized human-rights protections. ### Research, pilots, and recommended approach - Several central banks have studied the adoption of CBDC and have undertaken pilots, while many have not actively explored it and remain skeptical. - The note summarizes pilot projects and analyses from central banks exploring CBDC, drawing on publicly issued materials and discussions with central bank and technology provider staff. - Central banks should consider country-specific circumstances and carry out further work on technological feasibility and operational costs before deciding on CBDC adoption. *International Monetary Fund — CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY (EXECUTIVE SUMMARY)* ### 18. In addition, central banks will prefer forms of money that support, or at least do not ### sdn1808 - 18. In addition, central banks will prefer forms of money that support, or at least do not ### Central bank evaluation criteria and public policy goals - Central banks will prefer forms of money that support, or at least do not undermine, three public policy goals: financial integrity, financial stability, and monetary policy effectiveness. - Financial integrity includes AML/CFT rules, customer due diligence measures, additional measures aimed at fighting corruption, and fostering good governance. - These public policy goals in turn support the three functions of money (means of payment, store of value, unit of account). ### Historical context: The birth of central banking (Box 1) - Coins dominated medieval and early Renaissance payments but imposed high transportation costs as commerce spread. - Bills of exchange reduced transport costs but carried counterparty risk when debtor banks did not pay. - The Bank of Amsterdam (established in 1609) reduced these risks by standing ready to pay high-quality Dutch guilders against bills and, in 1683, offering account balances to settle bills of exchange and later suspending the right of coin withdrawals. - At its peak in the mid-1700s, yearly turnover through accounts at the Bank of Amsterdam was more than 2.5 times Dutch GDP. - The Bank of Amsterdam provided immediate and final settlement and liquidity backstops to merchant banks funded with bills of exchange—anticipating modern state roles in payment safety (bank supervision, lender of last resort, deposit insurance). ### Competitors to CBDC (paragraphs 19–22) - Competitors fall into four categories (vary by country): cash, commercial bank deposits, narrow finance, and cryptocurrencies. - Cash: immediate settlement, no default or cyber risk, full anonymity; high transaction costs and vulnerability to theft; no interest. - Commercial bank deposits: - Historically facilitated by debit card networks; recent transformations include wrapper technology and central-bank-provided fast-payment solutions. - Wrapper technology example: Venmo in the United States (enables mobile-device transactions, bypassing point-of-sale terminals and adding security). - Fast-payment solutions: allow payments of any size and type to be settled instantaneously by the central bank in reserve money via a dedicated platform running continuously at negligible cost. - Examples and timing: European Central Bank’s Target Instant Payment Settlement service (to be introduced in November 2018); Hong Kong SAR’s Faster Payments (introduced in August 2018); Sweden’s Swish; Denmark’s Straksclearing; Australia’s New Payments Platform. - Fast payments can be viewed as a form of CBDC offered through a public-private partnership, allowing settlement in central bank reserves at will through banks. - Narrow finance solutions (term introduced in this note): - Privately provided money backed one for one by central bank liabilities (cash or reserves), offering stable nominal value, security, liquidity, and potentially close to a risk-free rate. - Two versions: - Stored value facilities (examples: AliPay, WePay in China; PayTM in India; M-Pesa in Kenya; Bitt.com in the Caribbean): private e-money issued against funds placed in custodian accounts; centrally cleared within networks; some risk depending on access to and use of custodian funds. - Narrow banks: institutions investing client funds only in highly liquid and safe government assets (such as excess reserves at the central bank) and not lending, while allowing payments via liabilities (debit cards or privately issued digital money). - Cryptocurrencies: - Examples: Bitcoin, Ethereum, Ripple. - Not liabilities of any institution, not backed by assets, often volatile due to rigid issuance rules. - Some attempt stabilization by controlling issuance according to price deviations (examples: Basecoin, Stablecoin). - Transactions are settled in a decentralized fashion using distributed ledger technology. ### User perspective: how monies rank and CBDC’s competitive position (paragraphs 23–25) - Evaluation method: spider charts (Figure A1.1 of Appendix I) rank competing monies by criteria; higher scores are farther from center; liquidity treated as given. - Comparative findings: - Cash: low attractiveness due to high transaction costs, meeting-in-person requirement, withdrawal difficulties in remote areas, vulnerability to theft, no interest; advantages are immediate settlement, no default/cyber risk, full anonymity. - Cryptocurrencies: lowest attractiveness; low settlement speed (technological limitations); main advantage is anonymity. - Private e-money (stored value facilities): scores high on acceptance, low transaction costs, user-friendly interfaces, full-service bundling; narrow banks could reduce default risk and enable larger-value payments. - Commercial bank deposits (traditional): average value—security from theft/loss and integration with services vs. limited acceptance and scalability; recent fast-payment reforms have greatly improved attractiveness (completely scalable, widely accepted without network limits, no settlement risk, limited default risk where deposit insurance exists, minimal transaction costs). - CBDC’s position: - CBDC would not strictly dominate alternatives; closely competes with evolving commercial bank deposits and e-money. - CBDC stands out in anonymity and default risk. - Fixed design features: on par with fast payments for acceptance, settlement risk, and transaction cost (assuming well-designed mobile interfaces); likely superior on default risk in many jurisdictions; scores poorly on offering additional services (banks could front-end manage CBDC and cross-sell). - Flexible design features: CBDC could offer interest, protection from theft/loss, scalability, and varying degrees of anonymity—though not all simultaneously, because these features trade off against each other (e.g., greater anonymity increases difficulty reversing fraud and claiming ownership; full anonymity likely only with strict low limits on holdings, undermining scalability). - If CBDC paid the policy rate, it would be as attractive as narrow finance solutions, though commercial banks could still offer higher deposit rates. - Demand implications: - Demand for CBDC depends on design. - May be low in advanced economies (except as cash replacement) but could be attractive in jurisdictions with limited banking penetration and unreliable settlement platforms. - CBDC would compete mostly with cash for small-value transactions with some degree of anonymity and could potentially replace paper bills over time. ### Central bank perspective and social criteria for money (paragraphs 26–30) - Central bank objectives for CBDC: enhance social dimensions of money’s three functions and support financial integrity, financial stability, and monetary policy effectiveness. - Monetary policy constraints: - CBDC is unlikely to provide near-term assurance of price stability in all circumstances. - The global financial crisis showed policy rates cannot be brought significantly below zero without risking a massive shift into cash (zero-return safe asset). - Cash likely to persist for political reasons; only widespread long-term CBDC adoption with cash elimination would allow policy rates to go deep into negative territory—only if CBDC charged negative rates and did not exist alongside cash. - Alternative measures to enable deeply negative policy rates have been proposed but have questionable feasibility and do not necessarily require CBDC. - Financial inclusion and access: - CBDC could ensure equal access to a means of payment and favor financial inclusion, but other solutions may be more efficient depending on inclusion barriers. - If cash is difficult to obtain/use in underpopulated/rural areas, CBDC could help; however, if access to technology is limited, CBDC may not be viable. - Private-sector solutions (examples: M-Pesa in Kenya, PayTM in India) have succeeded, sometimes with state support. - Government interventions could include subsidizing cash distribution, subsidizing bank branches, facilitating online banking and communications infrastructure, or deploying fast payments. - If barriers stem from aversion to formalization, neither CBDC nor other initiatives may satisfy. - Cash provision costs and CBDC economics: - Issuing and managing cash are costly. Estimates: 0.5 percent of GDP for the euro area (Hasan, De Renzis, Schmiedel (2013)), similar to costs in Canada (Kosse and others 2017) and Uruguay (Alvez, Lluberas, and Ponce 2018). - Costs mainly fall on banks, firms, and households. - CBDC would likely entail substantial fixed costs but low marginal operational costs; business case likely better for larger jurisdictions that can absorb fixed costs. - Financial intermediation tension: - CBDC would not resolve the tension between offering a secure store of value and promoting financial intermediation. - Narrow finance solutions provide a liquid secure store of value at the cost of reduced financial intermediation because payments must be fully prefunded. - Fractional reserve banks pool liquidity buffers and can lend a portion of funds due to non-simultaneity of shocks. - If narrow banking grows, central banks should be concerned, but CBDC would not reverse the trend because CBDC also requires full prefunding. - Fast payments would help fractional reserve banks offer money that competes with stored value facilities and other narrow finance solutions. *Source: CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY (selected passages).* ### 31. Other potential benefits of CBDC must be seen against the backdrop of a reduction in ### 31. Other potential benefits of CBDC must be seen against the backdrop of a reduction in the use of cash ### Declining use of cash and drivers - Trend: Use of cash is already declining in some countries and is expected to become more widespread; Sweden is highlighted as the most striking example. - Counterpoint: In some countries cash in circulation as a share of GDP has increased in the past decade, but much of that movement appears cyclical and partly explained by low interest rates. - Demographic and structural drivers: - Demand for cash likely to diminish as older generations give way to more technology-adept generations. - Merchants and banks in both advanced and developing economies are trying to discourage cash transactions because of related costs. - Key statistic: Cash in circulation as a share of GDP is currently half its value 10 years ago, representing merely 6 percent of central bank liabilities and 2 percent of the money supply. ### Closer look at demand for cash (Box 2) - Observations: - In many countries, currency in circulation has increased significantly in the past decade, but much of this increase seems cyclical (linked to lower interest rates, higher uncertainty, and economic recoveries). - The unexplained (residual) component of cash in circulation—loosely associated with preferences—has often decreased or remained stable in selected countries. - Only Switzerland and the United States show a marked increase in this residual component, in part because of reserve currency status. - Behavioral patterns and payment system context: - Cash still accounts for a large share of transaction volumes, though not of value, even in advanced economies. - Use of cash is subject to habit, increases with age, and decreases with education and income. - Cash use is generally lowest in countries with the most developed payment systems. - Example: Cash share of payments is 82 percent by volume in Austria (63 percent by value), but 46 percent in the United States (23 percent by value). ### Security of the payment system and alternatives to CBDC - Concern: As cash use wanes, a payment system dominated by private firms raises security concerns. - Risks with private issuers: Private issuers of money, including stored value facilities, may not internalize social costs of systemic disruptions (cyberattacks or negligence) and may under-invest in security. - Central bank advantages and limits: - Central banks would be more prone to invest in security, but cyberattack risks would not disappear. - CBDC could offer a backup if digital infrastructure disruptions materialize (subject to caveat: large-scale natural disasters and power outages could affect CBDC; cash also requires electricity for infrastructure). - Alternatives to CBDC for security: - Deploy fast payments, which give central banks control over an essential piece of the payment architecture. - Adequate regulation to bolster security of privately provided money. ### Consumer protection, market power, and role of CBDC - Risk: Disappearance of cash could pose risks to consumer protection because modern payment systems tend to become natural monopolies (network externalities, decreasing average costs, high fixed costs, data aggregation benefits). - Market outcome risk: Private monopolistic providers may offer inadequate/expensive services and could take unfair advantage of data. - Competitive role of cash and potential CBDC role: - Prevalence of cash may have limited monopoly power of private monies. - If antitrust regulation and data protection prove insufficient, CBDC could serve as low-cost competition; low-cost fast payments could also serve that purpose. ### Summary of alternative benefits of CBDC - Potential CBDC benefits: - Help central banks satisfy some social criteria of money more fully. - Reduce societal cost associated with use of cash. - Potentially benefit financial inclusion if private-sector solutions and policy efforts fail. - Could, under some circumstances, help central banks bolster payment system security and consumer protection. - Limitations: - CBDC will not support efficient allocation of resources. - Regulation and fast-payment platforms are compelling alternatives to achieve many of the same goals. ### Privacy versus financial integrity - Trade-off: National authorities already face a trade-off between privacy (cash anonymity) and financial integrity (cash facilitates money laundering, terrorism financing, corruption, tax evasion). - Concentration: Most cash in circulation is in the top two largest denominations, often associated with illicit payments or store of value. - Implications of eliminating cash: - Eliminating cash would undermine privacy and is unlikely to improve financial integrity because illicit transactions may migrate to other forms of money. - Removing high-denomination bills is a more appealing policy proposal for curbing illicit use than eliminating all cash. - CBDC design choices and effects: - CBDC can strengthen financial integrity if it imposes strict transaction size limits or facilitates strong identity authentication and tracking of payments. - Identities would be authenticated through customer due diligence procedures, and transactions recorded. - Risks and open questions include: Would users trust privacy safeguards? Would central banks be held responsible for compliance failures even if due diligence were outsourced? To what extent could authorities scrutinize transactions in real time? - CBDC offering full anonymity and large-value transactions would undermine financial integrity relative to cash and current noncash systems. - Whatever design is chosen, it should accommodate effective AML/CFT measures. ### Financial stability and banking intermediation: scenarios and mechanisms - Baseline assumption: CBDC characteristics similar to bank deposits—traceability and protection from loss or theft. - Two hypothetical scenarios considered: - Scenario 1: Tranquil period after CBDC introduction — focus on bank responses, intermediation, funding, and central bank reactions. - Scenario 2: Period of systemic financial stress — focus on run risk and potential deposit shifts from banks to CBDC. Scenario 1 — Risk of disintermediation in tranquil times - Bank reactions and market power: - Some depositors may switch to CBDC; banks could raise deposit interest rates to retain customers, compressing interest margins. - Banks may raise lending rates to preserve margins, at the cost of loan demand. - Greater bank market power in lending reduces the contraction in credit and allows banks to better preserve profits by passing deposit rate hikes to loan rates. - Box 3 insights (banks’ response): - CBDC shifts up the deposit supply curve; banks raise deposit rates and pass part of the increase to loan rates. - Banks with more market power adjust more via price (rates) and less via quantity; banks with less market power show larger contractions in deposit and loan volumes. - Funding alternatives and implications: - Banks could replace deposits with commercial paper, bonds, and equity (wholesale funding). - Implication 1: Bank funding would become more expensive because deposit insurance and implicit guarantees lower deposit funding costs; switching away from deposits could reduce profits or raise lending rates. Magnitude may be limited because most deposit value in many systems is uninsured. - Implication 2: Market discipline could change depending on whether insured or uninsured depositors leave; diminished discipline could encourage greater bank risk-taking. - Implication 3: Funding could become less stable because retail depositors are generally more stable than wholesale funders; increased volatility could force banks to hold more liquid assets or cut lending. - Heterogeneity in impact: - Disintermediation will be greater for banks with larger shares of retail deposits. - Greater presence of nonbank lenders increases competitive pressure. - Central bank policy responses: - Limit CBDC holdings per individual or discourage convertibility from deposits to CBDC (fees). - Lend diverted funds back to banks (which would expand the central bank balance sheet, entail credit risk, and raise allocation questions). - Allow banks to manage CBDC wallets to maintain customer relationships and provide customer support. Scenario 2 — Run risk in systemic stress - Run facilitation risk: CBDC could facilitate runs by providing a safe, liquid alternative to deposits. - Muting factors: - CBDC would not facilitate idiosyncratic runs between banks (electronic movement of funds across banks already exists). - In a currency or sovereign crisis, funds will be withdrawn from all local assets, including CBDC. - If very safe and liquid alternatives already exist (reserves-only narrow banks, Treasury-only mutual funds, state banks with credible guarantees), CBDC may matter less. - CBDC as a tool in crises: - CBDC could help central banks ease liquidity pressures and contain runs by facilitating the provision of reserves and cash replacement. - Central banks can already increase reserves electronically; CBDC could particularly assist in geographically vast countries where transporting cash to branches and ATMs is costly and slow, thus helping provide liquidity and resolve runs faster. - Empirical context: Central banks provided liquidity assistance in almost 96 percent of the 151 crisis episodes studied by Laeven and Valencia (2018). *CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY, INTERNATIONAL MONETARY FUND — Section 31.* ### 50. Even if the introduction of CBDC increased the risk of systemic bank runs, deposit ### sdn1808 - 50. Even if the introduction of CBDC increased the risk of systemic bank runs, deposit ### Deposit insurance and bank-run risks - Deposit insurance can alleviate the effects if CBDC introduction increases the risk of systemic bank runs. - Liquidity provision needs are smaller in countries with deposit insurance before a banking crisis. - In the Laeven and Valencia (2018) sample of crises, median peak liquidity provision was 15.3 percent in countries with deposit insurance; it was 22.4 percent of deposits for countries without it. - Recommendation: - Countries adopting CBDC should have a deposit insurance scheme to lower the probability of runs. - Effectiveness caveats: - The effectiveness of deposit insurance in mitigating runs depends on the credibility of the fiscal backstop and the extent of coverage. - Some runs have been associated with gaps in deposit insurance coverage for small depositors (example: Northern Rock, United Kingdom, 2007). ### Would monetary policy transmission remain effective? - Overall assessment: - The introduction of CBDC is unlikely to significantly affect the main channels of monetary policy transmission under plausible CBDC designs. - Four main channels and expected effects: - The basic interest rate channel: - May be the most affected and could strengthen. - If CBDC increases financial inclusion and access to interest-sensitive instruments, monetary policy transmission could strengthen. - Gains would be most evident if CBDC were interest bearing. - The bank lending channel: - Could strengthen if CBDC increases the share of banks’ wholesale funding. - Policy rates and expectations affect bank balance sheets, profits, creditworthiness, nondeposit funding cost, and lending rates. - The credit channel: - Unlikely to be affected much; policy rates affect asset prices and collateral values, and CBDC should not markedly impinge on these effects. - The exchange rate channel: - Unlikely to be affected; rebalancing between foreign and domestic assets and exchange rate effects on exports and imports should remain similar. ### Preconditions for benign transmission and potential adjustments - Preconditions for transmission to remain effective: - Central banks must remain able to affect market interest rates relevant to the channels above. - Central banks should be able to affect term spreads through communication (e.g., releasing and discussing interest rate projections). - Central banks should retain control of interest rates on reserves as long as banks demand reserve balances to pay each other. - The price of reserves determines the opportunity cost for banks to lend to each other and influences rates in broader money markets. - Presence of banks across markets, arbitrage, and lack of market segmentation are key to transmission; CBDC is not expected to markedly affect these under most design scenarios. - Operational implications and interim measures: - Some adjustments may be necessary to central banks’ operating frameworks because CBDC is likely to displace cash and could partially drain reserves from commercial banks. - Central banks can replenish reserves via liquidity-injecting open market operations if banks need reserves for precautionary purposes. - Demand for precautionary reserves might decrease because CBDC could attenuate the variance of payment shocks or increase their predictability. - In the interim, movements between deposits and CBDC could be volatile and require more frequent liquidity-injecting open market operations—perhaps on a fixed-rate full allotment basis—to stabilize interest rates. - A floor system (paying interest on reserves) could be considered to stabilize interest rates since demand for liquidity does not need to be accurately forecast. ### Stress scenario: banks no longer intermediate payments - Scenario description: - If banks lose payment intermediation business to CBDC (or stored value facilities) and are no longer involved in intermediating payments, demand for reserves would disappear. - This resembles the “cashless world” considered by Woodford (2000). - Resolution via operating-framework change: - Monetary policy can remain effective by paying interest on CBDC. - Paying interest on CBDC would put a floor on interest rates if CBDC is provided without limit: "no one with access to CBDC would lend at a rate below that offered by CBDC." - This is analogous to a floor system via paying interest on excess reserves when banking-sector demand for reserves is low. ### Central bank research, experiments, and design considerations (summary of surveyed practices) - Extent of exploration: - Several central banks in advanced and emerging market and developing economies are considering retail CBDC; jurisdictions actively exploring retail CBDCs are summarized in Table 1 of the source. - Motivations cited by central banks: - Two main reasons: Declining use of cash in advanced economies and financial inclusion in emerging market and developing economies. - Advanced-economy rationales include countering the growth of private forms of money (operational risk and monopoly distortions) and reducing costs associated with managing cash (cost efficiency). - Emerging-market rationales center on fostering financial inclusion and reducing distribution costs and risks of physical cash. - Monetary policy at the zero lower bound was not cited as a rationale by any central banks surveyed. - Designs under consideration: - Most central banks contemplate account-based CBDC with various levels of anonymity; some token-based solutions exist. - Eastern Caribbean Central Bank and the People’s Bank of China could offer both account- and token-based CBDC, with accounts managed by commercial banks and/or other licensed financial institutions. - The People’s Bank of China is also considering fully anonymous token-based wallets with low payment limits. - Many central banks avoid fully anonymous solutions because they would not meet Financial Action Task Force requirements. - Availability and offline capability: - Several central banks indicated CBDC should be available 24/7, mimicking cash. - Canada, China, and Sweden are investigating offline capability via preloaded tokens and encrypted messaging to point-of-sale terminals, with limits on such transactions. - Interest-bearing CBDC: - None of the central banks surveyed are seriously considering interest-bearing CBDC due to concerns about financial intermediation, lending contraction, and bank balance sheet volatility. - Some central banks assert CBDC should be fungible; token-based CBDC providers note technical challenges to paying interest and tax-tracking hurdles. - Sweden’s proposed e-krona will have the built-in ability to pay interest if the central bank decides to do so. - Infrastructure management and costs: - Marginal costs of managing physical cash are likely higher than those of CBDC, but high up-front fixed costs may favor CBDC adoption in larger economies. - Most central banks plan to outsource CBDC development and maintenance under close supervision; some consider cost-sharing with third parties (examples cited in the source). - Offline resilience caveat: Functionality could be temporarily available during electricity or infrastructure breakdowns but remains susceptible to catastrophic events (example: recurrence of the 1859 Carrington Event could knock out communications and power for up to a year and render digital money useless). - Cross-border considerations: - Most central banks focus on domestic applications; only Canada and China mentioned cross-border issues, more as complications than opportunities. ### Findings and concluding messages - CBDC could be the next milestone in the evolution of money; form evolves while basic functions of money remain. - CBDC is a digital form of existing fiat money, issued by the central bank and intended as legal tender; it could be available for all types of payments and implemented with a variety of technologies. - A three-step conceptual framework is proposed to assess CBDC’s potential to create value: - Identify criteria with which users evaluate different forms of money. - Establish public policy goals of central banks with respect to money. - Lay out the competitive landscape of existing and evolving forms of money. - No universal case for CBDC adoption as yet: - Demand for CBDC will depend on the attractiveness of alternative forms of money. - In advanced economies, CBDC may replace cash for small-value, pseudo-anonymous transactions. - In countries with limited banking sector penetration and inefficient settlement technology, demand for CBDC may be greater. *Source: CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY (SDN1808), International Monetary Fund.* ### 68. From a central bank perspective, the case for CBDC is likely to differ from country to ### sdn1808 - 68. From a central bank perspective, the case for CBDC is likely to differ from country to ### Key findings (paragraph 68) - CBDC may reduce the costs to society that are associated with the use of cash. - CBDC may improve financial inclusion in cases of unsuccessful private sector solutions and policy efforts. - CBDC could help central banks bolster the security of, and trust in, the payment system and protect consumers where regulation does not adequately contain private monopolies. - Regulation and, where possible, novel payment solutions could offer compelling alternatives to a CBDC. ### Risks, mitigants, and operational considerations (paragraph 69) - Monetary policy transmission: - Monetary policy transmission is unlikely to be significantly affected and may even benefit from greater financial inclusion. - Financial integrity: - Though it will not eliminate illicit activity, CBDC may in some situations enhance financial integrity. - CBDC also entails risks for financial integrity if badly designed. - Banking-sector implications: - CBDC could increase the cost of funding for deposit-taking institutions and intensify run risk in some jurisdictions. - Design choices and policies can help ease such concerns. - Operational and reputational risks: - Operational and reputational risks arising from malfunctions of the digital infrastructure or cyberattacks are likely to remain as challenges. ### Cross-border implications and research agenda (paragraph 70) - Practical access and use: - How would tourists be able to make payments in a foreign country that has adopted CBDC? - Should foreigners have access to CBDC? - Compliance and standardization: - To what extent would this complicate know-your-customer and AML/CFT compliance, and could standardized information be requested across countries? - Currency substitution and safe-haven flows: - Would access to CBDC in a reserve currency (such as e- dollars) facilitate currency substitution in countries that have weak institutions? - To what extent might safe-haven flows be encouraged, potentially draining resources from countries that face banking, sovereign, or currency crises? - Central bank cooperation and risk allocation: - If CBDC were used for cross-border transactions, how might central banks be required to cooperate? - Would they absorb some of the functions of correspondent banks and thus take on additional liquidity, credit, and foreign exchange rate risk—or might tokens be created for cross-border payments among particular central banks, commercial banks, or firms? - Research recommendation: - Research on CBDC should proceed resolutely given that the questions to be explored are deep and difficult and have far-reaching implications. *CASTING LIGHT ON CENTRAL BANK DIGITAL CURRENCY, INTERNATIONAL MONETARY FUND* --- _Source: https://www.imf.org/-/media/files/publications/sdn/2018/sdn1808.pdf_