## New Forms of Digital Money: Implications for Monetary and Financial Stability

_IMF News, October 30, 2020_

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**Canonical URL:** [New Forms of Digital Money: Implications for Monetary and Financial Stability](https://www.imf.org/en/news/articles/2020/10/30/sp103020-new-forms-of-digital-money)

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## Bibliographic details
- Published: October 30, 2020

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### Context and motivation: cross-border payments and COVID-era vulnerabilities
- Remarks by IMF Deputy Managing Director Tao Zhang, CAFIN Webinar Series on “Financial Risks, Innovation and Inclusion in a Post-COVID” World, October 30, 2020.
- Cross-border payments are central to the international monetary system and affect the most vulnerable populations.
- Key facts:
  - Remittances still cost 7 percent on average, more than twice the target set by the U.N. Sustainable Development Goals.
  - Correspondent banks—those providing access to cross-border payments—are 22 percent fewer since 2011.
  - 1.7 billion people worldwide are unbanked.
- COVID-era impact concentrated in countries with:
  - a higher share of unbanked population,
  - greater reliance on remittances,
  - lower access to correspondent banks,
  - less liquid foreign exchange markets.
- Persistent frictions: slowness, opacity, high costs, inaccessibility, and collective-action underinvestment in interoperability and cross-border public goods.

### What are CBDCs and global traction
- Definition: CBDCs are a digital form of fiat money issued by a central bank. Retail CBDCs are defined as a widely accessible digital form of central bank fiat money that is legal tender.
- Two variations of CBDC prototypes—wholesale and retail (general purpose)—discussion limited to retail CBDCs.
- Adoption status and experiments:
  - No central bank has issued a retail CBDC at the time of the speech, but pilots underway in the Bahamas, the Eastern Caribbean, China, Sweden, and Uruguay.
  - Some countries (the United States, Canada, Australia) are undertaking experiments as contingency.
  - Recently, seven advanced economy central banks, including the U.S. Federal Reserve, issued a report articulating views on fundamental principles and core features of CBDC design.
- Rationale for cross-border CBDC use:
  - Potential to lower transaction costs and increase accessibility/financial inclusion.
  - Can be designed as a direct claim on the issuing central bank or as digital cash transferable peer-to-peer without going through a bank.
  - Bilateral experiments demonstrate feasibility for cross-border payments.

### Three scenarios for CBDC adoption in cross-border payments
- Scenario 1: Niche use for cross-border payments
  - CBDC used for small-value transactions (e.g., remittances) due to low cost and efficiency or legal/regulatory limits.
  - CBDC not held long; exchanged for local currency for domestic purchases; does not supplant local unit of account.
- Scenario 2: Greater currency substitution in some countries
  - Foreign CBDC pegged to an existing fiat currency induces greater use in countries with high and volatile inflation and unstable exchange rates.
  - CBDC replaces domestic currency significantly: as a store of value, as a means of payment for many transactions, and as a common unit of account.
- Scenario 3: Global adoption with multi-polarity
  - Competition between a few major CBDCs representing independent units of account.
  - Emergence of “currency blocs” within which countries choose one common CBDC for international and domestic transactions.

### Macro-financial impacts across four areas
- Overview: Impacts concentrated in monetary policy; financial stability; capital flow management; and the international monetary system.

- 1) Monetary policy
  - Primary concern: currency substitution/dollarization reducing monetary policy transmission.
  - Currency substitution limits monetary authorities' control over domestic liquidity.
  - CBDCs could enable faster and larger-scale substitution than traditional dollarization due to convenience and accessibility.
  - If CBDCs used mainly for specific international transactions (e.g., remittances), direct impact may be limited, but indirect effects could arise if reduced transaction costs increase remittance flows.
  - Empirical illustration: In Cambodia, U.S. dollar usage rose rapidly within a few years as large foreign aid flows provided ample dollar liquidity; dollars migrated from payments to store of value.
  - If countries with weak fundamentals grant legal tender status to foreign CBDCs, monetary policy effectiveness could be significantly eroded.
  - Multipolarity (Scenario 3) implications:
    - Depend on whether multipolarity forms country currency blocs or currency competition within each country.
    - Could complicate exchange rate anchoring and require monitoring of several exchange rates and frequent price adjustments.
  - External demand for an issuing-country’s CBDC could complicate monetary policy in the issuing country if it results in large capital flows, particularly where financial markets are shallow relative to the economy.

- 2) Financial stability
  - Effects depend on CBDC design, scale of adoption, and financial system structure.
  - Greater currency substitution induced by foreign CBDCs could add pressures on funding and solvency risks beyond those in partially “dollarized” economies.
  - CBDCs could increase substitution where foreign-currency frictions are reduced.
  - Concerns include potential disintermediation in normal times and higher “run risks” in stress periods in issuing countries.
  - IMF staff view: such effects depend on CBDC features and can be mitigated by design choices.
  - In Scenario 3, currency competition within a jurisdiction could make local financial conditions more volatile; low switching costs could destabilize participation in currency blocs or digital currency areas.
  - Competition could also foster monetary discipline to maintain currency attractiveness over time.

- 3) Capital flow management / Capital account restrictions
  - Capital flow management measures and capital account restrictions could be circumvented by CBDCs, intensifying the “policy trilemma”: inability to have at the same time a fixed foreign exchange rate, free capital movement, and an independent monetary policy.
  - CBDCs could complicate monetary and exchange rate policy conduct.
  - Conversely, CBDCs might allow greater control of capital flows depending on design and issuer–recipient cooperation.

- 4) International monetary system
  - Forecasting evolution of the international monetary system with CBDCs is difficult; changes likely slow because reserve currency adoption typically requires structural institutions: policy credibility, rule of law, and deep liquid markets.
  - Longer-term possibilities:
    - Widely available CBDCs and strong network externalities could accelerate shifts in reserve currency status.
    - Digitalization could reshape demand for and supply of safe assets.
    - Uneven technological advances, alternative cross-border payment “rails,” or shifts to trade-invoicing and financial intermediation denominated in a CBDC or global stablecoin could reposition reserve currencies.
    - New digital platforms could emerge at global scale and offer alternative networks that CBDCs may tap to spur adoption.
  - Reserve implications by scenario:
    - Scenario 1 (niche adoption): limited implications for reserves; CBDC serves as payment conduit and would not change unit of account of trade and financial transactions.
    - Scenario 2 (greater substitution): central banks may increase foreign reserves for precautionary motives; reserve holders may shift into the CBDC unit of account; faster roll-out of CBDCs might lower inertia in reserve holdings.
    - Confidence in reserve issuers (e.g., cybersecurity, emergency liquidity provision) remains crucial.
    - Supply-side: issuers’ incentives to supply more safe assets vary; lack of accommodation could lead to shortage of safe assets, depressed risk premiums, and higher leverage.
    - Scenario 3 (competition among a few widely adopted CBDCs): reserve holdings could diversify; many reserve issuers yields high total issuance but low individual issuance protecting domestic stability; conversely, few issuers worsens coordination and may cause instability through rapid substitution across reserve assets.
    - Multipolar outcomes: reserve composition could be diversified between or within countries depending on currency bloc formation or within-country currency competition.
  - Broader payment ecosystem effects:
    - Cross-border CBDC issuance could reduce demand for correspondent banking services and SWIFT international financial messaging and payment systems as countries transact separately.

### Policy challenges and design considerations (drawn from international discussions)
- Realize benefits of CBDCs while mitigating risks requires attention to:
  - CBDC design features (to limit disintermediation, manage run risks, and control substitution).
  - Interoperability and public-goods investments across borders to address collective-action problems.
  - Coordination among issuers and recipient countries to manage capital flow, reserve, and monetary policy implications.
  - Ensuring policy credibility, cybersecurity, and mechanisms for emergency liquidity to preserve confidence in reserve issuers.

*Remarks by IMF Deputy Managing Director Tao Zhang, October 30, 2020.*

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## References

- [Tao Zhang](https://www.imf.org/en/About/senior-officials/Bios/tao-zhang)
- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2020/10/30/sp103020-new-forms-of-digital-money_