Explaining Central Bank Digital Currency to Mom
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- Authors: TOMMASO MANCINI-GRIFFOLI
- Published: March 1, 2021
Overview and explanation
- Central bank digital currency (CBDC) described as "a digital form of cash" that can be held on a phone in an app called a "digital wallet".
- Users could:
- Transfer money to the digital wallet from a bank account.
- Receive and hold balances received from others (for example, instead of sending a picture via phone, a family member could send unused euros).
- Registration and identity:
- Users might have to register and provide passport and other information to obtain a digital wallet, primarily for anti–money laundering and counterterrorist financing purposes.
- Privacy trade-offs:
- Cash offers anonymity; the extent to which countries allow anonymity in CBDC spending is an open question.
- Possible distinction in practice: small purchases (e.g., buying cake) might be allowed more privacy than large transactions (e.g., buying a new car).
Motivations and potential advantages
- Lowering costs of handling cash, especially across vast territories or multiple islands.
- Improving financial inclusion by providing access to a means of payment as cash use diminishes, and serving as a first step to other financial services like savings accounts and loans.
- Providing a domestic alternative to payment systems dominated by a few large, often foreign, companies; serving as a backup and inducing private sector efficiency and low-cost services.
- Spurring innovation: a new digital currency could foster development of new services and applications, analogous to the effect of personal computers or smartphones.
- Real-world example cited: The Bahamas already has a central bank digital currency.
- Contextual drivers:
- During the pandemic, fewer stores accept cash because of health concerns.
- Practical inconveniences: branch closures forcing detours to withdraw cash; instances where merchants may not have change (example: a baker potentially unable to give change for €50).
Risks and systemic concerns
- Payments are systemically important; CBDC systems must not crash, be subject to cyberattacks, or facilitate criminal activity like money laundering or financing terrorism.
- Bank funding risk:
- Risk that individuals withdraw savings from banks to hold only CBDC, which could disrupt banks’ ability to channel savings to finance loans (example: baker needing a loan for a new oven).
- Possible policy measures: central banks may impose fees if users hold more than a certain amount of digital currency.
- Cross-border and foreign-currency issues:
- People may hold a foreign CBDC if it is perceived as safer, more stable, or more efficient, posing problems for domestic banking systems and for central banks’ monetary policy transmission.
- Managing cross-border flows in and out of digital currencies is described as "a big open issue" under active work.
- Institutional and operational demands:
- Central banks could face increased credibility risk and significant demands, potentially needing capabilities more akin to a software company to keep pace with technology and user needs.
Role of the private sector and operational design
- Private sector can partner with central banks to extend functionality:
- Private firms could enable user-friendly features (for example, sending money to a phone number linked to a verified identity).
- Private firms may design digital wallets that hold official digital currencies.
- Private firms could create their own digital currencies, but these would need to be fully backed and supervised by the central bank (contrasted with many crypto coins).
- Central banks need not implement all functions alone; partnerships can help deliver safe, stable, and efficient means of payment to users.
Tone and conclusion
- The author emphasizes cautious and deliberate central bank action: CBDCs offer considerable potential advantages, but central banks are "proceeding cautiously, and rightly so."
- The author frames CBDC adoption as likely a matter of "when, not if," given existing implementations and widespread testing and investigation.
- Personal note: the explanation is framed as a letter to the author’s mother, acknowledging personal preferences for cash while outlining technological and policy considerations.
International Monetary Fund — March 2021
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