Why central banks are pushing digital currencies

In the first of a two-part series, Kim Engman explores why “suddenly” there is a new frontier in payments for central banks, called Central Bank Digital Currencies – or CBDCs.

Money, as we know it, is in transition. Banknotes and coins are no longer accepted by many merchants; digital money crosses platforms and newly created private currencies have emerged.  

Central banks around the world have not been standing idly by, while a plethora of alternative money forms are moving into the currency space. 

Increasingly, they commit to exploring and pursuing the opportunities that a digital, interlinked, and networked society affords them, even where money production is concerned. 

The cashless society  

The transition of money can be best witnessed in the Nordic countries, which are moving rapidly towards a "cashless" society – hastened by a large uptake of person-to-person mobile apps such as Danish MobilePay, Swedish Swish and Norwegian Vipps, and in-store payments via Apple Pay and various Android wallets. Norway leads the region, indeed all of Europe, with a mere 3% of retail payments being cash-based. See below illustraion.

The cash countdown 
Copenhagen Business School and Sweden's KTH Royal Institute of Technology estimate in a research paper commissioned by The Swedish Retail and Wholesale Council, that by 2025-2027, cash will no longer be in wide use. The paper even sets a date by when cash will no longer be feasible for merchants as a means of payment: March 24, 2023! 

Reliance on the private sector escalates 

With open banking, instant payment solutions and alternative means of payments popping up, the complexity for lawmakers as well as central- and commercial banks, businesses and consumers is increasing. 

Add to this mix, private and (mostly) unregulated digital “money” such as Bitcoin and Ethereum often labeled “cryptocurrencies”, and stable coins like Facebook’s Diem, and it is easy to see how complexities quickly escalate. 

As cash usage decreases, the reliance on the stability of commercial banks combined with a solid system of regulation, is imperative within the financial sector and the various payment rails built on top of this e.g., Visa, Mastercard, and domestic cards. 

Noteworthy, is that upwards of 97% of money is actually “produced” by commercial banks (by extending loans and credits to consumers and businesses) making the banks “systemic” in a societal context. 

However, even with the most stringent regulations and legislation in place, commercially generated money sitting in bank accounts, and their concurrent worth, will never be 100% guaranteed for account holders. Only cash comes with that guarantee as it’s a direct claim from a central bank. Case in point: within the Eurozone, deposits over EUR 100.000 will be lost, should a commercial bank default. 

The road to Cash 2.0 

So why do central banks want digital currencies? 

Well, commonly, central banks are required to ensure financial stability, stable prices, and safe and efficient payments, i.e., supply cash and regulate wholesale and retail digital payments. 

And with an increased reliance on the private sector for payments and money production, central banks are increasing their efforts to come up with an alternative to cash and perhaps re-establish their role in the money production and -payments eco-system and create something other than just money as a means of payment, but a digital version of cash that may include value-added features – or Cash 2.0. 

Coined by Bank of England in 2016, this new form of money is called CBDCs – or Central Bank Digital Currencies. 

In a 2020 discussion paper, the Bank of England also listed what seems to be seven primary reasons that central banks are pursuing CBDCs. Diminishing cash usage being one of seven.

Don’t miss Part Two 

In a follow up blog post, I will look at the progress of CBDCs, how they might be designed, why they may impact most parts of the economy – and why commercial banks and users should/would care.