CENTRAL BANK DIGITAL Currencies (CBDCs), or digital sovereign currency tokens, are among the hottest topics in the financial world today. A 2021 BIS survey found that more than 86% of central banks around the world were actively researching CBDCs, and 14% were even deploying pilot versions.
India is also keenly aware of the change, with the Ministry of Finance confirming that it has taken a proposal from the Reserve Bank of India (RBI) to improve the scope of the definition of banknotes to include currency in the form digital. In his book The future of money, Eswar Prasad, Tolani Senior Professor of Trade Policy at Cornell University, explores the pros and cons of CBDCs. Edited excerpts from a conversation:
For an end user, what would be the use of a CBDC today?
This is the fundamental question for any central bank considering CBDCs. What is the use case versus physical money? Many central banks recognize that, given declining levels of liquidity in the economy, issuing CBDCs can keep central bank money relevant at the retail level.
From a user perspective, private actors have business goals to deliver fast, efficient and inexpensive digital payments. Of course, there is competition in space, with network effects at play that make the market less contestable. Thus, a CBDC, if well designed, can promote private sector innovation in payments.
What are the design possibilities for CBDCs? Is it absolutely necessary that decentralized accounting technologies come into play?
At a basic level, retail CBDCs can take two forms. There is the very simple and value based option of mobile phone apps where you can just transfer money and use it. Many Latin American countries use it, but it is not a versatile form of CBDC. This limits functionality and it is not scalable.
Account-based CBDCs hold much more promise. Every person in an economy would have access to a central bank portfolio or account. There are benefits and risks to this. Account-based portfolios will allow more public participation and flexibility in monetary policy, but there are potential problems as well.
If you even have interest-free CBDC accounts available, people could be sweeping deposits from the commercial banking system, which is a particular risk in a country like the United States where interest rates are low. This even applies to emerging countries in times of financial turmoil.
Second, you risk limiting innovation in the financial sector. This is not a good result, where the Central Bank starts to play a bigger role in the economy, in terms of credit management, payments, etc. However, there are technical solutions to all of this.
Countries like China have double-layered systems in place where digital wallets are not managed by central banks, but by front-line operators like commercial banks. Central banks only provide tokens and an underlying payment infrastructure for the use of those tokens. Commercial banks handle the Know Your Customer (KyC) process and others. This reduces the risk of capital flight from traditional systems. This double layer system is considered to be the most advantageous. India can learn a lot from the trials going on in other countries.
CBDCs can also mean the rise of programmable money. What are some maneuvers that the Central Bank can perform with the help of CBDCs? One of the more controversial suggestions seems to be money with “expiration labels” to stimulate spending.
Certainly, smart money can generate a whole range of opportunities, in terms of economic and monetary policy. However, it is a somewhat risky road to go down. For example, if you have money with expiration tags, you might find yourself in a situation where different units of central bank money start to trade for different amounts.
An even more dystopian situation would be if a government started using the money to achieve not only economic but social goals. This, in my opinion, raises a set of concerns at the societal level. CBDCs can be used for many purposes – what economists call “helicopter drops” [instant, targeted money transfer] is one of those goals. But the setback should give a break.