In the digital economy, cash is no longer a useful tool, and a central bank digital currency (CBDC) is the “only solution” to continue the existing monetary system, according to a new paper from the European Central Bank (ECB).
A CBDC, such as a digital euro, would be the “only solution” to facilitate a “smooth continuation” of the present monetary system, the researchers concluded. Amid debate that CBDCs would limit the credit supply and be a disruptive force in financial markets, the paper rejects those concerns as unfounded.
Digital money is critical in a digital economy, the ECB noted. Since “cash is losing its appeal as efficient means of payment,” a CBDC is a necessary tool to install. While the research identifies drawbacks of instituting a uniform digital monetary system, such as the sluggish pace of settlements, market developments, and adoption, the paper notes that “a digital update of cash” is crucial to advancing “the two-layer system of public and private money.”
Ultimately, cash possesses “large economic costs without clear benefits,” so “it is by construction not ‘fit’ for the digital age.”
Digital money might generate privacy concerns, the authors warn. However, researchers point to a “privacy paradox”: consumers will emphasize the importance of privacy in surveys, but they will give away personal data for free or in exchange for small rewards.
“From a public policy perspective, these observations warrant further scepticism concerning the ability of market forces to reach efficient levels of privacy protection,” the report notes.
The paper also rejects cryptocurrencies and stablecoins, calling them a “threat to monetary sovereignty.” It welcomed President Joe Biden’s digital asset working group to put together a regulatory framework for the crypto sector, as well as the myriad of other regulations being considered worldwide.
The Rise of CBDCs
Across the globe, many governments and central banks have been studying CBDCs as a potential successor or complement to physical money.While delivering his semiannual monetary policy report to Congress in June, Fed Chair Jerome Powell recommended that a digital dollar is “something we need to explore as a country” that “should not be a partisan thing.”
“It’s a very important potential financial innovation that will affect all Americans,” he told the House Committee on Financial Services. “Our plan is to work on both the policy side and the technological side in coming years and come to Congress with a recommendation at some point.”
He added that if the United States were to create a digital dollar, it would need to be issued by the federal government and not by a private institution.
“One question around CBDCs is do we want a private stablecoin to wind up being the digital dollar? I think the answer is no,” Powell said. “If we’re going to have a digital dollar, it should be government-guaranteed money, not private money.”
Congress is requesting faster action on a digital dollar. A bipartisan group of members of Congress has urged the Fed to speed up work on a CBDC.
Last month, ECB President Christine Lagarde championed a digital euro, stating that digitizing the official currency in 19 of the 27 member states of the European Union can “achieve” stability and public access.
A digital euro would complement cash rather than replace it, according to Lagarde. She also pointed out that a CBDC would only be successful if it addressed the needs of consumers and businesses and ensured that privacy safeguards were established from the beginning.
US, Europe Take on Digital Yuan?
But while the United States and Europe might be attempting to take the lead on such a critical issue in the global monetary system, market analysts note that advanced economies might be responding to action by China.Some aver that Beijing is seeking to dismantle the global currency system, but officials say otherwise.
“Remember, China is the largest trading country, and you’re going to see digital yuan slowly supplant the dollar when buying things from China,” he said. “If we go about five to 10 years out, yes, the digital yuan can play a significant role in reducing the dollar’s usage in international trade.”
Do CBDCs Offer Risks?
But while many public policymakers are ebullient over the prospect of CBDCs, critics acknowledge that there are many drawbacks.The primary risk for CBC is an erosion of privacy. Whether by the federal government or law enforcement agencies, every consumer’s financial transaction can be monitored by the state. As with China’s nationwide credit score system, experts warn that it isn’t hard to see the government imposing digital money to facilitate the institution of social monitoring programs.
“In this way, control over money can create a social chilling effect.”
Another factor is the faster adoption of monetary policies, especially in times of crisis such as the coronavirus pandemic.
Although proponents contend that it could support the financial system, the World Bank has warned that it actually threatens the “financial integrity” of today’s banking infrastructure.
In the end, CBDCs could turn out to be a costly investment that fails to achieve anything of substance, the Center for European Reform says.
With more nations assessing CBDCs and other markets already implementing it into the fabric of their economies, a monetary experiment may be unfolding in real time.