SOME THOUGHTS ON CENTRAL BANK DIGITAL CURRENCY.

• Author: Andolfatto, David

The literature examining the question of central bank digital currency (CBDC) has grown immensely in a very short time. Much progress has been made since I first learned of the idea in a blogpost authored by J. P. Koning in 2014. That modest article soon led me to openly speculate on the merits of a central hank cryptocurrency in a talk I delivered at the International Workshop on P2P Financial Systems in Frankfurt (Andolfatto 2015). My audience, which consisted mainly of entrepreneurs, seemed to receive my talk with a polite mixture of bemusement and anxiety. Surely, I couldn't be serious? To be honest, I'm not sure that I was. But then the threat of Facebook's Libra came along, and central bankers around the world suddenly began to take the idea very seriously indeed.

In this article, I wall share some of my thoughts on CBDC--what it is, the rationale behind the endeavor, and how it might be implemented in broad terms. I'll also address some of the concerns expressed by skeptics--in particular, the possible impact on banks and the implications for financial stability. I discuss these issues primarily in the context of the United States.

Before I begin, let me provide a sketch of the way money and payments work in the United States today. As is well known, the largest component of the money supply by far is created and managed by U.S. depository institutions. All of this money is already in digital form; that is, as checkable deposits. But if this is the case, then what is all the fuss about digital currency in general and CBDC in particular?

As it turns out, CBDC already exists in the United States in the form of Federal Reserve accounts. These accounts are fully insured and (since 2008) bear interest. Payments across these accounts occur through Fedwire, a real-time gross settlement system operated by the Federal Reserve. This service is only available to U.S. depository institutions, the U.S. Treasury, and a select number of foreign agencies. The services often cost less than a dollar per transaction, which, for an average transaction size of about $4M, is practically free. (1) For individuals and nonbank businesses, small-value electronic payments are typically cleared through the ACH net settlement payment system. The interchange fees faced by merchants are typically in the range of 3-5 percent and can take up to three business days to settle.

This is normally the place where one provides a laundry list of the problems associated with making payments in the United States. Instead of doing this, I want to acknowledge the tremendous advancements that have been made in the past few decades. Whatever problems and inconveniences people experience today, believe me, were much worse a generation ago. It seems likely, to me, that technological developments and competition will continue to improve the payment experience for most Americans going forward. Nevertheless, I think some version of a retail-level CBDC remains desirable, even if it is not essential.

Central Bank Digital Currency vs. Central Bank Private Currency

All the money we use today consists of bank liabilities, either private or central. As I've already mentioned, private banks provide us with digital currency in the form of demand deposit liabilities. Let me label this private bank digital currency (PBDC). I've also mentioned that CBDC exists in the form of reserves held in accounts with the central bank. Reserves are counted as a liability of the Federal Reserve. The third type of money takes the form of small-denomination paper bills issued by the Federal Reserve. Let me label this central bank paper currency (CBPC). These too are counted as liabilities of the Fed.

The way things presently stand, everyone in the world is permitted access to CBPC, the paper component of the Fed's balance sheet. However, only banks (and a few other agencies) are permitted access to CBDC, the digital component of the Fed's balance sheet. Why is this the case?

One reason has to...