THE CASE FOR CENTRAL BANK DIGITAL CURRENCIES.

• Author: Prasad, Eswar S.

New financial technologies--including those underpinning cryptocurrencies such as bitcoin--herald broader access to the financial system, quicker and more easily verifiable settlement of transactions and payments, and lower transaction costs. Domestic and cross-border payment systems are on the threshold of major transformation, with significant gains in speed and lowering of transaction costs on the horizon. The efficiency gains in normal times from having decentralized payment and settlement systems needs to be balanced against their potential technological vulnerabilities and the repercussions of loss of confidence during periods of financial stress.

Multiple payment systems could improve the stability of the overall payments mechanism in the economy and reduce the possibility of counterparty risk associated with the payment hubs themselves. However, multiple systems without official backing could be severely tested in times of crisis of confidence and serve as channels for risk transmission. Decentralized electronic payment systems are also exposed to technological vulnerabilities that could entail significant economic as well as financial damage.

The potentially transformative potential of cryptocurrencies was highlighted by Facebook's 2019 announcement that it plans to issue a cryptocurrency called Libra, which would be backed by reserves of fiat currencies. According to Facebook, the goal is to create a more inclusive financial system as well as a more efficient and cheap payments system for both domestic and cross-border transactions. The fully backed nature of Libra suggests that it will provide a stable store of value and will not have any monetary policy implications. The latter proposition, which is the one of more direct concern to central bankers, remains to be seen. After all, it is not obvious what could restrain Facebook from using its massive financial clout to issue a cryptoeurrency backed by its own resources rather than by a basket of fiat currencies.

It is an intriguing, and in some ways disturbing, prospect that other large nonbank financial institutions and nonfinancial corporations could also become important players in financial markets, perhaps even issuing their own tokens/currencies. For instance, a company such as Amazon could conceivably issue electronic tokens for trading goods on its platform. The backing of such a large company could ensure the stability of its value and make it a viable medium of exchange, reducing the demand for central bank money for commercial transactions. Such digital tokens issued by Facebook and other well-known nonfinancial corporations could end up being seen as stores of value as well, given the scale, apparent stability, and financial firepower that these corporations command. The major implications of such developments would not just be the reduction in the demand for central bank money as mediums of exchange or stores of value, but the consequences they would have for the business models of banks and other existing financial institutions. Although the potential effects are not obvious and need careful study, these developments could have implications for central banks.

While it is premature to speak of disruption of traditional concepts of central banking, it is worth considering if the looming changes to money, financial markets, and payments systems will have significant repercussions for the operation of central banks and their ability to deliver on key objectives such as low inflation and financial stability. The rapid rise of cryptocurrencies has...