In an article published by the Financial Times, author Iswar Prasad discusses how with the end of the cash era approaching, many central banks worldwide are working on launching their digital currencies.
The time for central bank digital currencies (CBDCs) seems to have arrived, considering their advantages compared to physical cash.
However, they also pose threats to the very institutions that issue them.
The article highlights that storing money in digital wallets linked to CBDCs is safer than depositing it in commercial banks, as central banks never go bankrupt.
The challenge faced by central banks lies in making their digital currencies a viable option for financial services provided to individuals and facilitating peer-to-peer payments without displacing existing payment systems.
The recently released white paper by the Monetary Authority of Singapore explores how CBDCs can be designed for specific purposes, such as having a limited lifespan, targeting specific retail sellers, and being pre-allocated to certain categories.
Distributing such digital currencies can stimulate consumption, as people often save government cash transfers during uncertain times, like COVID-19 stimulus packages, reducing their effectiveness.
Furthermore, CBDCs can be designed and allocated for specific purposes, like restricting their use to purchasing cars or durable goods, thus enhancing their economic efficacy in targeted sectors.
Another characteristic of digital currencies is their programmability. Imposing negative nominal interest rates can discourage hoarding, and money can be programmed to facilitate contractual arrangements in specific fields, where funds are automatically released when all parties meet agreed-upon conditions.
The article suggests that such innovations open new avenues for enhancing the performance of economies and societies. However, it is also essential to consider the downsides of any new technology.
Setting a ceiling on CBDC balances in digital wallets can mitigate the risk of bank runs and depositor flight from commercial banks.
Nevertheless, the author cautions that financial innovations are not without risks. Using CBDCs as tools for law enforcement or surveillance purposes might result in central banks being seen as political agents of governments.
Moreover, central banks already face threats to their independence, credibility, and legitimacy. As the scope of digital currencies they issue widens, so does the political pressure they encounter. At the very least, these innovations threaten the integrity of central bank money, a paradoxical and concerning development, given that digitizing major bank money was meant to enhance its trustworthiness.