Central banks are right to consider the merits of digital cash
The tenacity of bitcoin reflects dissatisfaction with current payment systems
Reza Moghadam
The main problem plaguing bitcoin and other cryptocurrencies as money — extreme price volatility — would be resolved through a 'central bank coin' © Bloomberg
The refusal of bitcoin to just deflate and die, even after the supposed bursting of the crypto bubble, might reflect the extraordinary power of popular delusion. But it may also say something about our dissatisfaction with the current payment system — physical cash and credit cards — and the desire for a faster, cheaper and safer alternative.
Fortunately, when not preoccupied by crypto bubbles or fraud, central bankers have been thinking about this problem. One solution under consideration, most prominently in Sweden but elsewhere too, is to introduce a digital version of physical cash.
The most straightforward way of doing so would be to let the public open digital checking accounts at the central bank. Not only would such accounts displace most cash transactions, they would also give bank cards a run for their money, to the benefit of consumers. Funds can be transferred instantly within a central bank, without intermediaries or hidden fees.
There are several concerns, but two give central bankers cold feet. First, an exodus of deposits could disrupt banks’ business models. Second, if it becomes too easy to convert bank deposits into central bank deposits, a run could overwhelm a bank in minutes.
Both concerns are overblown. Moving payments to the central bank need not be destabilising. Only checking accounts are likely to move, not other deposits offering higher interest rates; that is hardly the end of banking as we know it. Bank fees from payments services would fall, as they already are doing, due to competition from the likes of PayPal. But the loss for banks is a gain for consumers.
Although banks might push up lending rates to compensate, that is not necessarily a bad thing — certainly not in Europe, where a shift from bank to capital market funding is a policy goal. Above all, a system where a central bank provides payment services while banks focus on credit is more stable. It removes banks’ capacity to fund loans simply by issuing deposits and relying on borrowing to cover unexpected outflows. This should reduce the incidence of bank crises and taxpayer-funded bailouts in the name of rescuing the payments system.
As for digital bank runs, it is true that in a crisis even non-checking deposits may want to fly to the safety of the central bank, and the capacity to do so with the click of a button would indeed make life difficult for crisis managers. But there is nothing about digital currency per se that prevents a central bank from slowing the process.
The authorities could arguably manage the process in a more orderly way, without queues outside banks and without disrupting the broader payments system of transfers between central bank checking accounts.
There is a more ambitious variant of the above: a “central bank coin” that resides on a blockchain, an electronic database of transactions. The central bank would issue coins against cash and banks’ reserves at the central bank. If it then stood ready to freely exchange coin, cash and reserves at par, the main problem plaguing bitcoin and other cryptocurrencies as money — extreme price volatility — would be resolved.
A key advantage of a blockchain-based currency over central bank checking accounts, or indeed the current system, is security. A unitary ledger residing on a network is harder to tamper with than one in a single location. In an age where everything from elections to email is hackable, protecting the payments system from shocks to the liability side of banks should be high on the policy agenda. Certainly, there are issues with blockchain, including processing speed, energy use and safeguards against money laundering and terrorist financing. But these are problems of practice, not principle, and there are already solutions within reach.
The question for policymakers is how long they can afford to wait before falling behind in payments technology. The recent turmoil in crypto markets should not distract central banks from embracing digital currency to deliver a system that is less costly in good times and less unstable in turbulent ones.
The writer is vice-chairman for sovereigns and official institutions at Morgan Stanley
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