A report titled Digital Innovation, Data Revolution and Central Bank Digital Currency, published by the Bank of Japan on Feb 19, provides a comprehensive overview of central bank-issued digital currencies (CBDCs), including their potential benefits and associated risks.
The authors, Professors Noriyuki Yanagawa and Hiromi Yamaoka, begin their report by pointing out the growing interest in CBDCs worldwide.
“Under the developments of digital innovation, global expansion of cashless payments and the emergence of crypto-assets, some argue that central banks should issue digital currencies that can be used by ordinary people instead of paper-based banknotes. The debates on central bank digital currencies are now gathering great attention from [sic] worldwide.”
They then continue to assess the potential impact of CBDCs on payment efficiency, financial structures and the wider economy.
The report attempts to categorize CBDCs into two main types:
A) CBDCs used by the general public for daily transactions instead of banknotes.
B) CBDCs for large-value settlements, which are based on central bank deposits and adopt new technologies such as distributed ledger technology (DLT).
This distinction aligns with the Bank for International Settlements’ categorization of CBDCs into “General Purpose CBDC” and “Wholesale CBDC”. According to the authors, this reflects the way central banks traditionally split money into two similar categories, namely banknotes and central bank deposits.
“Due to digital innovation, it is becoming possible to imagine various types of central bank money between them,” reads the report.
The report claims that type “B” CBDCs can be regarded as an evolved form of central bank deposits which have already been digitized – through the adoption of new technologies to enhance their utility – and hence may not present many significant new issues.
However, type “A” CBDCs require in-depth examination due to their potential to cause a variety of fundamental issues. According to the report, such issues could include “the risk of crowding-out of bank deposits and squeezing banks’ financial intermediation, as well as the risk of accelerating the shift of funds from bank deposits to CBDC through ‘flight to quality’ in stressed circumstances”.
Having defined and categorized CBDCs, the report continues to list their potential benefits, first and foremost, their potential for enhancing the efficiency of transactions and reducing the cost of payments.
According to the report, some scholars and practitioners argue that “the issuance of CBDCs will enable the general public to use risk-free and digitized payment instruments for daily transactions, believing that wider use of risk-free, digitized CBDC for broad transactions will enhance efficiency and safety of payments and reduce overall costs of economic transactions.”
Another potential benefit of CBDCs implementation is, according the authors, a decrease in the usage of cash. This claim is supported by Finland’s example, where the central bank is doing comprehensive studies on digital-based currencies (e-krona), while observing that the “volume of cash has recently been substantially declining, partly due to the developments of private-based mobile payment instruments.”
The authors also note the potential of CBDCs to “serve as an alternative to bitcoin and other such cryptocurrencies” currently in circulation. According to the report, the current crop of privately-issued cryptoassets have not been used as digitized payment instruments, but rather as speculative investment tools, resulting in consumer protection concerns.
“Some people also support the idea of issuing CBDCs, believing that the CBDC will discourage speculation on crypto-assets,” reads the report.
Interestingly, the authors list privacy protectionas a potential benefit of DLT-based CBDCs, stating that “applying blockchain, DLT and encryption technologies could realize anonymity similar to banknotes on a digital basis, in order to protect privacy of the users”.
Furthermore, CBDCs could help prevent crime and strengthen anti-money laundering measures by replacing “anonymous” banknotes with centrally-issued digital currencies “on the condition that the level of anonymity of CBDCs is lower than that of banknotes”.
Enhancing the effectiveness of monetary policy and enhancing financial stability through quasi-narrow banking are two more potential benefits of CBDCs highlighted in the report. The former assuming that “central banks could realize both positive and negative interest rates on CBDCs” while the latter by “eliminating destabilizing factors stemming from banks’ maturity transformation” through issuance of CBDCs.
The report then dives deeper into various categories of CBDCs (such as publicly-issued versus issued to intermediaries and account-based versus token-based) and continues to explore risks and benefits associated with those categories.
For example, the report states that account-based CBDCs won’t necessitate DLT adoption, whereas with “token-based CBDCs, which can be transferred directly among users without being recorded in central bank accounts, there might be some room to consider the adoption of decentralized technologies such as blockchain or DLT.”
The authors further elaborate on several issues associated with CBDCs, such as whether their amount should be regulated by the central bank, if they should bear interests, and what will their impact be on financial structures, monetary policy, banks’ credit intermediation and liquidity crises.
The authors take care to note that their report is part of a series of Bank of Japan “working papers”, circulated in order to stimulate discussion and comment, and that the views expressed are their own and do not necessarily reflect those of the bank.
Hence, while this report does not indicate whether the Bank of Japan intends to release its own CBDC, it nonetheless provides a comprehensive picture of CBDCs and the issues facing central banks considering issuing them.