Bloomberg Editorial: What Shapes the Future of Digital Finance?

Like any other large central bank, the Federal Reserve is concerned about the economic consequences of the pandemic. For now, your first order of business is handling the unprecedented supply shocks. But another topic also attracts attention, although in a more silent way. In due course, it will emerge, take on great importance, and involve all aspects of central banking policy: What, exactly, is the future of money?

Reflecting on this, the Fed and its counterparts are not leading a revolution but trying to catch up with one. Technology has transformed the monetary system in recent years and at a rapid rate. Paper money is falling out of use as consumers move toward more convenient electronic payments, using bank accounts, credit cards, and other online systems.

As a result, regardless of bitcoin and other cryptocurrencies, advanced economies are running out of cash. Paper money was used in about 40% of US consumer transactions in 2012. By 2019, the share had dropped to about a quarter.

In 2020, when the pandemic boosted e-commerce and led some traditional retailers to reject cash, the proportion fell to 19%.

This transition will surely have many advantages, but there is an undeniable risk: even if cash is no longer the primary medium for transactions, it provides valuable support. Regulators can do their best to ensure that private payment systems are robust, but things can still go wrong, and if this happens, the option to pay in cash provides crucial additional resistance.

One possible answer to this dilemma is the so-called central bank digital currencies (known as CBDC, for its acronym in English). Retail CBDCs are electronic cash, held by businesses and individuals in central bank accounts, on a robust and independent network, and backed, like paper money, by the full faith and credit of the Government.

They would still be vulnerable to (say) a shutdown of power and data systems, but in the absence of that, they could go much further to fill the space that physical cash freed up.

In fact, they could be a noticeable improvement. In their role of monetary backing, CBDCs could be used in a much broader range of transactions, including electronic commerce.

They could drive new payment systems and apply competitive pressure to incumbents, thus increasing efficiency and reducing costs. They could also meet the demand for innovations like stablecoins, cryptocurrencies supposedly backed by other assets, without posing any threat to financial stability.

Finally, CBDCs could serve a purpose that ordinary cash cannot, by creating a new channel for monetary policy. Rather than indirectly influencing interest rates, by trading the reserves of banks and other financial institutions, central banks could adjust the interest they pay on retail CBDC balances.

Of course, all of these opportunities come with potential downsides. The advantages of a CBDC as a payment system could initially be so great as to wipe out existing business systems, for example, in which case there would be less competition and innovation. Furthermore, the higher the perceived benefits of the new electronic cash, the less likely companies and individuals are to hold paper money and commercial bank deposits.

Tal “disintermediationIt would have big implications for the way banks finance themselves and could potentially reduce or make commercial bank loans more expensive.

Alternatively, if central banks chose to support the supply of credit by expanding their own balance sheets and channeling replacement financing to commercial banks, they would be drawn ever deeper into decisions they would rather not make, and their claims for independence, as under stress, they would seem increasingly doubtful.

None of this will be easy. Once in full swing, this debate will likely make the policy questions raised by the pandemic seem straightforward. But there will be no way to avoid the discussion. One way or another, the cashless society is approaching. Central banks will have to decide whether to just let that happen or to seize the opportunity to shape the future of finance.