Opinion: Cash in the bank: Cutting through the noise on digital currencies
Jeremy Kronick is associate director of research at the C.D. Howe Institute.
In the debate over whether the Bank of Canada should issue a central bank digital currency, it is tempting to take a black-and-white perspective. But, the truth is subtler. There exists a spectrum of CBDC design possibilities and a proper evaluation of the different options is necessary.
As it turns out, a token-based CBDC – one that mimics cash quite closely – would respect privacy, create an environment for new forms of private money to grow and wouldn’t disrupt the functioning and stability of our financial system.
To understand why this option is optimal, it is first important to distinguish between public and private money. Public money consists of the physical notes and coins in circulation – the cash in your wallet. Private money, on the other hand, is essentially all other mediums of exchange used in society. For the most part, private money consists of the commercial bank deposits you hold in chequing and savings accounts, though it now also includes cryptocurrencies, such as bitcoin and ethereum.
Part of what makes people so confident in holding most of their money as commercial-bank deposits is the knowledge that, at any moment, they can go to the bank and take out that money as cash. The other part is the regulatory framework we put on our banks ensuring their safety, and the deposit insurance that covers us to a degree on the chance that one of our financial institutions goes belly up.
However, no cryptocurrency provides the holder with that kind of safety net, which is one of the reasons why their values are incredibly volatile; this was reinforced in the recent crash. To stabilize the value of any given private cryptocurrency, thereby making it more appealing to a broader swath of society, there will need to be a true tether to the existing system. This requires direct regulation and a complete backing of the cryptocurrency with stable assets such as the Canadian dollar.
While the physical version of public money could continue to play that anchor, in a digital world there is value-added to both sides in creating a direct bridge from the private cryptocurrency to public money, such as CBDC, and vice versa. This ease of conversion to and from the Canadian dollar makes the private cryptocurrency more attractive to the customer. It also makes it more attractive to the central bank, as it encourages the private cryptocurrency to link itself to the Canadian dollar rather than a foreign currency.
The question we should be asking is what the CBDC design options are and whether there is one that can bring out the benefits of a public digital dollar without some of the potential costs, such as privacy concerns and disruption to our current credit intermediation (borrowing and lending) system. At the two ends of the spectrum, there is an account-based version and a token-based version of a CBDC.
Under an account-based system, Canadian households and businesses would hold their public money at accounts at the Bank of Canada. The bank would then have to do all the usual (costly) front-facing operations of a commercial bank – know-your-client, anti-money laundering, onboarding – and would have information on all retail payments as well as the parties to all transactions.
It is this information that has people worried about governments knowing too much. Also of concern is the fact that if an account-based version paid interest, it might siphon off some of the commercial bank deposits that fund commercial bank lending.
Alternatively, a token-based version would instead mimic how cash functions today. One option here is to allow only our commercial banks to hold CBDC, much as we do today with physical cash. With the token option, no one would have accounts at the Bank of Canada, and you get your CBDC from your financial institution (online). The central bank would not require any retail payments information, would only need to know the stock of CBDC in the economy and would not know who owns what token.
Canadians could register their tokens with either their financial institutions or the central bank to prevent any cyber-theft that might occur out of their digital wallet – something that cannot be done today with physical cash.
Privacy concerns are legitimate. Fear that governments might go too far with access to information is legitimate. But definitions and design matter. And the token-based CBDC could both support the growth in new forms of private money such as cryptocurrencies by creating a direct digital bridge, and limit any privacy and financial disruption concerns. We just have to look through the noise.
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