Central bank digital currencies: a monetary anchor for digital innovation (2024)

Speech by Fabio Panetta, Member of the Executive Board of the ECB, at the Elcano Royal Institute, Madrid

Madrid, 5 November 2021

The ongoing digitalisation of our economy is leading to far-reaching changes in many areas of our lives. Payments are no exception: innovative forms of private digital money are emerging in response to changing needs, which are transforming how we pay and the payment landscape more broadly.

These developments touch at the core of central banks’ mandates as issuers of sovereign money. And central banks around the world are looking for ways to respond. The ECB is exploring whether to issue a digital euro – a digital form of central bank money for people and businesses to use in retail payments.

It has been argued that such a central bank digital currency (CBDC), if issued, would be redundant given the vast supply of private digital monies available, including bank deposits, credit cards, electronic money and mobile applications, and possible future payment solutions based on stablecoins.[1]

Today, I would like to argue that, actually, monetary stability and the smooth functioning of payment systems ultimately depend on everyone being able to widely access and use sovereign money. And there is no reason why this should not hold true in the digital era. But this requires central banks to evolve alongside changing technologies, payment habits and financial ecosystems. Let me explain why.

The importance of central bank money as a monetary anchor for payments

People’s confidence in private money is underpinned by its convertibility on a one-to-one basis with the safest form of money in the economy – central bank money, the monetary anchor – and hence with other regulated forms of money.[2] Central bank money is the only money whose face value is intrinsically guaranteed.[3] Private issuers have to rely on convertibility, as their money is exposed to operational, credit, liquidity and market risks. These risks are reduced through public policy safeguards, such as financial supervision, capital requirements and deposit insurance.

Convertibility at par provides confidence in private money because it reassures us regarding its ultimate value and its usability for payments. For example, when we go to our bank’s cash machine and convert our deposits into an equivalent amount of cash, we are safe in the knowledge that our deposits have kept their value. By going to a cash machine on a recurring basis and withdrawing cash each time, we build confidence that this will continue to happen in the future. And we agree to store and use our money through private intermediaries because we are ultimately reassured that we will get cash if we ask for it, and therefore that we will be able to make payments even if our money cannot be used directly in its private form. Runs on private money start when this confidence in convertibility disappears, triggering a flight to safety.[4]

Convertibility into central bank money is therefore necessary for confidence in private money as both a means of payment and a store of value. By providing a monetary anchor, central bank money plays a key role in maintaining a well-functioning payment system and financial stability and ultimately trust in the currency. This in turn is a pre-condition for preserving the transmission of monetary policy, and hence for protecting the value of money.

Maintaining the monetary anchor in the digital age

Today we have access to central bank money in the form of cash. The importance of cash in payments is declining, however, as people increasingly prefer to make digital payments and shop online (Chart 1).

Chart 1

Change in the share of the number of cash transactions by consumers in selected euro area countries

(percentage)

Central bank digital currencies: a monetary anchor for digital innovation (1)

If given the choice, almost half of euro area consumers would prefer to pay with cashless means of payments, such as cards.[5] Internet sales in the euro area have doubled since 2015.[6] Cash is increasingly used as a store of value and decreasingly as a means of payment, a trend that the pandemic has accelerated.[7] And while the cash stock has continued to increase and has even been boosted by the pandemic owing to higher precautionary demand for cash, only about 20% of the cash stock is now used for payment transactions, down from 35% fifteen years ago.

If these trends were to persist and accelerate, cash would end up losing its central role and becoming a means of payment that people would be reluctant to use because it would be less adapted to their needs. Just as the postage stamp lost much of its usefulness with the arrival of the internet and email, so too could cash lose relevance in an economy that is becoming increasingly digital.

The upshot is that if this scenario were to materialise, it would weaken the effectiveness of central bank money as a monetary anchor. Even central banks’ pledge to continue to supply cash would do little to guarantee that cash would remain an effective anchor if there was insufficient demand for it as a means of payment.

While banks could continue to hold central bank money in the form of reserves, this may not prove sufficient to fully preserve the monetary anchor role of central bank money. People would be unable to use central bank money as means of exchange and would thus have little incentive to hold it. This would weaken the unit of account role of sovereign money.[8] If the currency is not demanded by the public, the mere announcement that the central bank would make it available would not be enough to preserve its role in the economy.

Some have also suggested that innovative private payment solutions such as stablecoins could, if properly regulated, make CBDCs superfluous.[9] But confidence in stablecoins also depends on convertibility with central bank money,[10] unless stablecoin issuers are granted access to the central bank balance sheet, allowing them to invest their reserves in the form of risk-free deposits at the central bank. However, this would amount to outsourcing the provision of central bank money to stablecoin issuers and risking a corresponding reduction in monetary sovereignty.[11]

Without central bank money to provide an undisputed monetary anchor, people would have to monitor the safety of private money issuers in order to value each form of money, undermining the singleness of the currency. Indeed, there were recurrent crises in the past when different forms of private money coexisted in the absence of sovereign money, such as during the free banking episodes of past centuries.[12] History shows that financial stability and public trust in money require a widely used public money alongside private monies.

As people start to use cash more as a store of value rather than a means of payment, having a digital euro would enable them to continue using central bank money as a means of exchange in the digital era. A digital euro and cash would complement each other and ensure that central bank money remains a monetary anchor for the payments ecosystem and continues to serve as a means of exchange, a store of value and a unit of account.

For this to come about, a large share of the population would need to use the digital euro on a regular basis. It would not be necessary for them to use the digital euro for most of their day-to-day payments. What matters is that such regular use would give people the confidence that they can always use the digital euro for payments if they wanted or needed to.

To this end, a digital euro would have to be designed in a way that makes it attractive enough to be widely used as a means of payment, but at the same time prevents it from becoming so successful as a store of value that it crowds out private money and increases the risk of bank runs.

The conditions for success of a digital euro

The previous discussion suggests that in a digital world CBDCs are necessary to guarantee the smooth functioning of the payment market, especially in periods of crisis. But this does not mean that the success of CBDCs should be taken for granted. Users may lack sufficient incentives to fully appreciate the public benefit created by the availability of a CBDC and – given the vast supply of private digital monies – could express insufficient demand for it.

While we have discussed at length the possibility of a digital euro being paradoxically “too successful”,[13] we need to devote just as much attention to the risk of it not being successful enough.

So what are the conditions for success?

Besides having an intrinsic appeal, a successful digital euro would need to be widely accessible and usable. In other words, while people would find a digital euro attractive because of its unique property as the only riskless digital form of money, they would also need to be able to use it easily wherever they can pay digitally.

Consumers will only use a digital euro if merchants accept it, and merchants will want to be reassured that consumers want to use it. Intermediaries, in turn, will only follow suit if there is compelling evidence that the benefit of distributing it outweighs the cost of doing so. Developing a convincing value proposition for all stakeholders is therefore critical to the digital euro’s success. This is a key part of the investigation phase of the digital euro project which we started in October. The ECB and the European Commission are together reviewing at the technical level a broad range of policy, legal and design questions emerging from a possible introduction of a digital euro, including the role that legal tender status might play in achieving the desired network effects.

For consumers, the digital euro would offer a cost-free and convenient way to pay digitally anywhere in the euro area. It would also increase privacy in digital payments: as a public and independent institution, the ECB has no interest in monetising users’ payment data and it could only process them to the extent necessary for the functions of the digital euro, in full compliance with public interest objectives and EU legislation.[14] The ECB could use privacy-enhancing techniques while still complying with regulations on anti-money laundering and combating the financing of terrorism.[15]

For payees such as merchants and small businesses, a digital euro would be an additional means to receive customer payments through the instant reception of risk-free money. Moreover, a digital euro could contain the cost of payments through its potential to mitigate the market power of dominant digital payment providers, which already control around 70% of European card payments.

The digital euro should not be seen as a competitor to digital payment services offered by the private sector. Intermediaries could play an integral role in the onboarding and provision of front-end services to ensure a pan-European reach. They would have the opportunity to distribute the safest and most liquid form of money, and could develop new services with “digital euro inside” – such as providing credit facilities to digital euro users or innovative value-added services in the form of automated or conditional payments − thereby generating additional revenues.

This would help level the playing field by making it easier for banks – including small ones, whose customers may have limited access to innovative products – and fintechs to compete with big tech firms, which are expanding into payments and financial services. It would support the competitiveness of European payments, making them cheaper and more efficient for users.

Finally, by providing a fast, cheap and safe digital means of payment, a digital euro would support the euro’s international use and Europe’s autonomy in global payments[16]. Making it accessible to non-residents and interoperable with other CBDCs could facilitate cross-border payments, which are currently fraught with high costs, low speeds and limited access.

A digital euro would thus expand payment options in the digital age without crowding out sound private payment solutions. And it would provide a monetary anchor to the rapidly evolving European digital payment ecosystem, underpinning trust and stability in digital payments.

Conclusion

Let me conclude.

It has been argued that the ample availability of private digital means of payment would make central bank digital currencies superfluous. However, this ignores the essential role that central bank money plays in the payment system and the financial sector as a whole.

Central bank money provides the reference value for all other forms of money in the economy. Playing a crucial role in underpinning confidence in the currency and in the smooth functioning of the payment system, central bank money is necessary for preserving the transmission of monetary policy, hence for protecting the value of money and monetary sovereignty.

With digitalisation at full speed, central banks must prepare for a digital future in which demand for cash as a medium of exchange may weaken, requiring the convertibility of private money into cash to be complemented by convertibility into central bank digital money.

This is the primary reason why the ECB would issue a digital euro. Now that people are increasingly shifting towards digital payments, we need to ensure that they can readily access and use central bank money in digital form too. We are working to make the digital euro an attractive means of payment for everyone – households, firms, merchants and intermediaries alike – so that it can play its intended role as the necessary monetary anchor for the digital era.

I am a knowledgeable expert in the field of central bank digital currencies (CBDCs) and the ongoing digitalization of the economy. My expertise is demonstrated by a deep understanding of the concepts and implications discussed in the speech by Fabio Panetta, Member of the Executive Board of the ECB, at the Elcano Royal Institute, Madrid on November 5, 2021. I have thoroughly studied the ongoing digitalization of the economy, the importance of central bank money as a monetary anchor for payments, the declining role of cash in the digital era, and the conditions for the success of a digital euro. Additionally, I am well-versed in the potential impact of a digital euro on the payment market, the role of central bank money in preserving the transmission of monetary policy, and the necessity of central bank digital currencies in a digital future.

The Ongoing Digitalization of the Economy

The ongoing digitalization of the economy is leading to significant changes in various aspects of our lives, including payments. Innovative forms of private digital money are emerging in response to changing needs, transforming how we pay and the payment landscape more broadly. Central banks around the world, including the ECB, are exploring the possibility of issuing a digital euro – a digital form of central bank money for people and businesses to use in retail payments [[1]].

Importance of Central Bank Money as a Monetary Anchor for Payments

People's confidence in private money is underpinned by its convertibility on a one-to-one basis with central bank money, which serves as the monetary anchor. Central bank money is the only money whose face value is intrinsically guaranteed, providing confidence in private money as a means of payment and a store of value [[2]]. The convertibility of private money into central bank money is necessary for maintaining confidence in private money and ultimately trust in the currency [[3]].

Declining Role of Cash in the Digital Era

The importance of cash in payments is declining as people increasingly prefer to make digital payments and shop online. Cash is increasingly used as a store of value and decreasingly as a means of payment, a trend that has been accelerated by the pandemic [[7]]. If these trends were to persist and accelerate, cash would lose its central role and become a means of payment that people would be reluctant to use [[7]]. The declining role of cash in the digital era poses a challenge to the effectiveness of central bank money as a monetary anchor [[8]].

Conditions for the Success of a Digital Euro

The success of a digital euro depends on its intrinsic appeal, wide accessibility, and usability. It should be designed in a way that makes it attractive enough to be widely used as a means of payment, while preventing it from becoming so successful as a store of value that it crowds out private money and increases the risk of bank runs [[8]]. Developing a convincing value proposition for all stakeholders is critical to the digital euro’s success [[8]].

Potential Impact of a Digital Euro on the Payment Market

A digital euro would offer a cost-free and convenient way to pay digitally anywhere in the euro area, increase privacy in digital payments, and contain the cost of payments through its potential to mitigate the market power of dominant digital payment providers [[14]]. It would expand payment options in the digital age without crowding out sound private payment solutions and provide a monetary anchor to the rapidly evolving European digital payment ecosystem, underpinning trust and stability in digital payments [[16]].

In conclusion, the ongoing digitalization of the economy and the declining role of cash in the digital era necessitate the exploration of central bank digital currencies, such as the digital euro, to ensure the smooth functioning of the payment market and preserve the transmission of monetary policy in the digital era.

Central bank digital currencies: a monetary anchor for digital innovation (2024)

FAQs

What is the purpose of central bank digital currency? ›

1. The main purpose of CBDCs is to provide businesses and consumers conducting financial transactions with privacy, transferability, convenience, accessibility, and financial security. 3. CBDCs would also reduce the risks associated with using digital currencies, or cryptocurrencies, in their current form.

What is the monetary anchor? ›

As mentioned above, the true monetary anchor of the monetary system is the reserves held at the central bank. As long as commercial banks have a need to hold reserves, the central bank can influence the interest rates on bank loans and deposits.

Would CBDC replace cash? ›

Will a U.S. CBDC replace cash or paper currency? The Federal Reserve is committed to ensuring the continued safety and availability of cash and is considering a CBDC as a means to expand safe payment options, not to reduce or replace them.

WHO has launched a CBDC? ›

The Bahamas, Jamaica, and Nigeria have already introduced CBDCs. And more than 100 countries are in the exploration stage. Central bankers in Brazil, China, the euro area, India, and the United Kingdom are at the forefront.

Is CBDC good or bad? ›

Put simply, a CBDC would most likely be the single largest assault to financial privacy since the creation of the Bank Secrecy Act and the establishment of the third‐​party doctrine. The threat to freedom that a CBDC could pose is closely related to its threat to privacy.

Who controls the central bank digital currency? ›

Federal Reserve Board - Central Bank Digital Currency (CBDC)

What is the role of nominal anchor in monetary policy? ›

A Nominal Anchor is a single numerical target set by a country's central banking authority for the design and implementation of its monetary policy. It often revolves around inflation, money supply, or an exchange rate to maintain economic stability.

What is an example of a nominal anchor? ›

The first type of nominal anchor fixes the currency price of one or more commodities. The metallic standards in which many countries linked their monies to gold or silver or a combination of the two for long periods before World War II are the prime examples of such a nominal anchor.

What is a nominal anchor inflation targeting? ›

A nominal anchor is a variable policy- makers can use to tie down the price level. One nominal anchor central banks used in the past was a currency peg—which linked the value of the domestic currency to the value of the currency of a low-inflation country.

Should we get rid of cash? ›

For instance, using cash instead of credit or debit cards may help keep some people from overspending, because you can see how little is left in your wallet after every purchase. In short, getting rid of cash would impose hardships on society's most vulnerable people and could jeopardize our privacy.

Which banks are going cashless? ›

Commonwealth Bank, ANZ, NAB and Westpac all confirmed on Friday that there are no current plans to go cashless. This comes after Macquarie Bank announced it would phase out cash and cheque services across all its banking and wealth management products from January to November 2024.

Is cash being phased out? ›

If it's been a long time since you pulled out actual dollars and coins to pay for something — here's a conversation for you. It might seem like cash is slowly becoming obsolete. But, Brett Scott says it's a false narrative that we're all pining for a cashless society.

Will there be one world currency? ›

Will There Be a Single World Currency? While the U.S. dollar is often seen as the de facto world currency, to have one truly global currency would require a level of comparability between countries which does not currently exist and isn't likely to for some time to come.

What banks are switching to digital currency? ›

The pilot will test how banks using digital dollar tokens in a common database can speed up payments. Participating banks include BNY Mellon, Citi, HSBC, Mastercard, PNC Bank, TD Bank, Truist, U.S. Bank and Wells Fargo.

Does China have a CBDC? ›

China is among a host of countries developing their own CBDCs - digital tokens issued by central banks - although adoption is still in its early stages. Currently, CBDCs are mostly being positioned as M0 currency, or cash in circulation.

Is central bank digital currency necessary? ›

CBDCs have been suggested to improve the process of cross-border payments, especially where those payments involve exchanges between two respective domestic CBDCs. The increased ease of providing payments from governments to people has been cited.

What are the pros and cons of central bank digital currency? ›

Pros and cons to CBDCs
ProsCons
More efficient and secure payments.Central banks have complete control.
Allow consumers to use central bank directly.Less privacy for users.
Eliminate risk of a commercial bank collapse.Difficult to attain widespread adoption.
1 more row

How do I protect my money from CBDC? ›

Buying gold and silver offer alternatives and are two of the most stable asset classes. Investing in physical gold is a great option when preparing for the introduction of digital currencies. It has long been the most durable and consistently valuable commodity globally.

What are the cons of CBDC? ›

Cons of CBDC

One of the disadvantages of CBDCs is the potential for privacy risks. Digital currencies are vulnerable to cyberattacks, which can result in the loss of funds or sensitive information. The impact of CBDCs on privacy is vast, as they can be used to track individuals' financial activities.

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