Central Bank Digital Currency
What is Central Bank Digital Currency?
A central bank digital currency is digital money issued by the central bank itself, giving holders a direct claim on it rather than a deposit at a bank.
Households can hold central bank money only as physical cash, since the balance in a banking app is a claim on that commercial bank, insured up to a limit. A central bank digital currency would extend direct central bank money into digital form. Designs split into wholesale, where only financial institutions hold it and which is close to what reserves already are, and retail, where households and firms hold it as well. The question that dominates the debate is disintermediation, because if anyone can hold a risk-free digital claim on the central bank, deposits may drain out of banks, slowly in normal times and very fast in a panic. Proposed answers include caps on holdings, paying no interest or tiered interest, and distributing the currency through banks instead of through accounts at the central bank.
Central Bank Digital Currency: a worked example
A bank holds $50 million of reserves and $470 million of loans, funded by $500 million of deposits and $20 million of equity. A retail digital currency with no holding limit then draws away 20 percent of its deposits, which is 0.20 × 500 = $100 million. The bank can meet only $50 million of that from reserves, so it has to sell or stop renewing $50 million of loans, or replace the funding at a higher cost. A cap of a few thousand dollars per person would limit how much could move, which is why almost every serious retail design includes one.
The mistake students make with central bank digital currency
Students file a digital currency issued by a central bank under cryptocurrency, or under online banking. It is neither, because its quantity is a policy decision rather than a protocol rule, and its value is fixed in the national unit rather than set by a market. The money already sitting in a banking app is a liability of that commercial bank, whereas this balance would be a liability of the central bank.
Central Bank Digital Currency questions
How is a CBDC different from cryptocurrency?
A central bank digital currency is issued and controlled by a central bank, so its quantity is a policy choice and its value is fixed in the national unit of account, while a cryptocurrency is issued by protocol rules and its purchasing power is whatever the market makes it. The two share a digital form and very little else.
How is a CBDC different from the money in my bank account?
A bank balance is a claim on a commercial bank, protected by deposit insurance up to a limit, while a central bank digital currency balance would be a claim on the central bank itself and carry no credit risk at all. In daily use the two would feel identical, and the difference only shows up in who owes you the money if the bank fails.
Why do economists worry a CBDC could weaken banks?
The worry is disintermediation, since deposits are how banks fund loans, and a safe digital alternative could pull those deposits away, raising bank funding costs and shrinking lending. The sharper version of the worry is that in a panic the move into central bank money would be instant and unlimited, making runs faster than they already are.
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