Digital Cash: Why Central Banks Should Start Issuing Electronic Money

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digital cashWith the impending ‘death of cash’ and the rise of digital currencies (such as Bitcoin), there are strong arguments for central banks to start issuing “digital cash” – an electronic version of notes and coins (also known as a central bank digital currency). But this raises a number of questions: how would central banks get new digital cash into the economy, and how would the public use it? What would the advantages be? And would there be any impact – positive or negative – on financial stability?

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The Bank of England has already posed questions about the potential of digital cash, or ‘central bank digital currency’, prompted by the ongoing rise of electronic means of payment, and the emergence of alternative currencies such as Bitcoin. One of the key questions to come out of the Bank’s One Bank Reserve Agenda, released in early 2015, was “From a monetary and financial stability point of view, what are the costs and benefits of making a new form of central bank money accessible to a wide range of holders?”

We argue that there are a significant number of of benefits to issuing digital cash:

It widens the range of options for monetary policy: Implementing digital cash can allow new monetary policy tools to be used. If digital cash is used to completely replace physical cash, this could allow interest rates to be lowered below the zero lower bound (although this is not a policy we would advocate). Alternatively, digital cash can be used as a tool to increase aggregate demand by making ‘helicopter drops’ of newly created digital cash to all citizens, making it easier to meet the Bank of England’s monetary policy target of price stability.

It can make the financial system safer: Allowing individuals, private sector companies, and non-bank financial institutions to settle directly in central bank money (rather than bank deposits) significantly reduces the concentration of liquidity and credit risk in payment systems. This in turn reduces the systemic importance of large banks.  In addition, by providing a genuinely risk-free alternative to bank deposits, a shift from bank deposits to digital cash reduces the need for government guarantees on deposits, eliminating a source of moral hazard from the financial system.

It can encourage competition and innovation in the payment systems: The regulatory framework we propose would make it significantly easier for new entrants to the payments sector to offer payment accounts and provide competition to the existing banks. It would also reduce the need for most smaller banks and non-banks to run their payments through the larger banks (who are able to set transaction fees at a level that disadvantages their smaller competitors).

It can recapture a portion of seigniorage and address the decline of physical cash: As physical payments are gradually replaced with electronic payments, the Bank of England will want to replace physical cash with its electronic equivalent. Doing so has the advantage of increasing the ‘seigniorage’ – the proceeds from creating money – earned by the Bank of England (and passed on to the Treasury).

It can help address the implications of alternative finance upon money creation and distribution: Non-banks, such as peer-to-peer lenders, are competing with banks and taking on a larger share of total lending. This has implications for money creation and distribution. When a bank makes a loan, it creates new deposits for the borrower. But when a peer-to-peer lending firm makes a loan, it simply transfers pre-existing deposits from a saver to a borrower; no new money is created. By proactively issuing digital cash, the Bank of England can compensate for any shift in lending away from money-creating banks, and the subsequent fall in money creation.

It can improve financial inclusion: The firms providing Digital Cash Accounts would be payment service providers first and foremost, whereas banks are primarily lenders. Digital Cash Account Providers are therefore likely to offer accounts to those customers that are excluded from conventional banking services.

How to Implement Digital Cash

The Bank of England already issues digital currency, in the form of deposits held by commercial banks in accounts at the Bank of England. It can provide digital currency simply by making these accounts available to non-bank companies and individuals (without the need for a Bitcoin-style distributed ledger payment system). There are two ways this can be done.

In a Direct Access approach, the Bank of England could provide accounts to all citizens in the UK, along with the payment cards, internet banking and customer service requirements this entails. However, the Bank of England is likely to see this as inappropriate state involvement in the private sector and a significant administrative burden.

Consequently, we recommend an Indirect Access approach, in which the Bank of England would still create and hold the digital currency, but all payment and customer services would be operated through “Digital Cash Accounts” (DCAs) provided by (or ‘administered’ by) private sector firms. These private sector “DCA Providers” would have responsibility for providing payment services, debit cards, account information, internet and/or mobile banking, and customer support. Any funds paid into the DCA would be electronically held in full at the Bank of England, so that each DCA Provider could repay all its customers the full balance of their account at all times. DCA Providers are prohibited from lending or taking any risk with their customers’ funds.

The Indirect Access approach is a much more market-driven approach which will help to increase competition in current and payment account services. It minimises the administrative burden on the Bank of England. Conveniently, the regulatory framework for this approach already exists in the form of the Payment Services Provider model (with minor adaptations).

Managing the Issuance of Digital Currency

The Bank of England currently issues central bank money reactively: it issues banknotes in whatever quantities are needed to meet demand from the public, and issues central bank reserves in order to meet demand from the banks. It could choose to issue digital cash in the same way, by providing the infrastructure for Digital Cash Accounts but letting the public determine how to split their holdings of money between bank deposits and digital cash. By making transfers from their bank deposit accounts, the public, rather than the Bank of England, would determine how much digital cash needs to be issued. In this case, the money issuance would be entirely reactive.

Alternatively, by taking a proactive approach to issuance, the Bank of England could use digital currency as a monetary policy tool to stimulate aggregate demand and influence the economy. If every citizen had a Digital Cash Account at the Bank of England (either directly or indirectly), then it would be a simple process for the Bank of England to make small and occasional ‘helicopter drops’ of newly created digital cash to every citizen. This could be done on a small scale (for example, just £50 per citizen) and at short notice. This new monetary policy tool may give the Bank of England a far more accurate and direct method of implementing monetary policy than conventional monetary policy (adjusting interest rates) or post-crisis policies such as Quantitative Easing.

Please note, this is not a proposal to abolish physical cash. Notes and coins are going to be around for at least another 30 years or so – as long as people keep using them. For privacy concerns, digital cash issued by central banks is no different in terms of privacy than payments made using electronic bank accounts. And again, cash will still be around for 30 years or so.

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  • dharmaverick

    There is a risk, under the Indirect Access approach, that the Digital Cash Accounts would be colonised by the dysfunctional ‘to big to fail’ banks (as it is, they’re taking an unhealthy interest in disruptive technologies like the blockchain as it is). This is where digital currencies like Bitcoin that can operate wholly outside the framework of the banking system, and which now has its own ecosystem of payments and transaction services, should be openly encouraged by the Bank of England, and the government, to provide the DCA services. Indeed, perhaps the big banks should be shut out of DCAs altogether?

  • Lorenzo Sleakes

    The best use of electronic money will be the transition from transaction based taxes to a tax on money itself via the negative interest rate. Demurrage (i.e. the accumulation of money should cost something so it cannot be speculatively hoarded), and the reform of seigneurage become seen as flip sides of the same thing..legitimate public ownership of the money supply with corresponding legitimate privacy of transactions.

    My natural rights based philosophy arrives at many of the same conclusions and the ultimate desirability of an electronic money

    Money when conceived of as a public utility rather than debt created by private bankers can be thought of as loaned out by the state for private use at interest. Rather than making individual loans without 100 percent backing (today’s system) a Gesellian tax or publicly collected negative interest rate would act as if money itself was loaned out by the public for private use by everyone.

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