The Case for

Central Bank
Digital
Currencies
B y A n d r e a s D o m b r e t a n d O l i v e r Wü n s c h

T
he last dozen years have seen the emergence of digital cur-
rencies, starting with Bitcoin in 2009, a highly specula-
tive asset with some currency characteristics that is pri-
Why it could soon vately issued and not connected to any central bank or
government-issued currency. This was followed by Libra,
invented and de facto controlled by one of the largest tech
be time to go bold. companies, which aimed at merging the advantages of be-
ing based on existing official currencies with the advantag-
es offered by technology (“stablecoin”). More recently, several central banks
are contemplating or already experimenting with issuing a digital currency
themselves—a central bank digital currency, or CBDC—that would comple-
ment “account-based money” which exists as central bank money (physical
cash issued by and reserves with the central banks) and private money (deposits
at private credit institutions).
Pervasive digitization has reduced the leverage policymakers have over the
choices made by economic agents about which currency they use, particularly
in countries with less robust institutions and less stable currencies. While it
is difficult to predict exactly what role digital currencies will play, it is quite

Andreas Dombret is a global senior advisor with Oliver Wyman, and formerly
THE MAGAZINE OF INTERNATIONAL
ECONOMIC POLICY served as board member at the Deutsche Bundesbank and as a member of the
220 I Street, N.E., Suite 200 Supervisory Board of the European Central Bank. Oliver Wünsch is a partner
Washington, D.C. 20002 with Oliver Wyman, and formerly served as one of the International Monetary
Phone: 202-861-0791
Fax: 202-861-0790 Fund’s mission chiefs to Greece and Cyprus, and as representative of the IMF
www.international-economy.com and the Swiss administration to the Bank for International Settlements and the
[email protected] Financial Stability Board.

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banks emerged in mediaeval times as trans-European

trade intensified. Merchants like the Fugger family,
With the advent of digital currencies, needing to pay for goods at a distance, branched out into
banking, where moving around physical money is re-
placed by moving claims on money around with a stroke
we might stand at a juncture in of a pen, or today through computers.
Deposit money comes with many advantages. From
a macroeconomic perspective, it provides the means of
economic history as significant as the money creation to private sector banks that did not is-
sue base money in the first place, by way of leveraging
and providing credit. The issuer of base money, today the
invention of paper money and banking. central bank, can rely on a widespread banking system to
contribute to money creation while itself determining the
right amount and the conditions for credit. Practicality
and convenience count.
certain that significant shifts will happen. Policymakers For consumers, stocking the right amount of cash
will want to ensure that the official monetary system is at the bank counter or the ATM and paying physically
the most attractive one. at the baker or the butcher shop is not convenient, which
CBDCs might be a possible avenue for safeguarding explains economies moving away from cash for daily
the “public good” features of a monetary system brought use as soon as electronic alternatives became available.
to the broader economy. Especially in the retail area, The financial system benefits because providing credit,
these experiments are still in their early stages. More pol- deposit, and payment services is lucrative, albeit less
icy and technical work needs to be done, although many so recently. And governments enjoy the universal trace-
central banks have still not determined whether they will ability of non-cash transactions in enforcing tax or anti–
roll out CBDCs at all. money-laundering laws. Due to all of these factors, today
Taking a long-term view, here is an outline of what the value of physical cash in circulation is marginal com-
might be achieved in the next few years. We explain why pared to the value of deposit money.
central banks should go bold on CBDCs in the long term, The advent of cryptocurrency leads to a new equilib-
as such an approach is the only one that will allow CBDCs rium. The laws of physics and rules that used to provide
to become viable, in particular as alternatives to physical for scarcity and non-duplication are replaced by the laws
cash and as co-existing alternatives to deposit money.

THE END OF PHYSICAL CASH?

The concept of money emerged several thousand years Central banks should go bold on
ago. From the beginning, money provided three basic
functions: a unit of account, a means of transaction, and
a store of value. An important reason for something to CBDCs in the long term.
be called money or currency was that a particular type
of money was accepted by convention, custom, or law as
a means to account for and settle claims—legal tender.
Different kinds of specie were used: coins made of mathematics that ensure the same, however without
of precious metal, paper money, or exotic items such as the inconvenience that comes with physical goods.
shells. They all have in common that they are scarce, ei- In recent years, digitization has become pervasive,
ther by natural constraints (the availability of precious and in such a world, physical cash becomes anachronis-
metals), technology (security features of banknotes), tic. Still, physical cash for now stays around for several
and/or through legal safeguards, such as the monopoly to reasons. First, the world has not yet arrived at broadly
issue coins and notes protected by criminal law and the accepted alternatives. Non-sovereign cryptocurrencies
enforcement power of a government. such as Bitcoin and Ether are not universally accepted,
Reliance on the laws of physics comes with an im- exhibit significant volatility in value against official cur-
portant inconvenience. Cash has to be physically moved rencies, are technically not fit for large-scale applications,
and stored. This is logistically expensive and comes with and hence come with significant costs and risks for their
security risks. It is for this reason that in Europe the first users and cannot be regarded as efficient. Stablecoin-like

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instruments “backed” by official currencies promise to ad- A CASH-LIKE INSTRUMENT

dress the issue of volatility. But they still suffer from the Physical cash today provides for anonymity and limited
issue of fragmentation, as attempts to establish broadly traceability, and these features allow it to be exploited for
used stablecoins have failed so far for a number of rea- illicit activities. It is for that reason that several jurisdic-
sons, including the fact that sovereigns are not willing to tions are pushing back on the use of cash, in particular
hand over a key element of sovereignty to private actors. in countries where tax evasion and organized crime are
CBDCs are still in their infancy, with central banks (right- pervasive. The perception of physical cash becoming
fully) conducting very limited experiments given the po- outdated and inconvenient and its reduced use for trans-
tentially significant implications to the monetary system. actional purposes is the most important facilitator of the
However, these issues are not insurmountable from “war on cash.” In that sense, it might seem inconsistent
an economic and technological perspective, and devel- to call for an instrument that replicates those features of
opments in the theoretical foundations of cryptography physical cash that are perceived by some as disadvan-
as well as digitization will not be rolled back. Rather, tages. But there are important advantages that remain
as practical and viable alternatives might emerge in the relevant.
future, the shift to a new monetary equilibrium could First, the availability of a monetary instrument that
be swift and irreversible. Political and legal roadblocks does not fully rely on private sector infrastructure is an
might slow down or try to prevent such shifts, but this important public good. Private sector firms such as credit
approach could come with costs to the general trust in the card companies are commercial enterprises that (rightly)
monetary system, as we argue below. decide which counterparties they want to engage with
and on what terms (contractual freedom). They abide
“STORE OF VALUE” by mandatory and universally accepted legal constraints
Prototypes of CBDCs focus on the “means of transac- (for example, not aiding or abetting criminal activities),
tion” function and de-emphasize the function of “store but also pursue their own strategic objectives. Clients
of value.” In the short term, such restrictions are justified. have few avenues to challenge such decisions, particu-
Important policy questions remain to be answered and larly if they are confronted with oligopolistic structures
most CBDC initiatives are regarded as experiments from
a technical point of view. It is sensible not to allow or fa-
cilitate the aggregation of significant value in something
that is not fully developed, especially as the security of The advent of cryptocurrency
digital currencies still needs to be proven.
In the medium term, however, it is questionable
whether a CBDC that is significantly limited regarding leads to a new equilibrium. The laws
the “store of value” function is viable. To be fully ac-
cepted as an alternative to other currency instruments
including cash, a CBDC needs a strong use case. In de- of physics and rules that used
veloped economies with broad financial inclusion and
where most individuals and businesses have access to
bank accounts, debit/credit cards, and other means of to provide for scarcity and non-
non-cash payments, the added value of CBDCs over
industry-provided payment products such as cards or
mobile apps is limited. The enforcement of a limit on duplication are replaced by the laws
the amount of CBDC an individual or business can hold
would require the central bank as issuer or an appointed
third party to monitor the content of CBDC wallets. This of mathematics that ensure the same,
would result in an account-like system that does not of-
fer material benefits for end-users over today’s bank ac-
counts and payment systems. Although CBDCs could be however without the inconvenience
introduced to serve as a fallback option only, that would
require economic agents using them regularly and to a
significant extent. Rather, for a comprehensive business that comes with physical goods.
case, economic agents should be able to “store value”
in future fully developed CBDCs if they chose to do so.

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that develop when network effects are at play, such as To this end, central banks might be best situated
with mobile application platforms (such as Apple’s App to lead the development of a CBDC as an alternative to
Store) or payment providers. The market conduct of physical cash. They are the competent monetary authori-
companies such as Apple and Google that leverage their ties, enjoy the trust of the broader society, can ensure
mobile phone business to exert influence over any eco- close coordination with policymakers, and ensure any
nomic activity that is performed through their mobile
devices is currently under scrutiny by lawmakers in the
United States, the European Union, and elsewhere, and
subject to several high-profile court cases. These net- Pervasive digitization has reduced
works and their effects don’t stop at jurisdictional bor-
ders, and the two global economic points of gravity—the
United States and China—have substantial leverage over the leverage policymakers have over
the platforms. Other regions, including Europe, have so
far failed to establish competitive alternatives. It is likely
that for many economies, creating a secure alternative to the choices made by economic agents.
physical cash is now more promising than the develop-
ment of autonomous digital or payment platforms.
Second, not having a monetary instrument that pro-
vides for anonymous use creates huge amounts of data such initiative is well-embedded in the broader financial
that, as experience shows, is not safe against data breach- system, including banks and financial market infrastruc-
es and will exist forever. Preventing such data from ac- ture institutions. In contrast, one must be skeptical of pri-
cumulating in the first place might be the only effective vate sector initiatives such as privately issued stablecoins,
solution, especially if legal frameworks of involved juris- except for very limited-use cases. Private companies
dictions do not provide for strong data protection domes- would be at risk of pursuing strategic interests that might
tically and across borders. conflict with the public-good character of the monetary
Third and finally, while physical cash requires elab- system. As much as fragmentation will hamper the ac-
orate and expensive logistics to be available in the entire ceptance of any initiative, the emergence of a dominant
economy, an actual transaction does not need any techni- stablecoin player comes with policy, financial stability,
cal infrastructure, as bank notes and coins can be used and anti-trust issues. Furthermore, a privately issued sta-
without electricity, internet, or digital devices. While we blecoin cannot be regarded as central bank money, even
have made significant progress in improving the resil- if it is backed by it, as it remains a claim on the issuer of
iency and availability of core elements of our financial the stablecoin, not directly on the central bank.
market infrastructure (such as real-time payment systems
and communication networks), it is challenging to reach MANAGING THE RISK OF DISINTERMEDIATION
similar standards in the broader economy, which for ex- The ability of economic agents to hold central bank mon-
ample would need to include internet access for consum- ey in a more convenient way than physical cash might
ers and merchants. Recent high-profile failures of cloud shift the balance between holdings of central bank money
infrastructures demonstrate how these vulnerabilities and deposit money with commercial banks. Many of the
could cause entire economies to grind to halt. Again, it constraints that deter agents from holding larger amounts
might be more promising to design a payment instrument of cash do not apply to holdings of CBDC, in particu-
that is resilient by design than to develop a global, cen- lar costly logistics and security measures. Commercial
tralized system that is fully resilient. banks could be (partially) cut out, leading to “disinterme-
The above examples show that even if physical cash diation,” which by some is seen as a key obstacle to the
might not have a significant role in a future economy, rollout of the CBDC.
its specific characteristics remain important. However, A CBDC that allows for the storage of value comes
at least to our current understanding, the features that with challenges in two situations. In the stressed scenario,
make cash resilient to the challenges described above economic agents might choose to withdraw money from
are highly correlated with the characteristics that are tar- their bank accounts, turning their deposits into CBDCs.
geted by the “war on cash.” Smart choices need to be While they would still be exposed to the risk related to the
made to find workable compromises, as the abolishment currency (foreign exchange risk, or inflation), they could
of a monetary instrument as useful as physical cash will effectively avoid the counterparty risk of fragile banks.
likely backfire. There is the concern that the availability of CBDCs could

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facilitate such bank runs and thereby create or amplify fi-

nancial stability risks. As withdrawals materialize, central
banks would need to backstop the banks confronted with There is the concern that the
withdrawals through emergency funding.
But it is not yet clear how the availability of a CBDC
would significantly exacerbate an issue that already ex- availability of CBDCs could facilitate
ists today: larger depositors who have, in several past
crises, moved early and quickly, diversifying cash hold-
ings towards banks that are perceived to be safer either bank runs and thereby create or
within an economy or outside. Their behavior not only
stems from the size of the risks they are facing. Rather,
large depositors have an information advantage as well amplify financial stability risks.
as accounts with several banks at home and abroad that
facilitate the reallocation of funds. Retail investors, on
the other hand, have less incentive to move, because a
large share of their funds is credibly covered by a de- CBDCs (without the burden of handling physical cash)
posit guarantee. Risks only materialize if the capacity of and bank deposits. Even with CBDC holdings at the ex-
the safety net is not sufficient and the sovereign is not pense of bank deposits, banks are not cut out. Rather,
able to (or chooses not to) backstop the safety net, which they can be an important part of the CBDC ecosystem
could be the case in a systemic crisis. The availability of by playing a role in its operation and offering addition-
CBDCs might thus have no significant impact on deposi- al services such as payments and asset management.
tor behavior in stressed scenarios compared to the status However, as many of the additional services will not in-
quo. The availability of a CBDC could even contribute to clude deposit-taking since it is central bank money that is
deposit stability, as depositors would be assured of being managed or held in custody, the regulatory requirements
able to withdraw funds if they decided to, reducing the will be less burdensome than those applying to a deposit
incentive to move early. taker. Banks might therefore face additional competition
Even during business-as-usual periods, economic from non-banks for certain services. A CBDC ecosys-
agents might prefer to hold CBDCs rather than depos- tem that is run as a public good could make it easier to
its at banks that the latter can use to extend loans. Some foster a level playing field and prevent anti-competitive
voices have claimed that this could lead to a credit crunch behavior.
and/or a massive expansion of central bank balance The issues mentioned here deserve close scrutiny
sheets, which might then face public pressure to grant and need to be carefully analyzed both in theory and
loans directly to companies and individuals. However, it in practice, including through experiments and studies.
should be expected that depositors make rational choices. Structural changes are to be expected. However, it is un-
If banks are offering higher interest rates than a CBDC, clear whether such changes would be so costly as to be
economic agents should have the choice of depositing the ultimate roadblock for CBDC deployment.
money with banks.
It cannot be ruled out that a CBDC would lead to FINANCIAL INTEGRITY, BUT ALSO INNOVATION
lower deposit amounts, the gap being filled by central Recently, the European Parliament has taken a funda-
bank funding. So while a new equilibrium between mental stance on the issue of preventing the use of digi-
CBDCs and bank deposits might materialize, cen- tal currencies, including CBDCs, for illicit purposes.
tral banks can develop required mitigation strategies. Legislative proposals such as the Markets in Crypto-
Political pressure on central banks to provide direct lend- assets Regulation and anti-money laundering regulation
ing to corporations and individuals cannot be ruled out, require all transactions with digital currencies, regardless
but would in most countries require far-reaching changes of whether issued privately or by a state entity includ-
to the central bank and monetary legal framework. With ing the central bank, and regardless of the transaction
development banks as well as with lending rules such as amount, to be traceable. Lawmakers held that the speed
the recently enacted EU taxonomy for sustainable activi- and low cost of digital currency transactions would fa-
ties, policymakers already have significant leverage over cilitate the structuring of larger value transfers into
lending decisions. several transactions to such an extent that any material-
The new equilibrium will bring more choice to eco- ity threshold would open the possibility of large-scale
nomic agents, as they can allocate their deposits between money-laundering.

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Effectively, this means that any transaction, includ- “fair” anymore, but open to abuse by powerful private
ing the purchase of a cup of coffee, will require the and public stakeholders, thereby undermining the trust in
identification of the involved counterparties, although one of the most important pillars of our liberal societies.
the circle of individuals and institutions that would have The existence of this exit door might be more important
access to such information would depend on the actual than its actual use.
regulation and technical implementation.

W
On the other hand, the European Central Bank has ith the advent of digital currencies, we might
performed several studies on the end-user acceptance of stand at a juncture in economic history as sig-
digital currencies. These surveys show that among many nificant as the invention of paper money and
potential aspects, “privacy” is regarded as most impor- banking. The geopolitical, societal, and monetary envi-
tant. It seems then that there is some degree of conflict ronment is facing significant challenges to the stability
between the objectives of policymakers and the charac- we have enjoyed for nearly thirty years. The future de-
teristics that would drive the acceptance of digital curren- sign and continued broad acceptance of digital curren-
cies by the general public. These divergences also seem
to be driven by culture, which will make it difficult to
align on a set of universal rules in the European Union,
let alone globally. It cannot be ruled out that
In the end, it will be necessary to allow for a certain
“risk appetite.” The calibration will require careful consid-
eration. Too much risk appetite might make a digital cur- a CBDC would lead to lower deposit
rency vulnerable to abuse. Too cautious an approach might
hamper the acceptance of a digital currency, as overreach-
ing compliance-related restrictions will negatively impact amounts, the gap being filled
legitimate use. Trade-offs between resilience, the risk of
data breaches, and centralization versus more decentral-
ized approaches need to be well thought out. by central bank funding.
FAILURE MIGHT UNDERMINE PUBLIC TRUST
The establishment of trusted monetary systems can be
seen as one of the greatest achievements of economic de- cies will be an important determinant of our political,
velopment and is one of the most important pillars of lib- social, and economic environment for years to come.
eral markets. A key success factors of currencies is that Given the stakes, governments and central banks
they are “abstract” and “apolitical.” As long as one stays are right to pursue a cautious approach. A stable mon-
within the limits of the law—usually a broadly accepted etary system is one of the pillars of stable nations, and
consensus on what is legal and what is not—economic changes to this important public good need to be care-
agents can rely on the unimpeded use of monetary instru- fully considered.
ments in their daily activity. In the absence of a viable The system’s ultimate design should be driven pri-
alternative to physical cash, economic agents are at the marily by market forces and user requirements to ensure
mercy of private companies, and policymakers who pur- broad acceptance. Regulation and policies should focus
sue overly broad objectives might not enjoy broad and on preventing market failures and safeguarding stability,
sustainable consensus within the society, within or even while not stifling the move toward an economic equi-
across jurisdictions. librium between different types of money, or protecting
Safeguarding a certain degree of “abstractness” in market structures that are not efficient as technology de-
the monetary system comes with two important benefits. velops. Otherwise, economic agents might be attracted
First, it provides economic agents with an “exit door” to to alternatives to the formally regulated financial system,
safeguard their funds from the interests of private sector with policymakers having limited power to prevent such
firms and policymakers that are not covered by funda- shifts. Countries with less robust institutions and less sta-
mental legal principles. Second, this exit door tames the ble currencies might be perceived as more vulnerable to
ability of firms and policymakers to “go financial” when such developments. However, the recent Covid crisis has
they should instead address the root of policy failures demonstrated that even in developed countries, the social
directly. Closing the exit door further might cause eco- fabric and trust in institutions might be more fragile than
nomic agents to suspect that the monetary system is not we would have thought.  u

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