Two Peas in a Pod: Cash and CBDCs

There is much talk and activity around Central Bank Digital Currencies (CBDCs) at the moment, particularly retail CBDCs. As one reads the papers and listens to the frequent webinars about them, it is striking that there is a requirement for CBDCs to replicate the performance of cash. And that is clearly proving a challenge.

The strengths of cash are well known, with privacy, resilience, financial inclusion, security being most commonly referred to. In addition, cash provides an alternative payment option that means private money providers cannot increase their charges and fees too much.

Equally, cash is also regarded as having weaknesses. Some argue it is expensive, most consumers like the convenience of digital payments, economists and the authorities see it as an enabler of tax evasion and criminal activity, and banks generate little profit from cash whereas they generate significant profit from the alternatives. There is also a sense that it is old fashioned.

Retail CBDCs also need to deliver a payment system that does not disrupt the financial system, that fosters payment innovation and that works across borders. The expectations on retail CBDCs, are high which makes their design a challenge.

Compliance with the regulatory requirements of know your customer, anti-money laundering and anti-terrorism financing, and the inherent digital signature of a CBDC, means that they cannot be private in the way a banknote is. Although it is possible to design a CBDC so that banks don’t have access to payment histories as they do today, citizens know that ultimately a state can access their CBDC payment records.

Resilience is much talked about, and while it is possible to design CBDCs to be held and used on and between wallets without the full payment infrastructure, the value held has to be limited due to the privacy rules and even then the wallets need power and connectivity. If the CBDC shares infrastructure with existing payment options, then it is no more resilient than they are. If the system runs on an independent system, that system still needs to have power and somebody has to pay for the new infrastructure.

Financial inclusion is easy to say but hard to deliver. Financial literacy is extremely hard to achieve. Cash & Payment News™ ran a story this month about the Kenyan mobile money service M-Pesa, which now comes with what is effectively an overdraft function. Many people are now in debt and are no longer using M-Pesa because they cannot pay off their overdraft and have money to live on in the same month. If your circumstances mean you need a simple payment method, then a CBDC is unlikely to be the answer anymore than a bank account.

The media today is full of stories of financial crime based on digital payments. Much of this is defrauding people, but digital crime is a major cost to society overall. The crime relating to cash is low in comparison.

A CBDC needs to be safe against all of the existing digital crimes and against being interfered with or even falsely created. Technology is moving fast and the race to be one step ahead of the digital criminal will be constant and unrelenting, perhaps harder than the challenge facing cash.

As we have seen across a whole range of crises, when there is significant uncertainty, people withdraw and hold cash. Citizens will need to have enormous confidence in their governments to be willing to store value at a central bank rather than as a tangible token such as cash.

Perhaps it is time for central banks to think about cash and CBDCs as long-term partners, a sustainable system of payments that complement each other. While cash exists, along with a given level of infrastructure to allow it to function, people can choose to hold cash rather than a CBDC. The number of people who are concerned about privacy will be small. Those who struggle with the digital world can use cash. Until there are clear problems with the system outages or security breaches, people can use CBDCs. If people want to hold a physical store of value, they can.

This choice, these options, will come at a cost but they will allow the design of CBDCs to be significantly easier and their introduction to be quicker. It provides confidence and security in a transition phase that is likely to be important.

Design cash and CBDCs to deliver together, meeting all needs efficiently and cost-effectively. It might make the CBDC design easier and allow the cost of payments to be fairly met across the whole of society.