Could central banks embrace digital currencies – what might the benefits be?

A report by the Bank of Canada has highlighted the potential benefits of central banks becoming involved with digital currencies.

Digital currencies have been gaining a lot of attention recently, thanks mainly to the huge spike in the value of Bitcoin, the most high-profile form of the currency.

Over the last year, the value of Bitcoin has increased by more than 1,800 percent – with much of this occurring in December 2017, when it hit a peak of almost $19,000. However, the volatility of the currency has led to major concerns about its long-term viability, and there is an expectation among many in the financial industry that it is a matter of when, not if, the bubble will burst.

One of the key arguments against Bitcoin and its competitors is that it is a completely decentralized currency without the oversight of a central bank. But while this has until now been a defining features of the digital currency sector, does this have to be the case?

Central banks increase interest

Several central banks around the world have been expressing interest in digital currencies for a while, but one recent study conducted by the Bank of Canada has suggested there could be a range of benefits as a result of central banks issuing their own digital currencies.

The paper, by researchers Walter Engert and Ben Fung, highlighted six key reasons why a central bank digital currency (CBDC) is something that should be given serious consideration, particularly as the use of cash payments in developed countries like Canada continues to decline.

In a future where a cashless – or at least a ‘less cash’ – society is considered to be a realistic scenario, the researchers noted that providing a wider range of alternatives may be essential if central banks are to effectively serve the public, though they added that issuing CBDC should be viewed as an addition to bank notes and central bank reserves, and not as a replacement for cash.

Embracing new payment options

Of the potential benefits of CBDCs, the researchers suggested that improving “contestability” in the payments system is one of the most compelling arguments in favor of the technology. As central banks have a strong interest in maintaining an efficient payment environment, CBDCs could provide a useful alternative to bank notes, checks, debit and credit cards and online money transfers when it comes to retail payments.

The potential to reduce costs across the financial system is another key factor than must be considered. For consumers, using CBDCs could be less costly than using cash, while merchants may be able to benefit because there would be no transaction fees charged by the central bank.

Elsewhere, the researchers suggested that CBDCs may have a role to play in boosting financial inclusion. While this would not be a compelling motivation for adopting such solutions in advanced economies, CBDCs could provide an “accessible general purpose electronic payment method” for emerging economies.

“Consideration of CBDC is a new challenge, which is complex and subject to significant uncertainty,” the report concluded. Therefore, it urged central banks to proceed with caution if they are considering embracing digital currency technologies and taking incremental steps in order to learn from experience.

Written by Jack Dougal

Jack Dougal

Jack Dougal is Banking.com's resident news reporter. He writes regular blogs covering the latest stories and key developments in the global financial services industry.

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