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Cash Payments

Will Digital Cash Be the New King of Payments?

February 26 2021

 

First of a series on Central Bank Digital Currencies

Central banks around the world are in the process of developing digital cash, commonly known as central bank digital currency, or CBDC. At Glenbrook, we’re kicking off a series of Payments Views posts that explain CBDC and its implications for various aspects of the payments value chain. 

In this post, we start with a couple of basic concepts: what is digital cash, what is CBDC, and why is 2021 a pivotal moment for CBDC?

What Is Digital Cash?

To understand what “digital cash” is, it’s useful to define what cash is and how it relates to other forms of money. We divide the sort of money that we hold into two categories: notational and token-based. 

Notational Money

Think of notational value as the money stored in your Chase bank account or on your Venmo app. The funds in these accounts represent value, and can be credited or debited from other accounts.

Token-based Money

In contrast, cash is token-based. Whether a coin or a paper note, cash is not a representation of value, but a store of value. Funds are transferred not through debits and credits but through the transfer of the token itself. For example, I can exchange two quarters for 20 minutes of parking on the street in Berkeley, California. Another aspect to note: tokens can be lost. If one of the two quarters falls out of my wallet and rolls into a sewer drain while I’m standing at the meter, the token is gone forever.

 

What Is CDBC?

The idea of creating digital cash isn’t new. Companies like DigiCash, CyberCash, Mondex, and others explored digital coins during the 1990s. None stuck. An early concern was that tokens, like any type of digital file, could be copied, creating a digital version of counterfeit bills. This fear was assuaged, in part, by the introduction of new encryption technologies like public key encryption. However, you still had to trust your digital cash provider to keep your tokens safe and secure. The emergence of bitcoin in 2008 was a breakthrough in terms of trust. By distributing encryption across a ledger and deploying well understood encryption in a novel fashion, users could trust that their digital tokens would not be counterfeited.

But even as the value of bitcoin climbs, and a cottage industry of startups makes the digital currency more convenient to spend at the POS terminal, the notion of bitcoin as a transactional instrument remains a novelty (at least outside of the dark web). 

Inspired perhaps by bitcoin’s success, Facebook believed in the transformational transactional potential of digital coins and spun up Libra (now known as Diem) with development beginning as early as 2018 on this Facebook cryptocurrency. Libra was envisioned as a blockchain-based currency that could be used for transactions by all Facebook users. The project touted lofty goals of financial inclusion and promised to unite the world through a single currency.

Lighting the CDBC Fire

This spooked central bankers, who were concerned that a currency used by Facebook’s billions of users would have adverse effects on their ability to control macroprudential policy. After significant backlash, Libra 1.0 became Libra 2.0, a coin pegged to the value of real-world currencies including the U.S. dollar and euro. 

Despite these changes, central banks had already been catalyzed to act and began working on their own digital cash projects, or CBDCs. It’s worth noting that some countries had been working on CBDC projects prior to the introduction of the Libra concept, but the project clearly spurred central banks to act more decisively. More governments have entered into CDBC development. 

Beyond keeping control local over their domestic currency, CBDCs are attractive to central banks for a number of reasons: 

  • Depending on a variety of design options (that we will get into in subsequent posts), CBDCs could give governments greater insights into how money is spent
  • In times of economic uncertainty, CDBCs can be programmed to accommodate negative interest rates
  • CBDCs can be coupled with novel payment systems to facilitate instant payments to shift volume away from global card giants Visa and Mastercard, making domestic transactions less expensive
  • Digital cash is also cheaper to mint that physical currency
  • And, for the most ambitious CBDC developers, digital currencies represent an opportunity to unseat traditional reserve currencies like the U.S. dollar

Why Is 2021 Pivotal for CDBC?

Today, only one country has launched a CBDC: the Bahamas, with its digital Sand Dollar. However, R&D is well underway across the globe. China has been particularly ambitious in its pilot of a digital yuan, and is additionally exploring the idea of creating a regional digital currency to facilitate trade across east Asia. In the United States, the Boston Fed is working with MIT to develop a prototype CBDC, announced in 2020. 

As we continue to observe progress across the numerous countries testing the CBDC waters, we will publish a series of further Payment Views posts exploring the effects of government-backed digital currencies on consumers, merchants, and payments providers. We will examine design considerations for governments and opportunities for ecosystem participants to add value to CBDC projects.

We look forward to taking this journey with you.

 

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