History Gives Context to Future of Central Bank Digital Currencies

November 30, 2021

Interest in central bank digital currencies (CBDCs) is growing because of their potential to increase efficiency in payment and settlement systems.

In Regional Economist, St. Louis Fed Senior Economist Amalia Estenssoro discussed how CBDCs, in addition to cash and bank reserves, could become the third central bank liability if issued in the future.

Estenssoro examined technology that has introduced different forms of money throughout history and how those efforts could provide a glimpse of what’s to come with CBDCs.

A Look Back

The earliest forms of money technologies include coins. Introduced in the fifth and sixth centuries B.C., coins tied their value to the metals used in their production. Another form is promissory notes, which were used by early dynastic China, Carthage and Rome. In the 17th century, a chartered bank in Sweden issued bank notes, a concept brought back to Europe by Marco Polo.

A public bank first issued wholesale deposits backed by coins, also in the 17th century, leading to the development of public fiat money. Later, the Bank of Amsterdam became the first proto-central bank, but it lacked fiscal backing by the sovereign and eventually failed.

“This experiment of a deposit liability backed by safe assets and convertible to cash 1:1 on demand resembles today’s rigid stablecoin technology,” Estenssoro wrote. “In this context, digital private currency innovations are no different from innovations in the 17th century, and a new form of public money, CBDC, could turn out to be a significant and more efficient monetary innovation than digital private money.”

Monetary evolution continued in the 20th century. Public money became independent from an intrinsic value based on metals. Also, notes and coins set the unit of account for fiat money, allowing cash to settle any legal debt.

The coexistence of public and private money brought about two-tier payment system rails. Those use bank payment tools for retail transactions and reserves for interbank wholesale settlements.

Spotlighting Central Bank Digital Currencies (CBDCs)

Monetary history shows how private innovation results in public innovation. And CBDCs could be the next step.

The purpose of CBDCs depends on how they are designed, Estenssoro explained.

“Each feature, or technological detail, has important, implicit trade-offs that require specific policy decisions,” she wrote. “For instance, a CBDC can be designed as an account-based, centralized ledger resembling a bank account—with crime prevention features—or as a token-based, anonymous transactional tool.”

Privacy will be a vital factor of CBDCs and could determine their widespread use, she added.

A CBDC can also be wholesale or retail, with the latter adding immediate settlement capabilities for retail payments, she pointed out.

CBDC research currently focuses on the retail aspect of the technology—for example, the preferred exchange in the future for private wallet apps such as Apple Pay and Google Pay, the author noted.

“Digital payments create digital balances, carried in electronic form and recorded in an intermediary tech company’s balance sheet, as opposed to a bank’s,” Estenssoro wrote. “Nonetheless, digital transactions today almost always settle in the two-tier (bank) payment rails that deliver finality of payment on the central bank books.”

Because of efforts to reduce fraud and increase financial stability, jurisdictions are hesitant to discard the two-tier bank payment systems. However, new technologies could bypass banks and central banks if widely accepted by the public. But that movement would likely lead to more bank regulation for technology companies.

Becoming a Reality?

Central banks have incorporated technology before to improve operations, the author noted. Digital payments can do the same by lowering transaction costs, reaching unbanked populations and benefiting the economy. The rollout and pace of innovation will be determined by each jurisdiction’s ability to adapt to the changing landscape.

What role can central banks play in this move toward digital payments? They can choose to do one or more of the following:

  • Make existing payment systems faster and more efficient data transmitters
  • Give nonbank innovators access to wholesale public money.
  • Create a new central bank liability in the form of a retail CBDC.

“So far in the U.S., digital progress is gradually being introduced in the payment system as nonbank digital companies acquire bank charters or partner with existing banks to provide digital payment capabilities to end users,” Estenssoro said. “In 2023, the Federal Reserve is slated to launch FedNow, a retail instant payment system that will allow more dynamic digital service competition in the marketplace, while updating the existing two-tier bank payment system for 24/7 clearing and settlement.”

Other milestones, such as updated real-time payment systems, must be reached before any major central bank can issue a CBDC, the author noted.

However, China’s digital expansion bucks other jurisdictions in the way the country and its financial sector have implemented payment technologies. Chinese private mobile payment began in 2004, and by 2019, mobile transactions totaled $35 trillion for more than 1.2 billion users, she pointed out.

Research in Progress

Still, authorities have much to learn about the impact of CBDCs, both domestically and internationally, Estenssoro pointed out.

“The major central banks’ concerns are about stability and sovereignty—in the domestic and international arenas—and much research remains to understand how CBDCs will address these,” Estenssoro concluded. “However, the decision to launch a CBDC will likely be made based on each jurisdiction’s unique considerations, especially the potential for disturbing the equilibrium in demand for cash, bank deposits and credit creation in the economy.”

This blog offers relevant commentary, analysis, research and data from our economists and other St. Louis Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.


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