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Bank of Canada Weighs Implications of Creating a New Digital Currency

Posted November 30, 2017

Along with other central banks around the world, as interest in cryptocurrencies like Bitcoin and the underlying blockchain and distribution ledger technology explodes, the Bank of Canada has been weighing the merits of establishing a digital currency that could be used by the public.

In a discussion paper released today by the Bank of Canada, authors Walter Engert and Ben Fung explore the implications of such a central bank digital currency (CBDC), focusing on bank seigniorage, monetary policy, the banking system and financial stability, and payments. Finally, it considers the various features of a new CBDC that would differ significantly from the benchmark digital currency.

The paper suggests there could be merits to creating a central bank digital currency as the ongoing transition to a “cashless society” erodes the bank’s core revenue stream that involves profiting from the issuance of cash. The authors though don’t see this as a terribly compelling motivation for a CBDC because in Canada’s case, seigniorage, a function of the net value of bank notes outstanding, is largely buffered from this negative effect. Shifting currency distribution patterns in the country have managed to keep the bank’s revenue in this regard steady despite the declining relative importance of traditional bank notes.

A better reason to create a CBDC, according to the paper, is the potential role that it could play in improving financial stability. Being outside of the existing payment system involving highly-leveraged banks that under some conditions can be unstable, using a central bank digital currency as a means of payment and a store of value, “overall risk and financial stability could benefit because CBDC is essentially risk-free,” the authors say.

However they go on to caution that shifting from bank deposits to CBDC “could also have an impact on bank funding and credit provision, which could affect financial stability as well.” The paper also vaguely warns that the overall impact of CBDC on financial stability would depend on the “behaviour of economic agents over time.”

Among all of the various considerations examined, the authors determined that the most likely to provide the central bank with a “sound motivation” to issue CBDC is its potential to become a cheaper alternative to debit and credit cards and other forms of payment, thereby making it easier for competition to emerge in the retail and large-value payment sectors.

In bank-speak, the paper states this “could provide for more contestability” and may also “facilitate access to the central bank’s balance sheet for a wider range of financial institutions or even non-banks, thus making it easier for these firms to enter the payments industry.”

As noted at the outset, Canada is far from alone in looking at this issue. A recent Bloomberg article provided an informative overview of how the world’s largest central banks (and some smaller ones) are approaching the subject of digital currency.