The next generation ofdigital currencies:in search of stability. Bruegel Policy Contribution Issue #15 December 2019

Four major developments have challenged the status quo and reopened the debateon the forms that money will take in the future: 1) use of cash as a medium of exchange hasdeclined; 2) distributed ledger technology (DLT) has led to the emergence of thousandsof digital cryptocurrencies; 3) some global tech giants are planning to provide privatedigital currencies to their billions of users in the form of stablecoins; and 4) in turn, publicauthorities are thinking about providing their own digital currencies to the general public.• These developments raise questions about the implications for financial stability, thetransmission of monetary policy and financial intermediation. This Policy Contributionfocuses on the consequences stablecoins and central bank digital currencies could have.• Stablecoins, such as Facebook’s Libra, differ from earlier generations of cryptocurrenciesin three fundamental ways. First, they would start with large networks of users andglobal accessibility, two pivotal features for the critical uptake of a new currency. Second,given the current limitations of DLT, including in terms of energy efficiency, new stablecoinswould rely on (more) centralised systems to validate transactions. Third, stablecoinswould focus particularly on reducing the volatility in the value of the new currency.• These new features of stablecoins attempt to correct some of the critical deficienciesidentified in first-generation cryptocurrencies, which meant they did not acquire the mainfunctions of money. However, new stablecoins raise other questions and potentially createnew problems. One issue could arise from the more centralised (permissioned) validationsystem, which could lead to collusion problems. Another issue could arise from the reservesystem that is supposed to ensure the stability of stablecoins, such as Libra, which could beincompatible with the profit maximisation behaviour of a private issuer.• Facebook’s Libra plan has been a wake-up call to central banks and governmentswhich, afraid of losing their monetary sovereignty, have renewed their interest in centralbank digital currencies (CBDCs) as a potential solution. CBDCs could make private digitalcurrencies less attractive and slow down their adoption.• But there are other reasons to give the general public access to central bank liabilities.One important reason to provide CBDCs to citizens is that if cash disappears, citizens willlose direct access to sovereign money. Another benefit of the introduction of CBDCs is thatmonetary policy could be strengthened by transmitting it directly to the general public.• However, the introduction of CBDCs could also be disruptive and create risks. Inparticular, CBDCs could have major consequences for financial intermediation. Theserisks would have to be evaluated by policymakers before any decisions are taken.• If CBDCs are introduced, central banks would have to carefully calibrate their propertiesto minimise these risks. But, eventually, if these risks – and in particular the risk ofstructural financial disintermediation – do materialise, central banks would have variousinstruments to counter them