In search of gold: Exploring central bank
issued digital currency
A speech delivered to The Point Conference in Auckland
On 26 June 2018
By Geoff Bascand, Deputy Governor
Introduction
Kia ora and thank you to Payments New Zealand for the invitation to speak. Payments
systems are highly interconnected by nature, so it is fitting that we are all here connecting
with each other-learning, listening and discussing the hot topics in payments.1
The payments system is an integral part of our financial system. It is also one that is evolving
at considerable pace. We have already heard this morning about changing consumer
demands and advances in financial technologies. Retail payments have become faster, and
much easier to access. We can now initiate payments in a variety of ways - we can simply
tap our credit cards, hold up our mobile phones, or pay for things remotely using a mobile
banking app. Sellers at farmers' markets can now receive card payments by plugging a
small device into their mobile phones, and charities can now collect donations on the street
using Q-code technology. All of these developments have made transactions more
convenient, faster, and accessible for consumers and merchants. But they have mostly
been concentrated at the front-end of the payments process.
Crypto-currencies, and the blockchain technology they rely on, are bringing about more
farreaching changes in the payments system and the way we view money. Blockchain
technology is unique because there is no central agent managing the system, and there is
no separation between sending the payment instruction and the final settlement of funds. It's
a different type of payment system and could bring new opportunities to payments and
currency.
This period of change can be compared to an earlier time when exploration was fast-paced
and the stakes were high-the 1860s, when the gold rush hit New Zealand. During this
period, miners came from all over the world to find gold in our valleys and rivers. Gold, a
form of money (in respect, then, of its payment and store of value properties), could be found
by anyone with a bit of luck, determination and hard work.
The early 1860s gold rush is not unlike the search for wealth that has fuelled the speculation
in privately issued crypto-currencies. But beyond the speculation surrounding Bitcoin prices,
and the debate regarding whether it is a currency, an asset or a bubble, there lies a
fundamental question-should central banks enter this terrain, and issue digital currencies of
their own to the public?
The Reserve Bank has a strong record of innovation and welcomes technological progress.2
However, when considering digital currencies, it should be remembered that riches did not
come easily during the gold rush, and they will not come easily now. A central bank digital
currency would be attractive to us if it could improve our currency distribution, payments
efficiency and monetary or financial stability. But these benefits are by no means
guaranteed, and could come at some cost. We must explore both the pros and the cons
before deciding to issue digital currency of our own to the public. Many other central banks
are doing the same.
So that is what I will do today. Like prospectors during the gold rush, I want to take you on a
journey to uncover the risks, the gold, and possibly the fool's gold, in issuing a central bank
digital currency. I'll start by describing exactly what I mean by a central bank digital currency.
I will then explore how issuing a central bank digital currency could impact some of the core
central bank functions. I address three key questions:
•
What could issuing a central bank digital currency mean for currency distribution?
•
Can a central bank digital currency improve the current inefficiencies in payments?
•
Would issuing a central bank digital currency destabilise the financial system?
To answer these questions I will draw from the material recently published in our central
bank digital currency bulletin series.3
Finally, I will touch on regulatory aspects of privately issued digital currencies.
What is digital currency?
When I mention digital currency, or digital money, some of you might immediately think of
crypto-currencies, like Bitcoin. Some of you might think of your digital account balances.
And others might think of credit or debit cards. In fact, I am referring to all of these things.
Digital currency includes all electronic forms of money that represent a store of value,
medium of exchange (or payment) and unit of account.
Unlike banknotes and coins (cash), digital currencies can be issued by anyone, which also
means a wide variety of currencies have been issued. We can use the Money Tree (figure 1)
to broadly class digital currencies into two groups-conventional digital currencies, which
rely on existing infrastructure, and crypto-currencies, which rely on cryptography and
distributed ledger technology (DLT).4
The most common example of privately issued conventional digital currencies are bank
deposits. These electronic deposits carry a promise to be converted to fiat money-cash-at
par value, which makes them very stable. The most common example of privately issued
crypto-currencies is Bitcoin. These currencies are independent from fiat money, and not
backed by other assets, which contributes to their notorious price volatility.
Figure 1: The Money Tree
A central bank digital currency could take many different forms. So in order to explore the
pros and cons of a digital currency issued by a central bank, I will set out six assumptions
regarding the type of digital currency we are discussing today.
Figure 2: Key assumptions for a central bank digital currency
Our first assumption is that a central bank digital currency would be available to everyone.
The Reserve Bank of New Zealand already issues a digital currency to commercial banks,
through their accounts with us.5 But we could also offer digital currency to the public via
accounts, prepaid cards, or some other mechanism.
Secondly, this digital currency could be a crypto-currency and use distributed ledger
technology. Or it could be a conventional digital currency and based on existing payment
technology. For example, a conventional currency could involve members of the public
holding bank accounts at the Reserve Bank (i.e account-based). Or it could involve
members of the public holding currency on cards or other tokens, similar to prepaid cards
e.g. Visa Prezzy cards (i.e. token-based).
Third, this digital currency would co-circulate with banknotes and coins (and other privately
issued currencies). In New Zealand, we are not considering removing cash-demand for
cash continues to grow as a share of the economy, and currently sits at 2.7 percent of GDP.
Fourth, a digital currency would be convertible to cash at a fixed rate rather than having a
variable exchange rate. This would help develop trust in the value of the digital currency and
would avoid introducing a dual currency system.
Fifth, we assume that the public could not borrow from the Reserve Bank. This means that
the digital currency issued by the central bank would operate like cash.
Lastly, the central bank would not pay interest on balances of its digital currency. Again, this
assumption means that the digital currency issued by the central bank would operate more
like cash, which does not earn interest.
The pros and cons of issuing a central bank digital currency
Now that we have established what we mean by central bank digital currency, we can begin
our exploration of its pros and cons. I liken this exploration to a search for gold because they
both evoke images of venturing into new terrain in the hope of discovering something of
great value. But such explorations were not without peril, and while they could lead to great
rewards, they could also prove fruitless.
What could issuing a digital currency mean for currency distribution?
The Reserve Bank is the sole provider of banknotes and coins in New Zealand. These
banknotes and coins must be easy to use, difficult to imitate, and safely and securely
transported between the Reserve Bank and commercial banks. This is not a simple task.
New Zealand's geography means that cash typically moves from Auckland, to the South
Island. The Reserve Bank must then repatriate cash back to Wellington for quality inspection
and re-issuance. A digital currency has clear distributional benefits compared to banknotes
as it does not need to be transported. This makes it safer and cheaper.
Issuing a central bank digital currency would also ensure public access to legal tender
money regardless of the presence of cash.6 New Zealand is in the rare situation among
advanced economies where we use electronic forms of payments for the majority of
transactions,7 but are simultaneously seeing cash demand grow at a faster rate than GDP.
Figure 3: Cash in circulation for advanced economies (percent nominal GDP)
Index (2005) Index (2005)
250 250
200 200
150 150
100 100
50 50
Aust Canada EU Iceland NZ Norway Sweden Switzerland UK US
Japan
0 0
2006 2008 2010 2012 2014 2016
Source: Haver Analytics
However, we do not know what could happen in the future. If cash demand falls significantly
then retailers and banks might lose the incentive to provide ATMs and cash tills, which are
costly to maintain.8 If cash demand fell to the point where retailers and banks no longer
accepted, nor issued, it then legal tender money might disappear. This is the scenario faced
by Sweden. A digital currency would provide an alternative, electronic form of legal tender.
Issuing a digital currency would also pose some currency distribution challenges:
1. Significant investment in new infrastructure would be required to create, issue and
maintain a digital currency network (issuing accounts or tokens to the public).
2. Consumers could lose large sums of money, which might not easily be recovered, if
people accidently lost (by accident or theft) the device on which their token, or
cryptocurrency is stored. Consumers can also lose cash, but because cash is relatively bulky,
we do not tend to hold or carry large sums.
3. It would be vulnerable to outages in electricity and internet connections. This would
make it less reliable (than cash) in a state of emergency.
Can a central bank digital currency improve on the current inefficiencies in payments?
We are also interested in the payments efficiency aspects of a central bank digital currency.
The payment implications differ depending on whether the central bank issued a
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conventional digital currency or a crypto-currency.
A central bank issued, conventional digital currency could improve settlement speed and
transaction fees compared to existing payments.10 This is because the currency would be
centralised and transactions would be settled by a central bank updating account balances.
These improvements would be most beneficial for cross-border transactions, which are
currently subject to lengthy delays and large fees (and lack of transparency).
A crypto-currency issued by a central bank presents a more mixed argument for payments
efficiency. DLT combines clearing and settlement into a single step called validation.
However, how this impacts the payments process depends on the design of the technology.
If a central bank issued crypto-currency was based on Blockchain then it would circumvent
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the existing conventional payment system and benefit from several pros:
•
Faster settlement, which reduces default risk.
•
Cheaper cross border transactions.
•
Transparent payments, which incentivises faster payments processing.
• No single point of failure, which increases resilience to cyber-attacks and operational
failures.
However, it would also be subject to several cons:
• Slower release of goods and services due to slow confirmation of the payment.
•
High energy use for validation, and relatively high fees for domestic payments.
•
Not scalable to large volumes of transactions due to the longer time taken to validate
each block of transactions.
•
Probabilistic finality-there is a very small chance that the transaction could be nullified if
a malicious agent managed to change the blockchain.
•
Reliance on crypto-currency exchanges for cross-border transactions which could be
subject to cyber-attacks.
A central bank could mitigate these cons by introducing limited access, central validation,
and control to the ledger.12 This would improve the speed, cost and scalability of payments,
and enable deterministic payment finality (similar to existing payments) and privacy for
sensitive information. However, it would reintroduce a single point of failure. Experiments by
the Bank of Canada and Monetary Authority of Singapore revealed that these centralised
DLTs are very similar to existing payments systems, without additional benefits.13
Lastly, either token-based conventional digital currencies or crypto-currencies issued by the
central bank could offer more anonymity than conventional electronic payments. For
example, a central bank could issue a card or token that is not linked to an individual's
identity. This means payments with these tokens offer partial anonymity. I.e. we might find
recent purchases no longer show up in our social media adverts. However, any form of
digital currency would leave an electronic record of transactions and so be less anonymous
than cash. These records could be helpful in deterring tax evasion and illegal transactions.
How would issuing a central bank digital currency impact the financial system?
One of the most important contributions of a central bank to prosperity is its responsibility for
financial stability. A breakdown in the financial system can cause enormous economic and
social harm. We could not issue a digital currency if it might undermine financial stability.
Depositors might be attracted to a central bank digital currency as it is low risk. This safe
asset would compete with deposits in commercial bank accounts, which could be lost if there
was a bank failure. This competition could result in three substantial risks to financial
stability.
Firstly, if a large number of deposits were held in the digital currency rather than commercial
bank accounts, then New Zealand banks might become more reliant on overseas wholesale
funding. This would, accentuate our banking system's susceptibility to downturns in
overseas markets. For example, if there was an international shock in the European or US
markets, this could have more severe flow through to New Zealand via increased bank
funding costs (risk spreads) or reduced availability of funding.
Secondly, and relatedly, a central bank digital currency could reduce commercial bank
resiliency to economic downturns. This is because commercial banks might have to compete
for deposits by offering higher interest rates, which could lower their profitability. Further,
commercial banks' payment fee revenues could be diminished if a central bank digital
currency offered cheaper domestic and cross-border transaction fees.
Lower bank profitability due to competition might imply that bank activities are being
conducted more efficiently (assuming the central bank services were priced appropriately).
But there could be adverse consequences for financial stability if less profitable banks
become less resilient to shocks, or if they look to replace lost profitability by searching for
higher yielding (more risky) assets.
We need to be careful not to exaggerate these concerns, however, as commercial banks are
already facing increased competition in the deposit and payments aspects of their business
from non-banks such as PayPal and TransferWise. This increased competition has not
adversely affected bank resiliency to date. Further, US and Canadian history, where
commercial bank banknotes co-circulated with government-issued banknotes, suggests
commercial bank money can, to some extent, compete with central bank money.14
Thirdly, and more troubling, the presence of a low-risk digital currency could increase the
probability and severity of bank runs during periods of system-wide instability-depositors
could easily, and remotely, transfer large deposit holdings to a central bank digital currency
during any wide-spread period of perceived financial instability.
Other miners in the gold rush
The Reserve Bank is not the only participant in the exploration of digital currencies. There
are many providers of conventional digital currencies and crypto-currencies. These private
currency and DLT providers put competitive pressure on incumbent financial institutions.
Competition is good for innovation and efficiencies and could be the most enduring benefit of
the global exploration of new financial technologies. We encourage innovations that improve
banking and payments services, provided they do not generate systemic risks.
Beyond the payments systems, the Reserve Bank is also responsible for the prudential
regulation of banks, non-bank deposit takers and insurers. Private crypto-currencies
currently have limited implications for prudentially supervised entities. Entities subject to
Reserve Bank prudential regulation face a variety of requirements and incentives to ensure
that they manage all their material risks adequately. The Reserve Bank would expect these
entities to have prudent risk management in place for any of their activities involving
cryptocurrencies.
It is not yet clear what prudential scrutiny of a crypto-currency might entail. A crypto-currency
itself is not a legal entity, and distributed crypto-currencies like Bitcoin do not have a central
agent or issuer to manage the currency. Therefore, crypto-currency regulation could be
complex. Currently, the most likely way to regulate crypto-currencies is via crypto-currency
exchange platforms (between crypto-currencies and other currencies).
Regardless, the use of crypto-currencies by non-regulated institutions is small compared to
the size of our financial system so is unlikely to pose a material risk. And the volatility of
crypto-currencies (that do not trade at par value with fiat currency) make it highly improbable
that any regulated entity would start predominantly using crypto-currency.
In addition, anti-money laundering and countering financing of terrorism (AML/CFT)
legislation might create significant hurdles for financial entities to associate with
cryptocurrencies. AML/CFT legislation requires financial institutions to know their customers, which
is at odds with distributed pseudo-anonymous crypto-currencies. Crypto-currency issuers
and crypto-currency exchange platforms would need to remove anonymity from
cryptocurrencies to implement AML/CFT.
The Reserve Bank does not currently plan to issue any new regulation regarding privately
15
issued crypto-currencies as they do not currently pose a systemic risk to financial stability.
Moreover, existing prudential regulation and AML/CFT legislation already set out that
supervised entities should manage their business prudently and know their customers.
Conclusion
The gold rush began in New Zealand in 1861. The search for riches continues in today's
technological world.
For the Reserve Bank, that is searching for ways to harness new technologies and do things
better. We have explored whether issuing a digital currency is one way we can use new
technologies to better meet the needs of the public. At this stage it is yet to be seen that a
central bank digital currency will bring conclusive benefits.
From a system-wide perspective the pros and cons of a central bank digital currency are
mixed. Distributing a central bank digital currency could lead to both new costs and cost
savings. It would provide an electronic form of legal tender, but would be less reliable in
power outages. The payments pros and cons depend on how the digital currency is
designed. Digital currencies with central control can improve efficiency but potentially at the
expense of reduced resilience. There could also be considerable negative impacts on
financial stability. Judgement is required to weigh these findings, but it unlikely that a central
bank digital currency would be issued if it posed large and significant risks to New Zealand's
financial system.
The payments industry is dynamic, which is good. But the Reserve Bank must be a
considered prospector in the exploration for digital currency benefits-we have New
Zealand's currency and financial system at stake. Currently, it is too early to determine
whether a digital currency should be issued. Central banks and researchers are still probing
these technologies and currencies. But we will continue to explore digital currencies; for our
benefit and for the benefit of New Zealand's financial system.
References
Deloitte and Monetary Authority of Singapore (2017) 'The future is here. Project Ubin: SGC
on distributed ledger'.
Fung, B, Hendry, S and W Weber (2017) 'Canadian Bank Notes and Dominion Notes:
lessons for digital currencies', Bank of Canada Staff Working Paper 2017-5.
McBride, N (2015) 'Payments and the concept of legal tender', Reserve Bank of New
Zealand Bulletin, Vol 78. No. 6.
Monetary Authority of Singapore and the Association of Banks in Singapore (2017) 'Project
Ubin phase two. Reimagining interbank real time gross settlement system using distributed
ledger technologies'.
Payments Canada, Bank of Canada, and R3 (2017) 'Project Jasper: A Canadian experiment
with distributed ledger technology for domestic interbank payments settlement'.
Wadsworth, A (2018a) 'What is digital currency?' Reserve Bank of New
Zealand Bulletin, Vol 81. No. 3.
Wadsworth, A (2018b) 'Decrypting the role of distributed ledger technology in payments
processes' Reserve Bank of New Zealand Bulletin, Vol 81. No. 5.
Wadsworth, A (2018c) 'The pros and cons of issuing a central bank digital currency' Reserve
Bank of New Zealand Bulletin, Vol 81. No. 7.
Weber, W (2015) 'Government and private e-money-like systems: Federal Reserve notes
and National Bank notes, Bank of Canada Staff Working Paper 2015-18.