Public and private money can coexist in the digital age

We value innovation and diversity, including in terms of money. On the same day, we could pay by swiping a card, waving a phone, or clicking a mouse. Or we can hand over notes and coins, but less and less often in many countries.

Today’s world is characterized by a dual monetary system, involving money issued by the private sector – by banks of all types, telecommunications companies or specialist payment providers – relying on public funds issued by central banks. Although not perfect, this system offers significant advantages, including: innovation and product diversity, mainly provided by the private sector, and stability and efficiency, provided by the public sector.

These objectives – innovation and diversity on the one hand, stability and efficiency on the other – are linked. More of one usually means less of the other. There is a compromise, and countries – central banks in particular – must find their way. How much of the private sector to rely on, compared to how much to innovate themselves? Much depends on preferences, the technology available and the effectiveness of regulation.

It is therefore natural, when a new technology emerges, to wonder how the current dual monetary system will evolve. If digital currency – called the central bank’s digital currency – emerges, will it displace the money issued by the private sector or allow it to thrive? The former is always possible, thanks to stricter regulations. We maintain that the second remains possible, by extending the logic of the current dual monetary system. Above all, central banks should not have a choice between Is offer the digital currency of the central bank, or encourage the private sector to offer its own digital variant. The two can coincide and complement each other, for example, as central banks make certain design choices and update their regulatory frameworks.

Public-private coexistence

It can be disconcerting to consider that money issued by the private and public sectors has coexisted throughout history. Why hasn’t more innovative, practical, user-friendly and adaptable private money not been fully taken up?

The answer lies in a fundamental symbiotic relationship: the ability to convert private money into perfectly safe and liquid public money, be it banknotes and coins, or central bank reserves held by selected banks. .

Private funds that can be redeemed at a fixed face value in central bank money become a stable store of value. Ten dollars in a bank account can be exchanged for a ten dollar bill accepted as legal tender to settle debts. The example may seem obvious, but it hides complex foundations: sound regulation and supervision, government supports such as deposit insurance and lenders’ last resort, as well as partial or full support for bank reserves. central bank.

In addition, money issued by the private sector becomes an efficient means of payment as it can be exchanged for central bank money. Anne’s $ 10 in Bank A can be transferred to Bob’s Bank B as it is exchanged into the central bank currency between the two – an asset that both banks trust, hold, and can exchange. As a result, this money issued by the private sector becomes interoperable. And so it spurs competition—As Anne and Bob can hold money in different banks while paying each other – and therefore innovation and the diversity real forms of money.

In short, the option of repayment in central bank money is essential for the stability, interoperability, innovation and diversity of private currencies, whether it is a bank account or otherwise. A system with only private money would be far too risky. And whoever owns only the central bank money could miss out on important innovations. Each form of money builds on the other to provide today’s dual currency system – a balance that has served us well.

Central bank money in the digital age will come under pressure

And tomorrow, as we enter the digital age squarely, what will happen to this system? Will digital currencies issued by central banks be so attractive that they will eclipse private currencies? Or will they still allow private sector innovation? Much depends on the ability and willingness of each central bank to innovate in a consistent and meaningful way. Keeping pace with technological change, rapidly changing user needs and private sector innovation is no small task.

Central bank digital currencies are akin to both a smartphone and its operating system. At a basic level, it is a settlement technology for storing and transferring money, much like bits sent between a phone’s processor, memory, and camera. On another level, they’re a form of money, with specific features and appearance, much like an operating system.

Central banks should therefore be more like Apple or Microsoft in order to keep central bank digital currencies at the frontier of technology and in user wallets as the predominant and preferred form of digital currency.

Innovation in the digital age is orders of magnitude more complex and faster than updating security features on paper notes. For example, central bank digital currencies may initially be managed from a central database, but may migrate to distributed ledgers (synchronized ledgers maintained and updated automatically over a network) as and when technology matures, and one registry can quickly give way to another following major breakthroughs. Phones and operating systems also get major new releases at least once a year.

In addition, user needs and expectations are likely to change much faster and unpredictably in the digital age. Information and assets can migrate to distributed ledgers and require money on the same network to be monetized. Money can be transferred in entirely new ways, including automatically through chips embedded in everyday products. These needs may require new features of money and therefore frequent architectural changes and diversity. Money today, or even tomorrow, is unlikely to meet tomorrow’s needs.

Pressure will also come from the supply side. The private sector will continue to innovate. New eMoney and stablecoin systems will emerge. As demand for these products increases, regulators will work to contain the risks. And the question will inevitably arise: how will these forms of money interact with digital currencies issued by central banks? Will they exist separately, or will some be integrated into a dual monetary system where the offers of private and central banks will build on each other?

A partnership with the private sector remains possible

Keeping pace with changing technology, user needs and private sector competition will be a challenge for central banks. However, they should not be alone in doing this.

First, a central bank digital currency can be designed to encourage the private sector to innovate, just as application designers bring attractive functionality to phones and their operating systems. By accessing an open set of commands (“application programming interfaces”), a thriving developer community could extend the usability of central bank digital currencies beyond offering simple e-wallet services. For example, they could facilitate the automation of payments, so that a shipment of goods is paid for when received, or they could create a search function so that the money can be sent to a friend based on their phone number only. The trick will be to check these additional services so that they are perfectly safe.

Second, some central banks may even allow other forms of digital currency to coexist – just like parallel operating systems – while taking advantage of the settlement functionality and stability of central banks’ digital currencies. This would open the door to faster innovation and product selection. For example, a digital currency could compromise the speed of settlement to give users greater control over the automation of payments.

Could this new form of digital currency be a stable store of value? Yes, if it was redeemable in central bank money (digital or non-digital) at a fixed face value. This would be possible if it was fully backed by central bank money.

And would this form of digital currency be an efficient means of payment? Yes again, as settlement would be immediate over any given digital currency network, as is the case between accounts at the same bank. And the networks would be interoperable in that a payment from Anne to Bob’s digital currency provider would be settled with a corresponding movement of central bank money, just like in the current dual system.

This form of digital currency (which we have called synthetic motto in the past) may well coexist with the central bank’s digital currency. This would require a license agreement and a set of regulations to achieve public policy goals, including operational resilience, consumer protection, market conduct and contestability, data privacy and even prudential stability. At the same time, financial integrity could be ensured through digital identities and complementary data policies. Partnering with central banks requires a high degree of regulatory compliance.

A system for the ages

If and when countries go ahead with digital currencies from central banks, they should think about how to take advantage of the private sector. The current dual monetary system can be extended into the digital age. Central bank money – along with regulation, supervision and supervision – will remain essential to anchor the stability and efficiency of the payments system. And money issued by the private sector can complement that foundation with innovation and diversity – perhaps even more than today. When central banks decide to find themselves on the continuum between private and public sector participation in the provision of money, this will vary from country to country and will ultimately depend on preferences, technology and location. regulatory effectiveness.

Written by Tobias Adrian and Tommaso Mancini-Griffoli for the IMF

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