Types of e-money and possible government issued cryptocurrency

Riksbank, Sweden’s central bank, estimates that cash transactions made up only 15 percent of all retail transactions last year, down from 40 percent in 2010, thanks in large part to massively popular mobile payment services.

Riksbank and the central banks of other countries are taking a serious look at blockchain, the technology that makes Bitcoin and other cryptocurrencies run. These systems, also called distributed ledgers, rely on networks of computers, rather than a central authority like a bank, to verify and record transactions on a shared, virtually incorruptible database. Government bankers across the world believe this has the potential to replace cash and make other payment systems more efficient.

Riksbank is hedging its bets, investigating not only distributed-ledger technology—which it describes as unproven but “progressing incredibly rapidly”—but also traditional, centralized accounting methods for its “e-krona” project.

The Riksbank’s
e-krona project Report 1 September 2017

The Riksbank is investigating whether it would be possible to issue a digital complement to cash, so-called e-kronas, and whether such a complement could support the Riksbank in the task of promoting a safe and efficient payment system. This is not a unique situation: several times previously, the government has had to reconsider its role on the payment market when this has changed. An e-krona would have the potential to counteract some of the problems that could arise on the payment market in the future when the use of cash is rapidly declining.

An e-krona would give the general public access to a digital complement to cash guaranteed by the state and several payment services suppliers could connect to the e-krona system. Currently the Riksbank only offers participants in RIX digital payments. By functioning independently from the infrastructure used by the commercial bank system, the e-krona system could also make the payment system more robust in the event of disruptions to, for instance, the system for card payments.

Two-thirds of [Swedish] consumers say they can manage without cash and just as many mostly use cards for payments under SEK
100. In the not-too-distant future, Sweden may become a society in which cash is no longer generally accepted. Developments on the Swedish payment market are unique in an international perspective.

A cryptocurrency tied to central-bank-backed money could give governments a way to issue digital tokens that are a lot like cash. Users of such a “FedCoin” would enjoy the level of anonymity that Bitcoin provides, goes the theory, while being protected against the volatility that has plagued cryptocurrencies. Many countries’ central banks are investigating this idea, but Sweden looks to be the furthest along.

Over the last [two] years, the technology underpinning Bitcoin and the blockchain has inspired a number of central banks to pursue research on the topic of central bank digital currency. While Bitcoin shows some promise as a digital currency, its volatility makes it inaccessible to the majority of consumers. A central bank digital currency might rectify this problem by allowing consumers to own a safe form of fixed-price electronic money that, like cash (but unlike Bitcoin), is denominated in the existing unit of account. At the same time, unlike cash (and like Bitcoin) this digital currency would be capable of being used over long distances.

For monetary policy makers, the replacement of physical cash by digital cash means that the issuing central bank would be able to implement negative interest rates, a useful tool when a recession hits in an environment when nominal interest rates are already low or at the zero lower bound.

The effect that a central bank digital currency has on the existing banking system is a complicated question. As the history of economic ideas and systems shows, there is some precedent for a government-issued non-tangible currency for public consumption. For central bank researchers who are interested in central bank digital cash, episodes such as postal banking deserve more research to help determine the merits of the government entering into competition with the private sector for the provision of a publicly-available medium of exchange. These episodes tend to show that government competition does not cripple the private banking sector, although a more careful examination of the historical data is necessary in order to determine the magnitude of these effects.

There are many ways to implement government digital currency. If replicating the unique features of banknotes and coins is considered important , then something like Fedcoin deserves study. Fedcoin could provide cash-like levels of anonymity and censorship-resistance, perhaps with a built-in mechanism that limits usage to small value payments so as to reduce participation by criminals and tax dodgers.

A new journal article (pdf) published by the Bank of International Settlements, a kind of central bank for central banks, suggests a more straightforward approach than trying to use cryptocurrency to replace cash. In the article, Garratt and Morten Bech, a researcher at the BIS, draw an important distinction between a “retail” cryptocurrency like FedCoin and a “wholesale” one that would only be used by banks.

In principle, there are four different kinds of electronic central bank money: two kinds of CBCCs (the shaded area) and two kinds of central bank deposits. The most familiar forms of central bank deposits are those held by commercial banks – often referred to as settlement accounts or reserves. The other form is, at least in theory, deposits held by the general public. Tobin (1987) refers to this form as deposited currency accounts (DCAs).

So far, central banks have generally chosen not to provide DCAs. Universally accessible forms of money that are not issued by the central bank include (privately created) cryptocurrency, commodity money, commercial bank deposits and mobile money.

Cryptocurrency borders CBCC given that only one of its properties differs. The other three currency forms are more removed because they are, in addition, either physical or “not peer-to-peer”. A number of other forms of money are not universally accessible. Local (physical) currencies, ie currencies that can be spent in a particular geographical location at participating organisations, populate the right-hand petal of the flower. The upper left-hand petal contains virtual currencies, which are “electronic money issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community” (ECB (2012)). There is also the possibility of a private sector wholesale version of cryptocurrency. It would be transferred in a peer-to-peer fashion by means of a distributed ledger, but only between certain financial institutions.