Imagine a world where all money is digital. Instead of carrying coins and notes in your purse, you’re keeping digital currency units in electronic wallets on phones, watches or other electronic devices. Paying at the farmer’s market, giving the kids pocket-money for lunch, settling the tab at a restaurant — all of this could happen digitally the way cash is handed over today: in real-time, irreversibly, with no additional fees, using legal tender fully backed by the faith and credit of the national treasury.
Around the world, central banks from England to China have publicly floated the notion of issuing their own national digital currencies. Conceptually, they like the idea of harnessing the upside of the digital revolution—mobile payments, in particular—while preserving the existing legal and regulatory set up. Practically, they expect significant cost savings, a reduction of operational and fraud risks in the current payments systems, and a strengthened ability to execute monetary policy.
From a consumer’s perspective, the prospect of a digital British Pound Sterling or Renminbi is still mind-boggling. Which means, of course, societies would not go completely digital overnight. Instead, central banks could start issuing digital currency units alongside notes and coins as base money and adjust the mix over time, according to uptake. Once critical usage levels are reached and network effects kick in, universal adoption could happen very quickly.
The key requirement for central banks to feel comfortable with issuing their own digital currency, and for consumers to embrace it, is ironclad integrity and security of the underlying technology. There are efforts to separate the blockchain technology from the libertarian concept of a private currency, e.g. Bitcoin, that central banks are unlikely to embrace. Such efforts to trace the exchange of digital money via a public ledger could be combined with the counterintuitive concept of creating cryptographically protected digital currency units offline and injecting them into current payments systems, much like central banks distribute notes and coins to retail financial intermediaries today.
Blockchain would accelerate the settlement of transactions, and thereby improve the capital efficiency of making a transaction. It’s also more transparent, because any user has immediate access to all transactions on a blockchain. And it’s more efficient because it eliminates the need for intermediaries. It has the potential to redefine transactions and can change everything.
In most emerging markets and developing countries, financial inclusion is a major concern. The current formal financial system doesn’t cover the majority of working-age adult population. Smallholder farmers, self-employed households, and micro-entrepreneurs have to rely on the age-old informal financial mechanisms such as rotating savings clubs, moneylenders, and pawnbrokers. These mechanisms can be unreliable and very expensive.
For policymakers from the global south, the digitization of retail payment systems and financial services has become an important economic development priority. It offers the prospect of reaching far more people at far lower costs with the broader range of financial services they need to build resilience and capture opportunities. Wall Street is also obsessed with blockchain. JPMorgan last month announced it was launching a trial project with a blockchain startup.
The idea of a central bank-issued digital currency might well be the type of “soft infrastructure” investment that brings direct and immediate efficiency gains. But perhaps more importantly, it would also accelerate and help scale a wave of service innovations that help advance financial inclusion, stimulate economic growth, and ultimately spur social progress.