Morgan Stanley
  • Thoughts on the Market Podcast
  • Apr 30, 2021

Could Centrals Banks Shake Up Digital Currencies?

With Chetan Ahya


Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Economist and Global Head of Economics for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the benefits and disruptive risks arising from central bank digital currencies. It's Friday, April 30th, at 11 a.m. in New York.

The word 'disruption' is not typically associated with central banks; but as central banks edge closer to introducing their own digital currencies, significant disruption could play out in the financial system.

Central Bank Digital Currencies, often called CBDCs, are a new form of digital cash intended to replace physical cash. Before I go any further, it's important to note that digital currencies should not be confused with cryptocurrencies. Cryptocurrencies are either pegged to an underlying asset, like in the case of stablecoins, or backed by a blockchain like Bitcoin.

CBDCs by contrast, are just what their name implies. They are a digital form of currency and will be a liability of the central bank, which will maintain them in a centralized ledger. It's essentially digital cash.

And why are we talking about CBDCs right now? Well, efforts to introduce CBDCs are gaining momentum, with as many as 86% of world central banks exploring launching digital currencies. China has launched pilot trials in a number of cities, the European Central Bank will make a decision on the digital euro this summer, and the Boston Fed is set to release its initial research in the fall.

And so what explains this sudden interest from the central banks to launch digital currencies? Well, there are three reasons.

First, monetary sovereignty. Private payment networks have expanded rapidly, and as they gain market share, these networks could become a primary means of transactions. Central banks are concerned that money will circulate almost exclusively within the networks, posing a threat to their control of the monetary system.

The second reason is financial stability. Any potential failure of a private provider of digital money could disrupt the payment system and lead to financial stability risks. While regulators have taken steps to mitigate these risks, they cannot completely eliminate them. And hence central banks will issue and back the CBDCs, so they will be able to guarantee their reliability as a medium of exchange.

And the third reason is financial inclusion. The rise of private, narrow money networks could exclude segments of the general public, such as unbanked population. A CBDC, just like physical cash, can be made available more broadly, and even foster greater financial inclusion.

So how disruptive can CBDC's be? When something as fundamental as what you use to buy a cup of coffee changes, the effects are likely to be far reaching.

For example, commercial banks will face the risk of disintermediation. Once CBDC accounts are launched, consumers will be able to transfer their bank deposits there, subject to limits imposed by the central banks. And the technological infrastructure of CBDCs will also make it easier for new non-bank entities to enter the payment space. As this transition accelerates, the competitive pressures on commercial banks will increase.

Another impact could be on the transactions data. We see a tug of war playing out between the consumers who want to stay anonymous, and fintech companies that will innovate and incentivize consumers to get onto their platforms in order to acquire transactions data. If fintechs succeed, network effects could proliferate, allowing fintechs to take market share from commercial banks.

CBDCs will also have the potential to disrupt the international payment system. If a country's CBDC gains acceptance for international transactions, the country could gain significant advantages in financing costs and control over financial transactions, similar to US dollar's privileged role today. Some central banks like the ECB and the People's Bank of China see the move towards digital currency as an opportunity to raise the international status of their currencies, and increase their use in cross-border payments.

Innovations are typically viewed with caution, and their disruptive potential is usually underestimated. While CBDC initiatives are not intended to disrupt the banking system, they will have the unintended consequences, which are disruptive. The pace of disruption will hinge on how quickly network effects take hold in the CBDC system, and the more widely digital currencies are accepted, the more opportunity for innovation, and the greater the scope for disruption to the financial system.

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Plans to introduce digital currencies are gaining momentum among the world’s central banks. But what level of disruption will it bring to the financial system?

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