The road to digital money

We’re looking ahead to imagine how we’ll pay for things in the future.

Do you use cash?

How often does the cashier just hand over the debit machine when you pay for your morning coffee? Some even seem surprised if you give them cash.

Last year in Canada, people used cash for only 1 in 3 transactions. That’s down from more than half just 10 years ago. And Canada’s not alone. In many countries, people use cash less often.

It’s hard to imagine this trend reversing—especially since cash isn’t an option when people shop online.

And everyday, new competitors are showing up: payment platforms that offer speed, security and convenience.

Taking cash for granted

When times are good, we keep most of our money in the bank, knowing we can access it 24/7 to pay for things electronically.

But when the global financial system looks shaky—like it did in 2008—many people around the world turn to cash. That’s because central banks can’t fail like commercial banks do, so cash is the safest liquid financial asset.

While deposit insurance acts as a key safeguard in the event of a commercial bank failure, it’s not a cure-all. There are limits on how much can be insured, and usually there’s a bit of a delay before your money is paid out.

What about private digital currencies?

Despite their claim of being the money of the future, current private digital currencies, like bitcoin, don’t work well for making payments or saving for the future. Because of their fluctuating values and slow clearing times, very few merchants accept them.

It’s possible future digital currencies could at least partially solve these problems, leading to greater adoption.

But widespread adoption of private digital currencies would carry important risks, to both the economy and the financial system. The issuer could

• go out of business, or
• fall victim to cybertheft

If these situations occur, a loss of confidence in the payment system could ensue.

Private digital currencies could even hurt our ability as a central bank to

• control inflation, and
• act as the lender of last resort.

That’s because our policy tools, like the overnight interest rate and lending facilities, only work in Canadian dollars.

If private digital currencies aren’t the answer, is there a better version of ultra-safe cash for the future?

We’re taking note

Research is underway at the Bank of Canada, because exploring the idea of a central bank digital currency makes sense. In theory, it could provide the safety of cash, with the convenience of modern electronic payments.

It could take many forms, but two broad approaches are

• value-based—people transfer money from their bank account to a card or a phone app; or
• account-based—people and businesses can open an account at the central bank.

Either way, payments made using a central bank digital currency could allow payments to remain

• private to the parties involved, just like cash; but
• traceable to law enforcement, just like bank accounts.

Central bank digital currencies could give consumers more choice while maintaining competition among financial service providers like banks—the way cash does now. Depending on their design, they could even act as a backup if other payment methods become temporarily unavailable.

Basically, central bank digital cash would act like current electronic payment methods. Only difference: it wouldn’t be tied to a commercial bank the way bank accounts and debit cards are.

Rest assured, though, that even if we were to issue a digital currency, we wouldn’t stop printing cash. We will supply highly secure bank notes for as long as Canadians demand them.

Important challenges along the way

There would be some obstacles to think about on the path to a central bank digital currency. For example, people could decide to keep a large amount of their money in the central bank digital currency rather than in a regular bank account. The digital equivalent of putting money under the mattress, except easier.

If people keep their money under their mattresses, so to speak, there could be:

• less money available for lending, or
• higher lending rates,
• or even both.

Why? Because banks rely partly on deposits to make loans.

So, it could become harder to get credit, like a mortgage or business loan. If businesses invest less as a result, productivity and innovation could suffer. That’s because innovation often happens when companies borrow to create new products and services.

In other words, holding cash is safe, but it’s not very productive.

There are ways to lower the risk. One example is to not earn interest on central bank digital currency, the way cash in your wallet doesn’t earn interest. This would make holding it in large amounts less appealing in normal times. But in difficult times, it could still act as a safe asset—just like cash.

Other risks

There could still be a problem, though: a central bank digital currency could increase the risk of a run on the banking system. A run on the system basically means that people rush to withdraw the money they hold from all commercial banks because they don’t know which banks are healthy and which ones are in trouble.

But banks hold only a fraction of the total value of deposits in cash, so they typically can’t pay everyone at once.

A central bank digital currency would make it easier and faster to transfer money out of commercial banks. So these system-wide runs could, in theory, become quicker and more frequent. We could end up in a situation where a central bank digital currency, instead of making the financial system more stable, makes it less so. Thankfully, runs on the entire banking system are extremely rare in modern times. In fact, Canada has never had one.

We need to do more research

Creating a central bank digital currency is a pretty complicated decision. That’s why central bankers around the world, including us, are analyzing the pros and cons. We’re working to determine under which conditions it may make sense to, one day, issue a digital currency.

• Check out our latest research on digital currencies and new financial technologies.
• Read the background note explaining the Bank’s official position on CBDC.
• See Deputy Governor Timothy Lane’s speech, Money and Payments in the Digital Age.