There is a great deal of debate on the basics of how national digital currencies would work, as well as the benefits they might provide as a payment method. Experts point out that even today, currency exists largely in digital form as it is issued, loaned, and used in payments by central and private banks. A key difference is that a national digital currency does not have a tangible cash form such as banknotes or coins, although it could be converted to physical currency and vice versa.2
In a paper published in 2017 by the Hoover Institution think tank, economists discussed two possible ways that a national digital currency could work. One approach, which they considered analogous to physical cash, would be for a central bank to issue currency as digital tokens, which would then circulate as a payment method among businesses and individuals and might only rarely be redeposited back at the central bank. This approach would use a blockchain to verify and track transactions.3
In another approach, analogous to debit cards, businesses and individuals would hold accounts directly at the central bank or at supervised financial institutions. The payment method would be the central bank debiting the payer’s account and crediting the payee’s account.4 This differs from the current system, as operated in countries such as the U.S. and U.K., in which the central bank holds accounts for other financial institutions but not for individuals.5,6,7
As the Bank of England explains: “At the moment, we provide electronic accounts to banks and key financial institutions, but the public can only hold central bank money in physical form – as banknotes. If a central bank were to issue a digital currency everyone, including businesses, households and financial institutions other than banks could store value and make payments in electronic central bank money in addition to being able to pay with cash. While this may seem like a small change, it could have wide-ranging implications for monetary policy and financial stability.”8
Why Sovereign Digital Currencies?
Countries are looking at issuing their own digital currencies for several reasons, experts say. One is to counter the rise of new cryptocurrencies – payment methods outside the country’s control, such as Bitcoin.9,10,11 Some countries that are exploring national digital currencies, including China, have simultaneously restricted the creation and trading of other cryptocurrencies.12,13
National digital currencies could have a wide range of advantages and implications. If a national digital currency were issued by the central bank and were exchangeable with paper money, its value would be more stable as a payment method than cryptocurrencies like Bitcoin, experts say.14 Some suggest that introducing a digital currency would help speed the shift toward a cashless society; it would reduce cost and boost productivity, because businesses and individuals wouldn’t have to manage cash or pay charges such as ATM fees.15 In addition, some experts suggest that if central banks issue accounts directly to individuals and shareholders, the move could reduce the need for retail banks.16,17
Experts also say that a national digital currency could help combat tax evasion and illegal economic activity.18 Replacing cash with digital money could also make it easier for central banks to lower interest rates below zero percent, when desired, because “investors would have no cash to run to,” according to one expert.19 In developing economies, digital currencies could broaden financial inclusion by making a digital payment method available to many more people.20