Two types of CBDCs are in view, but only one is a wild card.

On February 19, the Bank of Japan published a working paper outlining the benefits and consequences of issuing a central bank digital currency (CBDC) and how one would function in Japan‘s current financial system.

The authors of the study split CBDCs into two different categories: (1) CBDCs used by the general public for daily transactions instead of banknotes; and (2) CBDCs for large-value settlements, which are based on central bank deposits and use distributed ledger technologies.

The researchers posit that the latter group can be considered the next step in the evolution of existing central bank deposits, which have long been digitized. In this regard, the authors of the study believe these kinds of CBDCs will not present many new issues, although they are concerned about the anonymity of transactions.

Although anonymity is a concern, CBDCs could be an improvement on banknotes in this regard. As the authors argue, the anonymity provided by paper banknotes means cash can aid in money laundering, tax avoidance, and other criminal activity. While a CBDC used by the general public for large transactions could help curb this kind of activity, the bank says the level of anonymity would have to be “lower than that of banknotes.” The authors use the example of the People’s Bank of China, which wants to issue a CBDC to help catch tax evaders.

When it comes to CBDCs used by the general public for daily transactions, the paper makes an interesting argument in favor of issuing a CBDC, saying it has the potential to enhance the financial stability of a country by eliminating “destabilizing factors stemming from banks’ maturity transformation.”

The authors explain that in the current banking systems “commercial banks issue demand deposits and make loans and investments through ‘maturity transformation.’” This system runs the risk of banks failing to meet “depositors’ demands” in the event of a “bank run,” during which customers panic and withdraw their money from the bank in mass. The authors argue that issuing a CBDC could help banks remain liquid in times of trouble and, therefore, help to stabilize the entire economy.

It’s not all good news, however. The paper claims that if too many people switch their accounts to the newly issued CBDC, it could very well cause a “digital bank run,” which would also leave the bank unable to fulfill the demands of depositors and issue loans.

The authors argue that if interest-bearing CBDCs were to replace both banknotes and bank deposits, the interest rate on bank deposits may drop, which would cause banks to be unable to issue loans to those in need and “could distort efficient resource allocation in the economy.”

Moreover, the paper suggests that a poorly designed CBDC could eliminate privately owned payment methods and discourage technological innovation. The researchers also expressed concerns over the effects an interest-bearing CBDC could have on existing monetary policy.

On a practical level, the authors map out several possible ways CBDCs can be developed and regulated as well as explore how to provide them to the general public and other financial institutions.

The Bank of Japan is not alone in exploring the idea of issuing a CBDC. In May 2018, the Bank of England published a working paper outlining three different models for a CBDC and how they would function in the existing financial system. In October 2018, Sweden’s Riksbank published a report discussing the possibility of issuing a CBDC because of the declining use of cash in the country. And earlier this month, the Bank of Korea issued a paper discussing the benefits and consequences of a CBDC.

Nathan Graham is a full-time staff writer for ETHNews. He lives in Sparks, Nevada, with his wife, Beth, and dog, Kyia. Nathan has a passion for new technology, grant writing, and short stories. He spends his time rafting the American River, playing video games, and writing.

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