Central banks are contemplating a world without cash

Headquarters for the central bank for central banks.
Headquarters for the central bank for central banks.
Image: Reuters/Arnd Wiegmann
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Cash may not always be king. That’s why, as apps and payment cards become more popular, officials at central banks are considering how and whether to create a digital form of cash.

The way we pay for things is changing quickly. The Visa and Mastercard payment card duopoly is steadily increasing its reach in many parts of the world. At the same time, tech companies like Apple, China’s Ant Financial, Sweden’s Swish, and Kenya’s M-pesa are rapidly changing the game for mobile phone payments. (Facebook has some of the most ambitious plans, but it hit a wall of resistance from government authorities.)

As money gets swept up by tech innovation, government authorities are taking a closer look at old fashioned notes and coins. More than a dozen countries are either researching, piloting, or, like China, have ongoing work in place for central bank digital currencies, according to a Bank for International Settlements report published today.

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“Central banks around the world are investigating a rich set of prototypes,” the BIS wrote. If these results are shared, it could help determine which technologies and designs are most optimal for a central bank digital currency, and whether and how they should be rolled out to the public.

This debate matters to officials because there’s a critical difference between the notes in your purse or wallet and your digital wallet or checking account. The former is issued directly by the central bank—the lender of last resort and typically the anchor for a country’s financial system. The latter depends on the stability of commercial institutions and can be more vulnerable.

In the event of a financial crisis, consumers can and do take comfort in knowing they can convert their electronic money to cash if needed, according to the BIS.

“This flight to cash has been seen in many crisis episodes, including recent ones,” the BIS wrote. “If, in the future, cash were no longer generally accepted, a severe financial crisis might create further havoc by disrupting day-today business and retail transactions.”

While physical cash isn’t yet endangered in most places, the experience of a few countries, notably Sweden, China, and even to some extent the UK, shows that a world with much less cash usage is increasingly possible. That’s why the BIS, sometimes called the central bank for central banks, published a report sketching out possible designs for a peer-to-peer central bank digital currency.


Digitizing paper money and metal coins presents a tough challenge. Such a currency would have to have “cash-like” safety from defaults, be private, impervious to electronic outages, and still easy to use. The architecture could use a traditional account system or be wired up with distributed ledgers to make it less susceptible to a single point of failure. Such a currency could also be linked to a digital identification system and be leveraged to make cross-border transactions cheaper and more efficient.

A critical issue is the interplay between the central bank and commercial institutions. The BIS described three scenarios:

  • Consumers rely on a commercial intermediary that keeps central bank digital currency at the central bank, pretty much like the existing system (indirect model)
  • Consumers hold the central bank’s electronic money directly, and the central bank itself keeps a record of all consumer balances and updates every transaction (direct model)
  • Consumers have direct access to central bank money but interact with it through commercial entities (hybrid)

All three architectures have strengths and tradeoffs, according to the BIS report. The first, the indirect model, leaves the consumer more exposed to defaults, as it might be difficult for the central bank to unwind who is owed what after an institutional collapse. The second, the direct model, is straightforward, but it would require the government to take over much of payment system, cutting out commercial entities that are more dynamic and innovative. A hybrid version would allow consumers to hold central digital currency while private institutions build a technology layer between them.  The hybrid model suggests the central bank would have its own record of holdings and could restore assets if there’s a default.

Another question is whether to use a much hyped distributed system for validating transactions (similar to the blockchain distributed database behind bitcoin) or a more centralized authority. Again, the BIS points out that there are tradeoffs. A distributed system avoids a single point of failure, but would likely be slower at processing payments (since it requires multiple database updates and validations). It wouldn’t feasible to use a distributed ledger system for the direct model, described above, because it wouldn’t be able to handle the sheer volume of payments, the BIS said.

The BIS writes that both systems—conventional and distributed ledger—have their own vulnerabilities. A central system is susceptible to hacking, for example, while a distributed method could be vulnerable to a denial-of-service form of attack.

A question of privacy

Critical questions about identity and privacy would have to be resolved. Most digital accounts are set up with a form of ID, which not everyone has. That could create a barrier to universal access to the most basic form of payments. (India’s system for universal ID could provide a model for overcoming this.) Another option is to make the funds available to whoever has a cryptographic key, which is essentially the system that bitcoin uses. This offers privacy and universality, but the “downsides are severe,”according to the BIS: the funds can be stolen if the key isn’t kept safe, and it could create a challenge for protecting against money laundering and illicit finance. There’s also not much recourse if the consumer loses their secret key.

Physical cash, meanwhile, offer the highest degree of anonymity. If governments issue digital currencies with tracking features, the public loses the protection and freedom that comes with anonymous transactions. On the other hand, a truly anonymous peer-to-peer digital dollar or euro would be ideal for drug traffickers and tax avoiders. Using physical cash to avoid the formal financial system is bulky and awkward; a truly digital version would be far more portable.

As usual with digital innovation, new technologies aren’t a perfect replacement for their analog predecessors. There are likely to be some real drawbacks to just about any digital currency design. It’s up to central banks to decide which tradeoffs to make before consumers and tech companies make the decision for them.