We have already talked about the influence of blockchain technology in the financial authorities all over the world. Several of the main Central Banks are discussing the possibility of issuing their own digital currency. These currencies, which are known as CBDC, would allow to increase the level of digitization of the economy. They would also serve as replacement (or at least a complement) to the cash money. Basically what we are talking about is a public money with a digital base. In the current model, the public money is the cash, while the credit cards are the best representative of the private money.
This model was sustainable thanks to the support of the Central Bank, which allowed to move from private to public money with no loss of value. Now we see the cryptocurrencies as Bitcoin, controlled by an algorithm and without any public support from the Central Banks. How will this change affect the current model?
What is the public money?
As we said, the public money is formed by cash and the deposits offered by Central Banks to the commercial banks. These forms of money are the most secure, as they are the only one backed by public financial authorities. During the economic downturns, the unique form of money that we know for sure that we cannot loose is the money we have in cash. In the same way, the banks have plenty assurance that their deposits in the Central Bank will remain safe, as this institution acts as a last chance guarantor.
Of course, every countries has different mechanisms to ensure the solvency of the traditional banking deposits. In Spain we have the Deposits Assurance Fund, which covers every deposit up to 100.000 € in case of banking bankrupt. However, this Fund just covers the retail banking deposits, which are not under the category of public money. In fact, what it is really considered as public money is that issued directly by the ECB in case of the Eurozone.
What is the private money?
On the other side, we can consider as private money all the forms of money out of the public money definition. In this category we find the retail banking deposits, the credit cards, etc. These different forms of money can coexist among them thanks to the support of the public institutions. By securing the convertibility, we can move from private to public money (and vice versa) with no loss of value. This is as assurance for the stability of the financial system, and it makes it reliable for the users.
Secondly, we find the cryptocurrencies such as Bitcoin, in which a software code controls and issues the new tokens. Thus, the cryptocurrencies have become in private alternatives very easy to design. Their issuance has more flexibility and the costs are quite lower. Moreover, their integration with the current payment methods is direct, as most of them are private and therefore, more flexible.
Despite the easiness of their integration, the cryptocurrencies do not have the support of the authorities. In many countries the government does not allow their use, and neither the convertibility is guaranteed. During economic downturns, there are no mechanisms that cover the financial loss. Therefore, the cryptocurrencies are a form of private money quite different from others. However, their technology is very for the developments of other alternatives, such as the CBDC or the stable coins. The former are to replace the cash money, while the latter link their value to the physical fiat money such as the American dollar.
Elements to compare
Now we are going to analyse all the necessary elements to compare both forms of money. We will be focusing on the Eurozone and the ECB, but this analysis is applicable to any other financial system.
Trust and safety
In the current financial model, there is no private payment method which can compete with the public in terms of confidence. The ECB acts as the last guarantor of the public money, so the people can trust it. This warranty does not exist for the private money, so the confidence is lower.
Some mechanisms as the Deposits Fund mentioned earlier can cover part of the private money, but not the 100%, and it is not backed by the ECB. The case of the cryptocurrencies is even worse, because they are not legal tender or official payment method. Therefore, there is no public support for them. Given this scenario, during economic downturns, the cryptocurrencies would never serve as a safe place to keep our savings.
This is the reason why any financial system would need public money in order to become reliable for the users. In terms of security, both forms of money should be equally reliable. In the case of the public money, its safety is even more important as it is directly the ECB who issues it.
The digitization of the financial systems has brought a great level of innovation for the private forms of money. The possibility to “tokenize” the money is something which allows to save costs and improve the speed of the processes. Due to their own configuration, these innovations are more feasible for the private sector.
However, in the public sector, the innovation usually comes as a consequence of the social transformation, instead of the opposite. That is the reason why the conception of CBDC means the adaptation of the public money to the social needs, where the cash money is loosing importance replaced by the private alternatives. This also means the financial adaptation for a more inclusive payments system.
Currently there are several countries where the ownership of any mobile device is more common than having a banking account. This causes that the public forms of money must adapt to the new needs in order to achieve their goals. In this sense, the innovation will probable come from the private sector, but the obligation of adaptation and provision of services will be for the public institutions.
The interoperability among the different currencies all over the world is one the main challenges for the financial systems. In the past, this interoperability was part of the duties of the public institutions. With the current role of the cryptocurrencies, we will need to review how the payment systems can adapt. That is the reason why the design of CBDC represents a clear opportunity for the interoperability to increase the use cases. Moreover, it can become a boost for the creation of a new place for financial innovation.
It is also important to have in mind that the interoperability among cryptocurrencies and public and private money can become a lever for new business opportunities. Specially in the private sector, the movement from private to public money and vice versa can allow the appearance of new applications such as the wallets, custody companies, or exchange platforms. These new applications would not be born if there were no integration between the traditional and the new forms and infrastructures of money.
Privacy is, with no doubt, one of the elements which people value the most of any currency. In this sense, the cash money represents perfectly the data protection for any transaction, not just against the governments, but also against any third party. The potential issue of a CBDC by the ECB must be really aware of this aspect.
However, sometimes it is not easy to make the difference between privacy and anonymity. While the former is not under discussion at all, the later crashes directly against the money laundering policy. That is the reason why the design of CBDC must take into account both elements. The design must allow fully privacy for the users, but without confronting the public goals.
On the other side, the private forms of money have been able to develop structures both private and anonymous. Thanks to that, the cryptocurrencies have become very popular. In the future, every form of money should be able to manage structures with both elements, and the regulation could be helpful.
One of the main tools of the Central Banks for the implementation of their monetary policies is the management of the interest rates. The interest rates have an impact in the real economy through the banking system, by providing credit lines and deposits. In this sense, the creation of a CBDC represents the opportunity of counting with another tool for the monetary policy.
The cash money is, by nature, absolutely independent from the interest rates. However, a digital representation of the cash money would be technically feasible to link to any interest rate, which would transform it in another tool for the Central Bank to manage the monetary policy.
This new role of the CBDC could reallocate the savings from banking deposits to CBDC and entail a new risk for the Central Bank. On the other side, the private money would not be primarily affected by the interest rates, as it occurs currently.
This is probably one of the elements which presents a bigger disadvantage of the public money against the private money. The public money can be grouped in coins and bank bills issued by the ECB. We can also include the deposits in the ECB, but as they are not accessible by the people, we will not count with them.
Both bank bills and coins are physical forms of money. This implies several costs for the ECB in terms of storage and issuance. Moreover, in order to avoid any fraud, the authorities spend millions of euros every year to develop new security measures to make more difficult to fake them. In fact, every few years the ECB issues new coins and bank bills to replace the old ones and to maintain the same level of security.
This is one of the reasons why the ECB are developing its own CBDC, which does not have this problem. It happens also that the cash money is the biggest source of tax evasion through money laundering. This implies that the cost of having this form of money is even higher due to the taxes evaded.
The private alternatives, however, are mostly built on digital environments (credit cards, deposits, etc.). This implies lower costs of issuance and storage, and it also affects the security measures. However, in the case of cryptocurrencies, we should also count with the mining costs. Depending on the algorithm used by the cryptocurrency, these costs can be really high. These costs are entirely assumed by the private entity/people in charge of the mining.
Lastly, it is important to analyze the need for public money in terms of financial efficiency. We can define the efficiency as the quality of the daily transactions in terms of costs and time. Nowadays, the efficiency of the payments system is great, and we have also a good level of financial innovation. This is true for the public money, but it is even more significant in the case of the private forms of money.
However, the decreasing use of the cash money and the increasing level of digitization demand a change of the financial system. The need for a better presence of the money issued by the ECB requires the creation of CBDC. Additionally, the appearance of technologies such as blockchain allow improvements in the efficiency. Therefore, we should expect an increase of the overall efficiency in the long term.
Public money vs. private money
As we have seen previously, the impact of CBDCs depends on the the final technical design. However, we found that there are several elements which justify the existence of digital money in the long term. This money should ideally be present in both public and private forms.
The public money is necessary to maintain the confidence in the monetary system, as well as to transmit the monetary policy and to guarantee the interoperability among the different payment systems. On the other side, the private money ensures efficiency and innovation in the process. Both systems should allow privacy for the transactions, without impeding other public goals.
Although this coexistence is already in place, the digitization of society and technologies such as blockchain should increase this relation. Therefore, the goals of the Central Banks and the innovation and efficiency for the private payment systems will be achieved. The combination of both should create a stable and reliable financial system for every user.