Innovation is key to the design of the central bank’s digital currency

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At the angel investor conference in Wellington yesterday, Adrian Orr (Governor of the Reserve Bank of New Zealand (reserve bank) gave a speech on how innovation in digital currencies has changed New Zealand’s money and currency system. The speech describes the problems identified by the Reserve Bank in adopting a Central Bank digital currency (CBDC), what a CBDC might look like, and why cash may still be relevant in today’s digital economy.

This speech summarizes and builds on recent Reserve Bank consultations on the future of money and cash (which began in 2019).

Links to the Reserve Bank’s press release and recent consultations on the future of the currency are available here and here.

Who needs to read it? Why?

Mr. Orr’s speech confirmed that the Reserve Bank was considering the case for a CBDC. The Reserve Bank wants to design a CBDC that provides an open public platform to further support innovation in the financial and banking industry.

The Reserve Bank takes a multi-step approach to developing a CBDC. Mr. Orr said the technology now exists to design a CBDC, however, the design will take many years.

The speech highlighted that the Reserve Bank considers any CBDC to have the following characteristics:

A new CBDC must preserve the public role of central bank money

The New Zealand monetary system is made up of central bank money (government-backed money issued by the central bank) and private money (such as digital currency accessed through a private bank). While all private money is digital (account-based and token-based), central bank money is made up of account-based digital money and physical money (i.e. cash ).

In his address, Mr. Orr described the role of central bank money as providing a safe and reliable anchor of value for the monetary and financial system, providing a fair and equal means of payment for all, and supporting financial inclusion and social.

Unlike private money, central bank money is public money issued by the Reserve Bank. Mr. Orr stressed the importance of the role of the Reserve Bank in managing business cycles through monetary policy. The value of central bank money lies in its institutional legitimacy, where unlike cryptocurrencies (like Bitcoin), the Reserve Bank is able to guarantee the public interest in times of crisis.

A new CBDC must promote financial inclusion

Mr. Orr stressed that any action to change the money and monetary system should promote financial stability for all. The Reserve Bank recognizes that a CBDC could support broader financial inclusion and wellness efforts, including reaching “digital natives” who are excluded from the current financial system or for whom digital product offerings existing ones do not meet their needs.

A New CBDC Must Overcome Problems With Existing Digital Currencies

In his speech, Mr. Orr warned that while the technology behind the currency may be new, the economic substance must remain as old as the currency itself, or potential gains could be lost in the process. effort to “reinvent the monetary wheel”.

A CBDC should overcome the current challenges presented by stablecoins. In particular, the Reserve Bank is concerned about how stablecoins seek to replicate central bank currency convertibility. The Reserve Bank considers that stablecoins can pose systemic risks, lead to anti-competitive and undesirable outcomes, and challenge New Zealand’s monetary sovereignty.

New forms of money also have the potential to fragment the money and currency system. The abundance of digital currencies (which allow people to transact in multiple currencies, each with a different value) creates confusion and inefficiencies.

A CBDC should also overcome the following challenges not yet faced by private digital currencies:

  • A CBDC must be operationally resilient to outages and cybersecurity risks.
  • Confidentiality and autonomy must be a central feature of the CBDC – this will involve balancing anti-money laundering concerns and the need for confidentiality.

The new CBDC should not supplant the important role cash plays in the lives of many New Zealanders

Mr. Orr confirmed that the Reserve Bank is not proposing to remove physical silver from the economy.

The speech emphasizes the importance of cash as a safe and reliable anchor of value. Cash also plays a role in supporting financial and social inclusion. Despite calls that cash is being used less, the Reserve Bank noted that the amount of cash in the hands of the public has increased by 3.7% per year since 1995.

Our point of view

It goes without saying that the prospect of a CBDC is very exciting. The use of money is changing in our increasingly digital economy, and the Reserve Bank must adapt monetary and treasury systems to reflect this. A CBDC also has the potential to change the way we all interact with money and the financial system in general. However, questions regarding the future of money and the use of a CBDC are complex and need to be carefully addressed.

The recent use of cash and cash during the COVID-19 pandemic demonstrates the key benefits and challenges of introducing a CBDC. The convenience of payments via digital currency has become even more evident. However, since the first lockdowns in March 2020, the Reserve Bank has also recorded large cash holdings in response to economic uncertainty. There is no doubt that a CBDC has the potential to increase financial inclusion and provide New Zealanders with a convenient, fast and efficient way to use money. However, it is essential that a CBDC also provides New Zealanders with certainty and security.

We look forward to consultation on the CBDC as the Reserve Bank addresses these issues.

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