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IMF: Public and private money can coexist in the digital age

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Central banks need to become more like Apple to keep their digital currency at the cutting edge of technology.

Public Money and Private Money Can Coexist in the Digital Age

Original source: International Monetary Fund, Tobias Adrian and Tommaso Mancini-Griffoli

We value innovation and diversification -- including in the currency area. Throughout the day, we can pay by credit card, mobile phone, the Internet, as well as banknotes and coins -- although in many countries cash is being used less and less.

The world today is characterized by a dual monetary system, in which various types of banks, telecommunications companies or specialized payment service providers issue private money on top of the public money issued by the central bank. This system, while not perfect, has significant advantages, including innovation and product diversification, largely provided by the private sector, and stability and efficiency, ensured by the public sector.

The goals of innovation and diversity on the one hand and stability and efficiency on the other are interrelated. As one of them increases, the other tends to weaken. This is a trade-off that countries, particularly central banks, must manage. How much should central banks rely on the private sector and how much on their own innovation? Much depends on preferences, available technology and regulatory efficiency.

So when a new technology emerges, it is natural to ask how today's dual-currency system will evolve. If digital cash (called central bank digital money) does emerge, will it replace money issued by private institutions, or will it allow private money to flourish? The first is always possible - through stricter regulation. We believe that the second scenario is still possible if the logic of the current dual currency system is extended. It is important that central banks do not have to choose between issuing central bank digital currencies or encouraging the private sector to provide their own. The two can co-exist and complement each other, for example, by central banks making certain design choices and adjusting their regulatory framework.

Public and private money coexist

Throughout history, privately issued and publicly issued money have coexisted, which can be confusing. Why is it that private money, which is more innovative, more convenient, more user-friendly and more adaptable, is not completely dominant?

The answer lies in a basic symbiotic relationship: private money can be exchanged for perfectly safe and liquid public money, whether notes and coins or central bank reserves held by some banks.

Private money, which can be converted into central bank money at a fixed face value, becomes a stable store of value. $10 in a bank account can be exchanged for a $10 bill and used as legal tender to pay a debt. This deceptively simple example hides a complex underwriting base: sound regulation, government support (such as deposit insurance and lender-of-last-resort functions), and some or all support from central bank reserves.

Moreover, privately issued money is an efficient means of payment only if it can be exchanged for central bank money. Anne's $10 at Bank A was able to be transferred to Bob's account at Bank B because the money was in the process converted into central bank money -- an asset that both banks trusted, held and could exchange. As a result, this privately issued currency became interoperable. So there was competition, because Anne and Bob could keep their money in different banks and pay each other; At the same time, in terms of the actual form of money, it has also brought about innovation and diversification.

In short, for privately issued currencies, whether in bank accounts or other forms, the nature of being convertible into central bank currency is important for stability, interoperability, innovation and diversification. A system with only private money is too risky. And a system with only central bank money could miss important opportunities for innovation. The two forms of money reinforce each other, creating the current dual monetary system -- a balance that has served a useful purpose.

Central bank money in the digital age will face challenges

How will this system evolve in the future as we move into the digital age? Will digital currencies issued by central banks be so attractive that they inhibit the development of private money? Or can the private sector continue to innovate while central bank money exists? Much will depend on the ability and willingness of central banks to keep pushing through big innovations. Keeping abreast of technological change, rapidly changing user needs, and the pace of innovation in the private sector has not been easy.

A central bank digital currency is similar to a smartphone and its operating system. At a basic level, they are a settlement technology that allows money to be stored and transferred, much like the transfer of information between a phone's processor, memory and camera. On another level, they are a form of money with a specific function and appearance, much like an operating system.

Therefore, central banks must become more like Apple or Microsoft to ensure that their digital currency remains at the cutting edge of technology and becomes the primary and preferred form of digital currency in users' wallets.

Innovation in the digital age is far more complex and rapid than updating security features on paper bills. For example, central bank digital currencies might initially be managed through a central database, but as the technology matures, there could be a shift to distributed ledgers (synchronously registered accounts that are automatically saved and updated within a network), and one ledger could quickly be replaced by another after a significant technological advance. Phones and operating systems also get major updates at least every year.

Moreover, in the digital age, user needs and expectations are likely to change faster and less predictably. Information and assets may move to distributed ledgers, requiring money to be monetized on the same network. Money could be transferred in entirely new ways, including automatically via chips embedded in everyday products. These requirements may require new characteristics of the currency, thus requiring frequent redesign of the architecture and diversification. The money of today or even tomorrow will hardly meet the needs of tomorrow.

Pressure will also come from the supply side. The private sector will continue to innovate. New e-coin and stablecoin schemes will emerge. As demand for these products grows, regulators will try to contain the risks. One question will inevitably arise: How will these forms of money interact with digital currencies issued by central banks? Will they stand alone, or will some of them be integrated into a dual monetary system in which private and central bank money reinforce each other?

Partnerships with the private sector remain possible

Keeping up with technological change, user demand and private sector competition will be challenging for central banks. Yet central banks need not act alone.

First, the design of a central bank's digital currency could encourage the private sector to innovate on top of it, just as app designers create attractive features for mobile phones and their operating systems. By accessing an open set of directives (" application programming interfaces "), a vibrant community of developers can extend the availability of the central bank's digital currency beyond the provision of generic e-wallet services. For example, they could make it easier to automatically pay for goods on demand; Alternatively, you could set up a lookup function that would transfer a sum of money to a friend based solely on her phone number. The key is to review these additional services to ensure that they are fully secure.

Second, some central banks could even allow other forms of digital currency to exist simultaneously (much like parallel operating systems), while taking advantage of the settlement capabilities and stability of their digital currency. This will open the door to faster innovation and product selection. For example, a digital currency could make some compromises on settlement speed, giving users more control over payment automation.

Will this new form of digital currency be a stable store of value? Yes, if it can be converted into central bank currency (digital or non-digital) at a fixed face value. This would be possible with the full support of central bank money.

Could this form of digital currency be an efficient means of payment? The answer is yes, too, because in any digital currency network, settlement is instantaneous, like between accounts at the same bank. And these networks are interoperable, as long as the payment made by Anne's digital currency provider to Bob's digital currency provider is settled through the corresponding transfer of the central bank's digital currency, as is the case with the current dual system.

This form of digital currency (It used to be called synthetic money) could coexist with central bank digital currencies. This requires a licensing arrangement and a set of regulations to achieve public policy objectives, including operational resilience, consumer protection, market conduct and competition, data privacy, and even prudential stability requirements. At the same time, financial integrity can be ensured through digital identity and ancillary data policies. Working with the central bank requires full compliance with regulations.

An enduring system

Countries should consider how they use the private sector when implementing central bank digital currencies. The current dual currency system can be extended to the digital age. Central bank money, coupled with effective regulation, will continue to play a key role in ensuring the stability and efficiency of the payment system. Privately issued money could reinforce this foundation through innovation and diversification -- perhaps more so than it currently does. To what extent will the private sector and the public sector each participate in money issuance? Central banks will choose from a range of possible options that will ultimately depend on their preferences, technology and regulatory efficiency.