Tuesday, November 30, 2021

A CBDC, eh?

David Andolfatto recently wrote a helpful article about whether Canada needs a central bank digital currency, or CBDC. I agree with David that a CBDC is "not an essential initiative at this point in time."

The way I see it, there are two big elephants in the room when it comes to introducing a central bank digital currency. Both of them suggest we should slow down any effort to issue CBDC.

But before I get to that, what is a CBDC? In brief, a CBDC is a new payments option that would allow regular Canadians to interact digitally with our nation's central bank, the Bank of Canada. For example, instead of having to use your Royal Bank account or Visa card to buy stuff at the supermarket or on Amazon, you could pay with a central bank digital tool, perhaps a Bank of Canada app or card. The Bank of Canada has been exploring whether the idea of issuing a CBDC for several years now, but so far hasn't pulled the trigger.

Here are what I believe to be the two big risks to rolling out a Canadian CBDC.

The most important one is white elephant risk.

In mature democracies like Canada, the provision of retail non-cash payments is a mostly-solved problem. Decent access to payments is already provided by a panoply of bank accounts, financial  apps, and cards. These existing options for connecting to the payments system are very safe. The $1,000 we hold in a checking accounts to make payments, for instance, is protected by government deposit insurance.

So if the Bank of Canada were to issue a CBDC, it's not obvious to me that many of us would bother using it. It would be just one more safe payments account among a sea of safe options.

That leaves the central bank in the position of having spent large amounts of money building and maintaining a payments network that none of us really needed or wanted in the first place.

Getting rid of an expensive and lacklustre CBDC could be difficult. Central bankers may feel like their reputations are tied to their CBDC projects. This, combined with the fact that central bankers don't feel the sting of a bottom line, may allow these white elephants to limp on for a very long time.

At the moment, most Canadians don't interact with Bank of Canada products (apart from holding cash, usage of which is falling). We mostly view the central bank as a competent technocratic body that does complicated stuff with interest rates. A CBDC project would suddenly put the Bank of Canada in direct digital contact with Canadians. But if the CBDC were to become a white elephant, this proximity could backfire on the central bank. It'll be know as the agency that runs a bloated payment system that the public dislikes. We don't want the Bank's brand to be hurt. We want the Bank of Canada to be trusted and deemed competent.

The second risk is black elephant risk. A black elephant is an obvious risk that people avoid discussing ahead of time.

Most discussions about CBDC centre on the technological hurdles involved in building one. But they often ignore the pesky sociological difficulties of running payments systems.

Fickle customers want to be able to reverse payments when they aren't happy with the products they buy. Users are frequently swindled out of their money by fraudsters and will expect restitution. If Jack accidentally send $500 to Alice instead of the $50 that he intended to send, he will want $450 back. What if Alice disagrees?

This requires that central bank constantly arbitrate disputes.

That's not all. Criminals will try to use a CBDC to sell illegal products. The central bank will have to start policing what is illegal and what isn't. Controversial businesses, say white nationalist publishing houses or kinky porn sites, will line up to use it. That means getting embroiled in politics.  

These are the not the sorts of issues I want my central bankers to get bogged down in. The risk is that demanding CBDC users distract the Bank of Canada from the vital task of conducting monetary policy.

The Bank of Canada might try to outsource the governance of a CBDC to the private sector. But that begs the question: if the central bank doesn't want the burden of running a payments system, why is it trying to get in the game at all? Why not just stick with the status quo, which seems to be working?

In sum, if I had any suggestions for Canadian citizens on how they should appraise a Canadian CBDC, it would be this. Given the above white & black elephant risks, the Bank of Canada shouldn't lead, it should follow. Watch the first few trail-blazing central banks to see how their CBDC projects pan out. (The Swedes, who are aggressively purchasing a CBDC, are a good candidate). If the Swedish CBDC succeeds, copy it. If the Swedes fail, continue on as before. There's no advantage to being the first to market.


  1. What if banks pay inflation as interest on CBDC deposits, to encourage savings directly if inflation rises undesirably?

    1. I'm not sure if I understand. What do you mean by "pay inflation"? Do you mean pay an interest rate that is indexed to inflation?

    2. Right, if you get paid the inflation rate on your savings, are you less likely to spend now because otherwise your real savings will decrease?

  2. Is the desire to have a CBDC linked to the emergence of new ideas such as quantitative easing for the people (QE4P/PQE)? It may be easier for the Central Bank to have a single account for each citizen, rather than checking the uniqueness of accounts among all commercial banks, I don't know.

    1. But it doesn't need to build an entirely new payment system to pay out funds to Canadians. It only needs to maintain an updated list of accounts. Far simpler and cheaper that way.

  3. I completely agree. Glad I found your blog JP. I think Crypto Assets in general need to find a solution to the Black Elephant problem, the current risk is not at all scaleable to the masses if digital currencies were to be dominant forms of value exchange.

    Do you see a risk of a CBDC being used to monitor wallets and transactions by governments too? I would be more concerned about this element than citizens using the money for illegal purposes.

    1. "Do you see a risk of a CBDC being used to monitor wallets and transactions by governments too? I would be more concerned about this element than citizens using the money for illegal purposes."

      Not really, or at least not to any degree that isn't already possible. PayPal, Bank of America, and Coinbase are all watching you and gathering your data:


      Meanwhile, everything you do on blockchains can be observed.

      A CBDC's privacy would be on par with existing options. And in principle it could actually be designed to be more private than all of these things.

  4. But CBDCs will remove so many intermediaries from the payment ecosystem and reduce costs associated. A digital version of paper money with no bank account involvement will simplify the transfer system so much, make things faster!! Provided risks like accidental transfers are minimised (by two factor authentication), CBDCs can also enable digital offline transfers.