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Central Bank Digital Currency – Will the ECB Lead the Way?

Posted: Tuesday, December 1st, 2020

Estimated Reading Time: 3 minutes

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One of the major themes in 2020 was the birth of a new concept – central bank digital currency. First introduced by the European Central Bank (ECB), it quickly became a topic among other major central banks.

Why the need for a central bank digital currency? Why suddenly this is a thing, and why is the ECB leading the race?

For the ECB to lead the race to digitalization should not surprise anyone. After all, the European Commission made no secret of the direction the European Union heads – digitalization is key to the European future. However, to think that it will start with a central bank digital currency is something different.

Yet, here we are, at the end of a year that made it possible that all digital projects to move along with greater speed. Forced to restrict the use of cash, the 2020 reality suggests a quicker transition to a digital currency.

Central Bank Digital Currency

When the ECB announced earlier this year that it applied for the “digital Euro” trademark, it signaled its serious intentions. Soon enough, papers from other central banks and even from the Bank for International Settlements covered the subject extensively.

For sure, challenges exist. Safety, for once, is a critical aspect. Moreover, national acceptance. However, some nations already reduced the use of cash to levels that it makes no sense having it anymore. As such, the need for a central banks digital currency is more than obvious.

Advantages and Disadvantages of a Central Bank Digital Currency

The decline in the use of cash represents one of the main reasons why to turn to a central bank digital currency. However, the implementation poses some real challenges.

On the one hand, many fear that by introducing a central bank digital currency, it would be easier for central banks to lower the interest rate below zero. During the last years, we have seen negative interest rate policy (NIRP) in the Euro area but also in some other jurisdictions. The fear is that with the gradual disappearance of cash and cash equivalents from the economy, the floor on negative interest rates will disappear.

On the other hand, central banks will have an easier time implementing a proper monetary policy. As the recent economic crisis generated by the pandemic taught us, each recession comes with its own specific characteristics. As such, there is no one single medicine to use to solve an economic crisis. Unconventional monetary policy went as far as quantitative easing and even NIRP – but can the topic expand more?

It could be the case that central banks already prepare the ground for the next crisis. This is the second time in a little over a decade when quantitative easing is used to further deliver monetary accommodation once the interest rates reach the lower boundary or go negative. What if it would be enough for the next crisis?

Digital bank runs also pose a threat. In tough times, they may end up being more difficult to handle than otherwise thought.

All in all, the world leans toward a central bank digital currency. We should not be surprised to see the digital Euro, but also the digital USD, digital CHF, and so on.

As the world changes, central banks will change too. By delivering on digitalization, they simply align with the overall direction the world is heading.

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