Shifting from fiat currencies to digital currencies requires as much finance and banking as, if not more, political commitment. Such a move will imply fundamental changes to both financial and monetary systems. But let us examine what fundamental changes mean.

A CBDC would mean that the deposit and lending business would shift from Commercial banks to Central banks, producing a one-layer banking system.

In our days, the monetary system is a two-layer system: Central banks and Commercial banks. Central banks interlink with Commercial banks and they in turn, interact with customers. Central banks may hold deposits from Commercial banks, but Commercial banks cannot live without customers deposits which, due to fractional reserve banking and lending business, are lent out several times to other customers and generating income from interest payments. A CBDC would mean that the deposit and lending business would shift from Commercial banks to Central banks, producing a one-layer banking system.

Unquestionably, it is going to affect how monetary policy and to some degree, fiscal policy is applied.

Some opponents of digital currencies claim that introducing CBDC could have unintended consequences. Unquestionably, it is going to affect how monetary policy and to some degree, fiscal policy is applied. However, claims that point towards negative implications on the “base money and its composition” are exaggerated.

Let us examine the “base money” for a moment and see if the consequences could be negative or positive.

Central banks can influence the monetary base (expand) by creating new money to purchase bonds issued from commercial banks.

Base money (or Monetary Base) is the total amount of a currency/money supply that is in general circulation in the hands of the public or/and in the commercial bank deposits held in the central bank’s reserves. This measure includes only highly liquid currencies (notes, coinage and current bank deposits). Central banks can influence the monetary base (expand) by creating new money to purchase bonds issued from commercial banks. This increases the banks holdings in cash. The opposite happens when the Central Banks sell bonds back and receive money, and thus reduce the overall money supply.

However, money supply is more than the base money/monetary base. It can expand to include other assets as in M1 and M2, accounting for cash in circulation and specific liquid assets including, but not limited to, savings and checking account. However, it excludes credit to pay debt as it is a transfer of debt from one party to another — it does not represent a final settlement. The controlling of the monetary base is done by Central Banks with the governments maintain some degree of influence through the selling of government bonds in the open market.

Replacing fiat money with Smart Contracts

Issuing digital currencies could be done in exchange of fiat money. If this is the case we will be merely replacing paper and metal with digital numbers and lines of code (Smart Contracts).

Base e-money is the total amount of a digital money supply that will be in general circulation, in the hands of the public through their e-wallets and in the central bank e-deposits held in the central bank’s reserves.

Base e-money is the total amount of a digital money supply that will be in general circulation, in the hands of the public through their e-wallets and in the central bank e-deposits held in the central bank’s reserves. This measure will include only e-money that are considered “highly liquid”, already present in people’s e-wallets and current bank e-deposits. Central Banks could still influence the monetary base (expand) by creating new e-money to buy bonds issued and sold previously to public and private enterprises, even the governments (Treasury Departments). This will increase peoples’ and banks’ holdings in e-cash.

…we see that minimal disruption could quite likely create a move to digital currencies, creating the feeling of safety and security to consumers, knowing that their deposits are kept by central banks and not by riskier commercial banks — subject to “run-on-the-bank” risk.

The opposite happens when Central Banks sell bonds back and receive e-money, and in turn reduce the overall digital money supply. Thus, we see that minimal disruption could quite likely create a move to digital currencies, creating the feeling of safety and security to consumers, knowing that their deposits are kept by central banks and not by riskier commercial banks —subject to “run-on-the-bank” risk.

Hence, it is evident to me that the fundamental changes will apply mostly at the Commercial bank level. The role of the Central Banks will not be drastically altered, and one could say that they may see their powers increase. However, Commercial banks’ role will shift to act either as the Customer Relationship and product and services sales arm of Central Banks or eclipse all together. Could the CBDC be a prelude to a more centralized, rather than a de-centralized system?

Most recently, some experts have voiced a “dual form of currency”. “At times of financial stress, money tends to move away from banks that are seen as high risk, towards banks that are considered more secure and therefore it is not far-fetched to picture a scenario in which a CBDC could command a premium over a fiat currency. For example: where one euro of deposits in the commercial bank buys less than one euro’s worth of central bank digital currency,” Agustin Carstens, General Manager, Bank of International Settlements (BIS) states.

…what would the incentive be to maintain a “dual currency”, other than keeping alive the commercial banks?

This sounds to me like a “transitional period” where there is one rate for one currency and another for another. But it begs the question; what would the incentive be to maintain a “dual currency”, other than keeping alive the commercial banks? This could buy them time but not necessarily bode well for their customers. However, this is a very likely, I hope a transitional scenario, until the role of commercial banks is redefined and the public accepts digital currencies as part of their daily transactions.

A non-scientific observation could be made at this point. Considering that the new generations are tech savvy, it could be much easier to imagine a world with widespread digital currencies within the next 10 years and a digital-currency-only society by 2040, just over 20 years from now.

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Athanasios Ladopoulos is the Chief Investment Officer at Lapo.io (http://lapo.io/), and is set to present on the “Role of Central Banks and the future of Cryptocurrencies— how to spot the Universal Cryptocurrency” at the Monaco Blockchain Masterclass on May 31st.