Innovation key to designing Central Bank Digital Currency

At the Angel Investors 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 cash system.  The speech outlines issues 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 summarises and builds on the Reserve Bank’s recent consultations on the future of money and cash (which began in 2019).

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

Who needs to read it?  Why?

Mr Orr’s speech confirmed that the Reserve Bank is exploring the case for a CBDC.  The Reserve Bank wishes to design a CBDC which provides an open, public platform to support further innovation in the financial and banking sector.

The Reserve Bank is taking a multi-stage approach to developing a CBDC.  Mr Orr said that technology exists now to design a CBDC, however, designing this will take many years.

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

A new CBDC needs to 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 the digital money 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 (ie cash).

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

Unlike private money, central bank money is public money issued by the Reserve Bank.  Mr Orr highlighted the importance of the Reserve Bank’s role in managing the economic cycles through monetary policy.  The value of central bank money lies in its institutional legitimacy, where unlike cryptocurrencies (such as Bitcoin), the Reserve Bank is able to secure the public interest in a time of crisis.

A new CBDC needs to promote financial inclusion

Mr Orr emphasised that any action to change the money and cash system should promote financial stability for everyone.  The Reserve Bank is conscious that a CBDC could support wider financial inclusion and well-being efforts, including to reach “digital natives” who are excluded from the current financial system or for whom existing digital product offerings do not meet their needs.

A new CBDC needs to overcome issues with existing digital currencies

In his speech, Mr Orr warned that while the technology underpinning money may be new, the economic substance should remain as old as money itself, otherwise the potential gains could be lost in the effort to “reinvent the monetary wheel”.

A CBDC should overcome the current challenges presented by stablecoins.  In particular, the Reserve Bank is concerned about the way in which stablecoins seek to replicate the convertibility of central bank money.  The Reserve Bank considers that stablecoins may pose systemic risks, cause 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 cash 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 would also need to overcome the following challenges not yet achieved by private digital currencies:

  • A CBDC should be operationally resilient to outages and cyber security risks.
  • Privacy and autonomy must be a central feature of the CBDC – this will involve balancing AML concerns and the need for privacy.

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

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

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

Our view

It goes without saying that the prospect of a CBDC is very exciting.  The use of money is evolving in our increasingly digital economy, and the Reserve Bank needs to adapt the money and cash systems to reflect this.  A CBDC also has the potential to change how we all interact with money and the broader financial system.  However, the issues concerning the future of money and the use of a CBDC are complex and need to be carefully navigated.

The recent use of money and cash through the COVID-19 pandemic demonstrates the key benefits and challenges of introducing a CBDC.  The convenience of payments through digital currency has become even more evident.  However, since the first lockdowns in March 2020, the Reserve Bank also recorded large holdings of cash in response to the 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 critical that a CBDC provides New Zealanders with certainty and security as well.

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

What next?

If you have any questions in relation to digital currency, the future of money consultations or are considering how these changes may affect your business, please contact one of our experts.

This article was co-authored by Sarah Jones, a solicitor in our Financial Services team.

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