There are many different types of money. The Bank of England lists 3 types of money currently available in the United Kingdom[1]. These are:
·Cash – banknotes and coins
·Central bank money – which is money deposited at the Bank of England by financial institutions
·Commercial bank money – which is the electronic money that individuals, households and businesses have in their bank accounts or the money that has been borrowed by individuals, households, and businesses from commercial banks
In addition, there will soon be Central Bank Digital Currencies (CBDCs). Most Central Banks have either introduced CBDCs, are running CBDC proofs of concept or are investigating them in one form or other. Much of the debate going on around CBDCs is looking at their design and the policies behind their introduction.
This leads to the heart of how money works at a technical level. One aspect of this is whether money is account based or token based.
Commercial bank money, the electronic money in a bank account, is account based. The balance of the account is the aggregate total of all the credits and debits that have gone into or out of the account. If I make an electronic payment for €4.50 from my Euro account, then the balance of my account will be decreased by €4.50. There is a single transaction for exactly €4.50. One key aspect about account-based money is that it is linked to the identity of the account holder. To access the account, you need to prove your identity. By design, account-based money is not anonymous.
On the other hand, cash is token based. Each note or coin is separately worth a fixed value. So, if I purchase something with cash, I need to give cash equal to or greater than €4.50. For example, if I pay with a €5.00 note then I will receive a 50 cents coin as change. The €5 note is worth €5, it is not possible to tear off a part of the note so that it becomes worth €4.50. As a result, unless I am prepared to pay more than €4.50 for goods worth €4.50, then I will expect some change in return. Which is a second transaction: debit of €5 and a credit of €0.50.
One of the design decisions about CBDCs is whether they are account based or token based. Intuitively we think of digital money being account based. This is because we are used to our bank accounts being account based money. Certainly, in a CBDC hybrid model, where a customer’s access to CBDCs is via a commercial bank, it would be possible for a customer to have a CBDC account alongside a commercial bank account. This may be invisible to the customer (they would see a single balance which would be a combination of their balances in commercial bank money and CBDC) or it may be shown separately depending on whether the CBDC is used as a store of value in addition to being a means of payment.
However, there could be advantages in having a token based CBDC. One aspect of token-based money is its anonymity. Once cash has been withdrawn it is essentially anonymous until it is returned to a bank. It is possible to identify who withdrew a $10 bill and it is possible to know who deposited it with a bank, but in between those two events there is no record of how many transactions it was used for, nor what those transactions were. In its public consultation[2] on the introduction of a digital Euro the European Central Bank found that the number 1 concern that the public had about a digital Euro was privacy. If a CBDC was token based, then it could be designed with privacy at its core.
A CBDC in token form could be true digital cash. Electronic Central Bank money, available to businesses and individuals, that can be used as a means of exchange.
It would also make offline transactions easier. If a CBDC existed in token form, then a payment could consist of a transfer of the CBDC token from one mobile phone to another. It would be truly anonymous.
However, truly anonymous money also has risks attached. It could be used for activities such as money laundering, tax evasion or avoiding sanctions.
A large value of physical cash takes up a lot of space. While it is easy to carry 5, 10, 20 Euro notes in a pocket or a purse, if you wanted to transport €100,000 not only do you need a means of transporting it, but there is also a risk of it being stolen. As cash is a bearer instrument, once lost it is often difficult to prove it is yours. For these reasons anyone attempting to deposit €100,000 would raise a lot of red flags and be subject to anti money laundering investigation. It is not something that is normal. On the other hand, €100,000 in CBDC would not be conspicuous. It would not be possible to know if a CBDC wallet contained €100,000 or €10 unless you had access to the wallet. Money laundering is easier in the digital world.
Offline transactions with CBDCs are an aspiration. The ECB in its Report on a Digital Euro specifically lists “cash-like features” including offline payments and privacy protections as the second requirement of a Digital Euro[3]. Having a CBDC in a token form could be a way of achieving that. However, there would need to be limitations on the amounts that could be used in offline transactions or the value that could be held to avoid problems with money laundering. Achieving all of these with a single design is something that will not be easy to achieve.
[1] https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-in-the-modern-economy-an-introduction.pdf
[2] https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210414~ca3013c852.en.html
[3] https://www.ecb.europa.eu/pub/pdf/other/Report_on_a_digital_euro~4d7268b458.en.pdf
