The Future of Money – Central Bank Issued Digital Legal Tender ?



Given the recent hype around digitalisation and artificial intelligence, I thought it might be worthwhile to consider what digitalisation might actually mean for money and monetary systems in general.

First of all, one should exercise restraint when considering digitalisation or AI. To me, it seems that AI – even in the case of deep learning neural networks is basically just complex nonlinear regression analysis (essentially fitting a nonlinear curve on a data set). At least Noam Chomsky is of the view that AI has not advanced much from the 1960’s in qualitative terms. Of course AI has advanced in quantititative terms, given Big Data, more powerful CPUs and so forth. But I think Kurzweil’s singularity concept is not really something that is just around the corner.

Digitalisation is a more interesting concept, although I do not see a giant leap for mankind here either. Digital means basically computers (1/0) and computers have been around since the inventions of the Turing machine and the ENIAC. Computers are of course a lot more sophisticated nowadays. And I guess programs are also in some sense “smart”.

However, in the field of monetary economics, current and rapid digitalisation can provide lots of new opportunities. Since the emergence of cryptocurrencies , bitcoin and distributed ledger technology in general, people are more and more interested in these issues because of potential financial benefit as well, on top of intellectual curiosity.

One of the most interesting concept for me is the concept of a digital central bank currency.

Think of money for a moment.

Money for most of the people is basically bank accounts and notes and coins issued by the central bank. Paper money is a liability of the central bank and a legal tender (you can use it universally to buy stuff and pay your taxes). The other major part of liabilities for the central bank consists of bank reserves or bank deposits at the central bank. These deposits have by the way expanded substantially due to quantitative easing, as central banks buy government bonds from the banking sector by crediting the banks’ accounts at the central bank.

Now, let’s consider the possibility of extending that set of liabilities

In particular, let us assume that the central bank would establish a digital universal access legal tender account for all legal entities and for consumers and households as well. In other words, let us assume that one  could use the balance of these accounts to settle day-to-day transactions at the local supermarket etc. Furthermore, let us assume that this new system of digital legal tender would integrate the current distributed ledger technology in order to facilitate peer-to-peer transactions and enhanced security. In a way the balances at the central bank could be used for netting the balances within the peer-to-peer universe. What would this mean for the current monetary system?

First of all, let us remind ourselves that commercial banks create most of the money in a given society by creating new bank deposits as a by-product when granting loans to their customers. So we can assume that in the first stage, when money is created, the newly created money is in the form of bank deposits. However, if we assume that there is the option for the deposit holder to transfer her money into the central bank digital money account (which is a legal tender), she would probably do so, because the counterparty credit risk is smaller at the central bank (practically zero). This would then mean that the banking system would need to refinance itself in the first place by borrowing short term from the central bank. This would mean that the balance sheets would look something like this:


In essence the central bank would finance the loans in the economy. This of course would be very risky for the central bank, and therefore the banking system would need a lot more capital to absorb losses compared to the current situation. Now households and firms are financing loans as they hold the majority of bank deposits.

However, money in this new monetary system would be super-safe,

as money would be direct liabilities of the central bank which can run with negative equity if necessary. This would of course make our monetary system more stable. It would also incentivize the central bank to supervise the banking sector more efficiently as the central bank would be the biggest creditor of the banking system !

Note that in this model the banks would still do most of their core business, which is credit screening and loan extension. So no moral hazard with politicians financing some projects 🙂

If the banking system would fail, the central bank would take the hit, and given the current regime of bail-in, the central bank would then become a partial owner of the banking system through debt-to-equity swaps.

Monetary policy in this model could be implemented easily

Monetary policy could be implemented by adjusting the interest rate at which the central bank lends to the banking system. Moreover, QE would be more efficient as well, because for the central bank the sphere of counterparties would be containing all economic agents in the economy.

One could also see opportunities for increased security in order to counter terrorism and money laundring, if the distributed ledger platform would be operated by the central bank/public authorities. All transactions would be verified within the network of blockchains and criminal activities could be exposed easily. Cash could be abolished in principle. Of course one would need to ensure sufficient privacy, and striking the right balance between security and privacy is paramount.

End of cash? QE4 people?

This digital legal tender system could replace the need for cash. Of course in order to make the system more resilient, numerous back-up systems would be necessary. And maybe some spare cash in the government’s vaults as a preparation for potential failures and crisis.

Some circles have been advocating for extending QE to all counterparties. The system described above would enable this, as the central bank could include all entities in society as its counterparties. However, in a traditional QE scheme the central bank is buying securities which for example households do not hold to a large extent. These aspects need obviously more elaboration and research.


I have presented here a model for central  bank digital legal tender. I think it provides a lot of opportunities, if we are to achieve a more stable and secure financial system. Obviously lots of threats are included in this model, but I think it would be worthwhile to have this discussion in the public sphere. Money is, after all, our common interest.

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