The central bank digital currency in the historical perspective: another crossroads in the history of currency

This article analyzes some arguments about CBDC from the perspective of currency history. In the final analysis, the history of monetary system reform shows that the technological change of currency is inevitably driven by the financial incentives of the market economy. The government has always played a key role in providing external currency, and external currency is a public product. The government also regulates the intrinsic currency provided by the private sector. This applies to trust currencies and may also apply to digital currencies. CBDC can improve the efficiency of monetary policy, and can also change the international currency and payment system.

Author | Michael D. Bordo

Compilation | Chen Mengyuan


We are at a crossroads in currency history. The advancement of technology-digitization has led to the development of new forms of financial assets (FinTech) and new forms of currency (currency-like assets). These include virtual (encrypted) currencies such as Bitcoin ; stable currencies such as libra/diem, and central bank digital currencies (CBDC) such as the Bahamas dollar. The innovation of currency (currency like assets) is consistent with the major early changes in currency history. There are three outstanding points:

  • In the 18th and 19th centuries, there was a shift from commodity currency (gold and silver coins) to trust currency issued by issuing banks (commercial banks and central banks) that can be converted into gold coins, and non-convertible government-issued legal tender
  • The transition from commercial bank bills (usually issued in a competitive market) to a central bank monopoly in the 19th and 20th centuries
  • The evolution of central banks and monetary policy tools since the 17th century (and even earlier)

Currency transformation in history

The three modern transformations have laid the foundation for the current digital transformation.

In the 18th and 19th centuries, new financial technology led to the emergence of trust currency (convertible bank notes), which greatly reduced the resource cost of currency.

Commercial banks originated in Italy in the Middle Ages, and goldsmiths issued warehouse receipts for stored gold. This led to the development of a partial reserve banking system. The social savings of trust funds must be balanced with the credit risk caused by potential runs. In addition, in the early modern period, the emergency situation of rising financial costs of war led to the issuance of non-convertible legal tender by the government. The Riksbank issued legal tender to finance the Seven Years’ War and used an inflation tax early on. Other early examples include the continental issue in the American Revolution and the distribution in the French Revolution that led to hyperinflation. Until the end of the 20th century, legal tender was still associated with high inflation and instability.

It is only in the last few decades that monetary authorities have learned the technique of operating a reliable, low-inflation fiat currency system. CBDC, as a social savings relative to legal tender, is expected to become the next generation in this process.

In the early days, commercial banks that were not supervised (insufficient or improper supervision) issued bills that were ostensibly convertible into coins, and their history can be described as turbulent. It is used to prove the government’s supervision of commercial banks and the government’s monopoly on paper currency issuance.

The classic case of instability is the experience of free banking after the bankruptcy of the Second Bank of the United States in 1836-1863. Many states allow citizen groups to establish bill-issuing banks under minimal supervision. Due to failure, fraud, and the discount rate of bill circulation depends on the distance from the initial redemption bank, this part of the record is very unstable. The counterfeit detector does provide information about counterfeits, broken banknotes and discount rates. However, the highly asymmetric information cost of the multi-currency system caused an inefficient payment system and led to the reform of the national banking system supported by federal government bonds in 1863 to provide a unified currency. Many other countries with free banks and competitive currencies have similar experiences, such as the National Bank of England, Swiss competitive currencies and paper money.

Notable exceptions are: Scotland in the eighteenth and early nineteenth centuries, although this was attributed to the Bank of Scotland oligopoly, bank owners’ unlimited liability, and the existence of the Bank of England as the lender of last resort; the National Banking System of the United States (1863) -1913) Created a secure bill system based on 110% support from the US government bond and bill redemption fund. The Canadian Chartered Banks after 1867 also have a good record. They established a bill redemption fund to prevent the loss of bank bills. However, in the United States and Canada, there are still credit risks brought about by bank failures, which has led to huge transaction costs.

In all these cases, the issuance of bills is ultimately monopolized by the central bank/government. Therefore, just as the history of multiple competing currencies led to central banks to provide currencies, the rise of cryptocurrencies and stable currencies today suggests that the result may also be an integration process to CBDC.

From the 17th century to the 20th century, the development of the central bank met several important public needs:

  • In the 17th and 18th centuries, it was war financing, which helped the government to raise funds and sell its debts, for example, the Bank of Sweden established in 1667 and the Bank of England established in 1694;


  • At the beginning of the 20th century, a number of central banks were established to provide an effective payment system to correct the defects of multiple competing currencies, such as the Swiss National Bank in 1907;


  • Related to the second stage, many central banks were established to provide financial stability. A typical example is the Federal Reserve System, which was established in 1913. Its purpose was to provide a flexible currency and act as a lender of last resort to the continuing panic in the banking industry.
  • Ensure the stability of currency value. During the evolution of the central bank, a set of monetary policy tools has been developed and continues to this day. The Bank of England perfected the use of bank interest rates (discount rates) in the 19th century to guide the economy through changes in external and internal shocks. Other European Central Banks have also developed similar tools. In the 20th century, different countries added additional tools: changing reserve requirements, Lombard arrangements, repurchases, and in the 21st century, quantitative easing and forward-looking guidance in the face of ELB.


  • Since the Second World War, the government and the public have been encouraging the central bank to provide macro-stability-stabilizing the business cycle, maintaining full employment and price stability. After a slow and painful learning process, this policy has evolved into today’s flexible inflation target based on the credibility of low inflation. The central bank’s digital currency will follow this tradition and use the CBDC interest rate (positive or negative) as a policy tool to stabilize the economy.

CBDC example

Many central banks are considering the adoption of CBDC, and the key factors that motivate them include:

  • CBDC will reduce the issuance and operating costs of physical currency by 0.5% to 1.0% of GDP. In addition, by providing a direct point-to-point interface and access to the central bank’s balance sheet, CBDC can reduce the monopoly rent earned by the commercial banking system.
  • CBDC can provide a payment medium that has almost all the attributes of physical cash, and is less prone to theft and loss. In addition, it allows central banks to continue to implement their currency and lender of last resort policies.
  • CBDC will improve financial inclusion. In many countries, the establishment of a CBDC can provide access to the financial system for disadvantaged groups without bank accounts. In less developed and emerging countries, this is the key reason for the establishment of CBDC. It can also make financial transfers quickly and efficiently in the event of a national emergency (such as the recent pandemic) by depositing these funds in a CBDC account.
  • CBDC may prevent the threat of stable currency to monetary sovereignty.
  • CBDC will provide a safe and reliable currency without the danger of fraud, hacking, money laundering and financing of terrorism.

The central bank currency satisfies the three functions of currency: 1) as a unit of calculation to measure the true value of economic entities, similar to meters or yards;) medium of exchange: currency transactions exhibit strong network externalities (such as water or electricity); 3) Store of value: There is no risk of default in the currency of the central bank, and the widespread use of its debt enables the central bank to act as the lender of last resort to commercial banks.

The central bank digital currency will also meet the three basic functions of currency by providing the following plans to promote economic behavior: real-time clearing and settlement on the central bank’s platform, with negligible cost of each transaction; a safe way of storing value. Interest-earning CBDC, its rate of return is basically the same as other short-term risk-free assets that provide the smallest opportunity cost; a stable accounting unit.

Bordo and Levin (2017) proposed a stylized ideal CBDC arrangement, which can be used as a template to consider how to implement it in the real world. In our framework, CBDC will be a direct liability of the central bank, allowing non-banking public to directly view its balance sheet. It will be used as legal tender. It is conceivable that the non-bank public can obtain funds by opening an account with the central bank, just as it has been the case with the Bank of England and other central banks in the past. Alternatively, CBDC can be provided through deposits in commercial banks or other public-private partnership financial intermediaries.

CBDC will pay market interest rates for short-term securities to provide an effective monetary system, and CBDC interest rates will become the main tool of the central bank’s monetary policy. In addition, with the introduction of CBDC, the central bank can eliminate ELB’s restrictions on monetary policy. Paper money will not need to be abolished, but the central bank will charge fees for huge transfers between paper money and CBDC. With the central bank lowering the CBDC interest rate below zero, this is like “sand on wheels”, inhibiting a large amount of money from flowing into banknotes.

In this ideal scenario, CBDC will improve welfare. In this plan, using the CBDC interest rate as a policy tool will allow policymakers to follow the true price stability by following the price level target of Taylor’s rule. The transmission mechanism can be simplified to a bill-only policy, because ELB will be eliminated as a problem, and the inefficient use of QE and forward-looking guidance can be discarded.

Realization of CBDC in the real world

In today’s world, technology is advanced enough that some form of digital currency is inevitable. What is the best way forward? The implementation of CBDC raises many important questions about its design. Central banks, international financial institutions, and academia, especially the Bank of England, Riksbank, Bank of Canada, Bank for International Settlements, and the International Monetary Fund, have conducted a lot of research on these issues. The Federal Reserve is conducting research, but so far, there are not many research results.

Wholesale or retail?

In a sense, this question has been answered, the reserves of commercial banks have been digitized, and banks can also view the balance sheet of convertible bonds. Most countries are already improving the wholesale settlement mechanism through digitalization, moving towards real-time and almost cost-free real-time total time settlement (RTGS). The really controversial issue is the retail CBDC: Should the central bank provide the public with digital currency with almost all the characteristics of cash, or should it be left to the private sector? As mentioned above, the public interest of currency is provided directly by the government or at least closely monitored and supervised. A strong reason.

The second question is whether to use an account (similar to a debit card) or tokens (similar to a stored-value card) to implement CBDC. In terms of tokens, the central bank will determine the supply of tokens, which will be fixed at a nominal price and used as legal tender. The controversy with tokens is that they are most like cash and anonymous. The disadvantage is that they can be stolen or lost. In addition, there is a cost to verify the digital system of tokens because the distributed ledger system behind them needs to be verified. They can also be used for money laundering and other illegal activities, just like cash. Therefore, account-based systems are generally regarded as more secure, but at the cost of some privacy, just like the current identity requirements for bank account opening. But the static token system can be used for small transactions. A key advantage of the account-based system is that CBDC payments can be almost instant and cost-free.

CBDC account of a central bank or a private financial institution?

The easiest way to implement an account-based system is through an account held directly at the central bank, as was the case in the early days. Today, in the current environment of massive data storage and high-speed data capacity, it is very feasible to provide CBDC through a central bank account. However, the central bank has no comparative advantage in financial innovation, so the possibility of private sector participation may be greater, at least in developed countries with well-developed banking and financial systems. In addition, there may be people who object to opening an account with the central bank on the grounds of privacy.

An increasingly popular compromise solution is to establish a public-private partnership, where designated financial institutions can provide CBDC accounts to the public. These companies will hold a corresponding amount of CBDC funds in the central bank’s separate reserve account. Commercial banks will be divided into narrow banks holding CBDCs (100% backed by CBDC reserves) and investment banks engaged in financial intermediation. A narrow bank, similar to a regulated utility, can charge fees for providing this service and/or pay interest on deposit CBDC determined by the central bank, deducting operating costs, plus a small amount of profit.

Reduce the risk of disintermediation in commercial banks

One of the concerns of some well-known current and former officials is whether the introduction of account-based CBDC in commercial banks will lead to the disintermediation of the commercial banking system, which has triggered a lot of research. But regardless of CBDC, modern central banks have several lines of defense to effectively prevent disintermediation and runs:

  • Supervision is the first line of defense to increase public confidence in the commercial banking system. Deposit insurance is the second line of defense, especially for retail deposits. The central bank’s role as the lender of last resort is the third line of defense, which may be particularly important for commercial banks that rely heavily on the wholesale financing market. Considering these stabilizing factors, the risk of a large-scale run seems quite remote.
  • The pressure on the financial system is reflected in credit spreads. Therefore, the most effective way for the central bank to prevent disintermediation is to impose negative interest rates on large holdings of risk-free assets. This policy will ensure that private credit interest rates remain at a moderately positive level, thereby preventing large-scale defaults and bankruptcies, and promoting the stability of the real economy, thereby enhancing confidence in commercial banks and reducing the risk of runs.

Promote safety

The central bank has made considerable efforts to ensure that the proposed CBDC facility is not affected by cybercrime and meets anti-money laundering and terrorism requirements (AML and KYC). It is also worrying whether to implement CBDC by establishing a centralized platform at the central bank or by launching a decentralized digital ledger (DLT) using the blockchain method. Although the Central Bank of the Bahamas is using licensed DLT technology, many central banks, such as the Bank of England, seem to prefer to be seen as a more secure central platform than DLT. Finally, Siklos (2020) believes that the introduction of CBDC will require changes to regulations and laws regarding guarantees and legal tender.

Impact on monetary policy

Some scholars believe that using the CBDC interest rate as a policy tool while reducing cash holdings will eliminate the ELB’s constraints on monetary policy. This will enable the central bank to maintain macroeconomic and price stability at all times. Allowing the CBDC interest rate to reach the necessary negative value to offset the major negative impact on aggregate demand will solve the problems faced by other developed countries in Japan since the 1990s and since the global financial crisis. If the current recovery from the Covid-19 pandemic continues to develop on a permanent inflation track, raising the CBDC interest rate may help eliminate inflation. Using the CBDC interest rate as a policy tool will also avoid the use of quantitative easing and forward-looking guidance, which did not perform as well as policy interest rates before the global financial crisis.

In addition, this will allow the central bank to significantly reduce its balance sheet and make it more transparent, returning to the practice of the pre-global financial crisis, when the central bank used short-term securities as its main asset. At the same time, using the CBDC interest rate as a policy interest rate can transform CBs from the current “floor system” that has been followed since the global financial crisis to a “corridor” system.

Many papers have studied the transmission mechanism of monetary policy in an environment where interest-bearing CBDC and interest-free CBDC deposits coexist and ELB has not yet been eliminated. They found that using CBDC interest rates as a new policy tool can improve transmission mechanisms and strengthen lending channels.

CBDC interest rates can also improve financial stability policies. In the financial crisis, lowering the digital cash interest rate below zero will prevent other assets from running into digital cash. In addition, a relatively steep yield curve will promote bank lending and rapid recovery. This is in contrast to the unconventional policy tools used after the global financial crisis, which flattened the yield curve and hindered recovery.

Finally, as mentioned above, the CBDC interest rate can be used to promote true price stability by following the price level target of Taylor’s law style rules.

Open economy considerations

CBDC has a very important impact on the open economy. CBDC can greatly improve the current costly and slow cross-border payments. Some of the proposed stablecoins promise to arrange peer-to-peer payments through their existing blockchain network. However, if stablecoin suppliers dominate these arrangements, they may threaten monetary sovereignty and also face credit risk. This requires some supervision or CBDC to complete this work. However, the digital currency provided by the central bank requires interoperability arrangements with foreign counterparts through new technologies. This can be arranged with the help of BIS.

The CBDC system that closely links the currencies and payment systems of different countries may expand the spillover effects of domestic monetary policies on other countries. The spillover effect after currency shocks may cause exchange rate fluctuations to amplify. As in today’s situation, these problems can be alleviated by pursuing policy and monetary policy coordination with similar rules.

CBDC (and stablecoins) may lead to currency substitution. Currency substitution—the digitization of the U.S. dollar—may affect the monetary sovereignty and monetary policy capabilities of small open economies, especially those with weak monetary and fiscal institutions. This is the case today, and digitization will only magnify it (IMF 2020). Brunnermier et al. (2019) believe that stable currencies such as libra/diem, based on a wide global network, and with the full and reliable support of safe assets, can compete with official currencies.

Some people believe that the emergence of CBDC (stable currency) may in turn change the current international monetary system dominated by the US dollar as the main invoice currency. Stablecoins (and possibly CBDCs from other countries such as China) may eventually subvert the dollar’s dominance because of the superiority of their networks. Since stablecoins can distinguish the functions of currencies, effective currency competition may occur. However, currency competition from private platforms will encounter interoperability and coordination problems. Just like currency competition in the 19th century, information asymmetry will provide reasons for CBDC. The convertible CBDC system will eliminate the imperfect substitution of private digital currencies.

Finally, the key reasons why the US dollar has become the dominant currency like the previous British pound are its economic and political strength, extensive trade and payment networks, deep and liquid financial markets, and a stable and credible monetary policy that took decades to create. record. In the foreseeable future, a stable coin or even a Chinese CBDC (which lacks most of these attributes) may replace it, which seems far-fetched.

Lessons from history

From a historical perspective, the case of the central bank providing digital currency has four key lessons:

Monetary/financial innovation and technological changes to improve the efficiency of the monetary/financial system are inevitable. The timing of adopting these new technologies is strongly affected by major shocks: large-scale and expensive wars; the Great Depression and today’s new crown epidemic. CBDC may be an innovation that has come.

The government plays a key role in providing funding. Since external currency is a public product, it is necessary for the central bank to provide these funds. This applies to fiat currencies and digital currencies. However, the ability to effectively provide fiat/digital currency depends on the credibility of the issuer. If this destabilizes currency competition from other CBDCs or stablecoins, it will erode monetary sovereignty. However, as Friedman and Schwartz (1986) pointed out, as long as there is an impartial government agency to maintain financial stability, the private sector may be most effective in providing intrinsic currency. This principle applies to digital deposits.

Interest-bearing CBDC can improve the transmission mechanism and transparency of monetary policy. This approach can greatly simplify the balance sheets of central banks and help them return to the simpler framework that existed before the international financial crisis. In addition, if the interest rate of the CBDC is used as the policy interest rate, the CBDC can bring about changes in monetary policy. If the ELB is cancelled because the cash becomes obsolete or is reduced by charging variable fees on its holdings, then the interest rate of the CBDC can be used to always maintain price levels and macro stability in a rule-like manner, as well as maintain financial stability.

CBDC is a global innovation. It will revolutionize international payment methods, just like the first Atlantic Telegraph in 1866 did with capital flows and international payments. It may intensify currency substitution/currency competition, and may require international currency cooperation like the current International Monetary System (IMS). CBDC (and stable currencies) may also challenge IMS. The fundamental forces that lead to monetary rule are unlikely to change, but digitization may accelerate the transformation they promote, as happened when the U.S. dollar surpassed the British pound in the 20th century.

In short, the digitalization of money and finance is expected to become the future. Central banks can learn from history and provide digital currencies (perhaps in cooperation with the private sector or financial institutions) to effectively fulfill their mission.

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