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Central Bank Digital Currency: A Macro-Financial Perspective

Thesis · September 2018

DOI: 10.13140/RG.2.2.14624.43525

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Central Bank Digital Currency: A Macro-Financial Perspective

Francesco Lariccia

September 2018

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Table of Contents
Key terms ................................................................................................................................................ 3

1. Introduction .................................................................................................................................... 4

2. Part I: CBDC - State of the Art ..................................................................................................... 5

3. Part II: CBDC implications on MP and banking policies ......................................................... 18

4. Part III: CBDC and legal issues ................................................................................................... 29

5. Conclusions ................................................................................................................................... 40

References ............................................................................................................................................. 42

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Key terms
CBDC: acronym for Central Bank Digital Currency

Cryptocurrency: a particular kind of digital currency (see definition below) where cryptographic
techniques are used to identify the exchangers and confirm transactions (Borgonovo et al. 2018)

Digital cash: all sorts of physical cash held in the form of digital reserves (e.g., Central Bank
reserves)

Digital currency: “an asset stored in electronic form that can serve essentially the same function
as physical currency, namely, facilitating payments transaction” (Bordo and Levin 2017)

DLT: acronym for Distributed Ledger Technology, defined as the combination of IT protocols
and infrastructure that allows to perform and validate transactions while updating the records in a
synchronized shared network (Bech and Garratt 2017)

ELB: acronym for Effective Lower Bound

MP: acronym for Monetary Policy

Paper currency: see physical cash

Physical cash (or simply: cash): paper banknotes and metal coins issued by the central bank

Privately issued cryptocurrency: cryptocurrency (see definition above) that is not issued by a central
institution. That is, a digital currency exchanged through a cryptographic technique that is not the
liability of anyone (e.g., Bitcoin, Ethereum, etc.) as opposed to CBDC (see definition above) that
are the liability of a central bank

Seignorage: refers to the total government profit generated from printing the sovereign paper
currency. Originally, this was the delta between the nominal value of the gold coin and the inputs
cost (Rogoff 2016)

Type C: refers to the central bank digital currency design in which individuals would be entitled
to own an account at the central bank

Type D: refers to the hypothetical design in which the central bank digital currency is distributed
through a Distributed Ledger Technology

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 1. Introduction
The present paper aims at providing a state-of-the-art picture of the trends concerning central
banks digital currencies. After Bitcoin hype has eventually lost much of its appeal, institutions
should promote a beneficial debate about a CBDC possibility without necessarily having to be
subject to the influence of Bitcoin and other privately issued digital currencies.

In other words, the present study will try to answer the following questions: what is a central bank
digital currency? What are its possible challenges and opportunities? Which are the main
implications from a monetary policy perspective? What changes should be made to the legal
framework? Would such CBDC have the features to replace paper currency? Should it be advisable
for central banks to do so?

To put this in concrete terms, it is questioned whether the public would welcome such an initiative,
and which risks it would entail. As an economic agent, say, a business owner, should I take the risk
of accepting payments in a digital currency? To date, privately issued cryptocurrencies are
characterized by high volatility and uncertainty on future developments due to the low scalability.
Moreover, privacy and anonymity features favour illegal usages of such currencies. Such concerns
are among the reasons why such cryptocurrencies are not capable of performing one (or more) of
the standard currency roles.

The paper will also analyse the possible implications of a new sovereign digital currency, which is
available to the public, on the current conventional and unconventional monetary policy
instruments. This will include an in-depth analysis of recent paper currency demand trends in
developed countries.

The introduction of a central bank digital currency is also posing a question on the current
fractional reserve banking model. Perhaps, it is unclear what the introduction of such an asset
would mean from the banking perspective, particularly on the lending market. With respect to the
latter, this paper will also focus on the role of trust in environments characterized by information
asymmetries such as the financial market.

The remainder of the dissertation is structured as follows: in Chapter 2 a review of the current
literature concerning Central Bank Digital Currencies will be performed; Chapter 3 will deal with
consequences on monetary and banking policies; Chapter 4 will focus on legal issues; Chapter 5
concludes.

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 2. Part I: CBDC - State of the Art
It is argued here the feasibility for a Central Bank to issue a Central Bank Digital Currency –
“CBDC” thereafter – to the public and its various possible designs and features.

a. What is a CBDC?

To begin, it is worth defining what will be referred to as Central Bank Digital Currency for the
purpose of this dissertation. That is to say, there is no single definition as the debate on both its
denomination1 and design remains unsettled. It is nevertheless possible to identify it as “an
electronic, fiat claim on a central bank that can be used to settle payments or as a store of value”
(Meaning et al. 2017). This definition will guide the analysis through the remainder of this paper
and narrow the scope of the research.

One of the founding principles of the modern state is the issuance of money from the sovereign
state under its authority, which entails (i) the currency’s power to extinguish a debt when offered
to the creditor (i.e., legal tender) and (ii) the obligation for everyone to accept it as a means of
payment (i.e., fiat currency). Particularly, such medium of exchange has been featuring the
distinguishing characteristic of complete lack of intrinsic value since the decoupling of currencies
from gold (i.e., after the Gold Standard ceased in most countries in 1914). It is worth noting how
the fiat currency was already described by Marco Polo in one of his early journeys in China, where
it was already in use during the Yuan dynasty in the 11th century2. This revolutionary change was
deployed thanks to increased trust in institutions. As a matter of fact, at that time, citizens were
asked to trust that the State would have been able to convert back paper currency into gold.

In most advanced economic environments, money has long represented a more convenient
alternative to barter. Such topic was famously referred to as the “double coincidence of wants”,
after W.S. Jevons famed characterisation (Rogoff 2016).

Today, the introduction of a CBDC would not only mean that the currency issued by the central
bank would have no intrinsic value (as for contemporary paper currency) but also that it could be
completely dematerialised even as it maintains its face value as well as the legal tender. The latter
is still a controversial topic within the cryptocurrencies framework: the acceptance of these

1 As a matter of fact, scholars still refer to Central Bank issued Digital or Crypto-Currency (CBDC or CBCC). This
difference becomes a key distinction when dealing with the legal framework: in the case of the digital currencies it is
already quite developed (e.g. EU Directive 2009/110/EC) while it remains mostly uncertain in the case of their most
common variety: cryptocurrencies. According to other definitions, such a currency (central bank-issued) could also be
named electronic base money (EBM), digital base money (DBM) or e-money (Meaning et al. 2017).
2 In fact, the Venice-born explorer, in his book “The Travels of Marco Polo” describes the widespread acceptance of

paper currency, with no intrinsic value, “as if they were of pure gold or silver”.
5
currencies is purely discretionary3 (e.g., as in the case of Bitcoins, which are only accepted in some
Swiss restaurants or luxurious ski resorts, or in selected online retailers like Microsoft, Expedia,
Shopify, etc.).

The debut of blockchain-based financial applications, such as the cryptocurrencies development,

can be compared with the introduction of the TCP/IP protocol4 (Iansiti and Lakhani 2017) or the
electronic mail. Indeed, one of the most disruptive changes introduced by e-mail communication
is the decentralisation of information transmission. Before the introduction of e-mails, the sender
had to rely on the national postal courier, who acted as an intermediary, and who would have been
in charge of delivering the message to the final recipient. With e-mail, the message goes directly
from the sender to the recipient via the internet (and using the Internet trust systems, including
DNS, for instance5) which by definition is a non-owned network institution. What is likely to
happen in the future, with people owning a personal digital wallet, is that banks will no longer act
as a broker within the payment sector (or at least not in the same way they are doing today), thus
reducing banks seignorage, as argued by Bordo (Bordo and Levin 2017). This also means that the
banking sector’s role in corporate financing should be widely reconsidered, as commercial banks’
deposits would suffer a substantial drop.

As a matter of fact, until today, cash transactions have been the most widespread form of peer-to-
peer financial dealings. This leads to the consideration of another key distinction between
electronic money and cryptocurrencies. Nowadays, commercial bank deposits of consumers and
businesses are stored in electronic form, which means they are no longer physically held in a vault.
However, they still represent a liability of the bank itself and transactions are still cleared across the
books of the same bank or, between two different banks, through the central bank. That is, central
banks’ deposits can concretely be referred to as a form of central bank digital currency although
they are neither a cryptocurrency (i.e., they are not distributed through an encrypted DLT network
infrastructure) nor – most importantly, for the purpose of this dissertation – they don’t have

3 For instance, it is worth mentioning how some sort of business activities (e.g., taxi or restaurants) can concretely
accept casino tokens (i.e., technically a form of physical local currency that can be used in a particular location or within
a given private issuing entity’s organization) as a means of payments in the Las Vegas area, although they are absolutely
not a legal tender. Of course, their acceptance is purely discretional and is not set forth by any law or institution. This
example opens the subject of anonymity which will be discussed in Chapter 4.
4 The most interesting comparison is the following. Just like internet allowed apps such as Amazon to deliver an online

bookshop experience, the introduction of blockchain could allow the setup of other transformative operational
innovations such as the ruling of the so-called “smart contracts”.
5 The Domain Name System is another example of a distributed database that has been in place for 40 years, the

existence of which could be compared to the hypothetical DLT of the Institutional Cryptocurrency.
6
universal accessibility (i.e., today a normal citizen is not entitled to a personal deposit account at
the central bank, as opposed to traditional commercial banks).

One of the most crucial questions concerning the design of the CBDC involves the difference
between two main alternatives for distributing the currency itself into the economic system. In a
first hypothesis, the currency could be distributed through a Distributed Ledger Technology (DLT)
thus assuming the fundamental concept of a proper cryptocurrency (hereinafter “Type D”).
According to a second hypothesis, individuals and firms could hold an ad-hoc account at the central
bank (hereinafter “Type C”). In the latter case, the currency would no longer entail the core features
of a cryptocurrency, but it would still be referred to as a central bank digital currency (Bordo and
Levin 2017; Meaning et al. 2017). To summarise, this design would entail the concept theorized by
Tobin of Federal Reserve deposit Funds directly available to the citizens (Tobin 1987).

In addition to that, it is worth mentioning how a similar concept of DLT – which is essentially a
log of activities shared by a community – has already been developed in the context of large
multinational organization (e.g., supermarket chains or other MNE), which allows storing a central
database to keep record of sales and stores’ stocks. This application, instead of using a decentralized
consensus-based proofing of the transactions (such as the one used with Bitcoins), involves a
central authority withal. Central supervision is essential to keep the records consistent across
multiple users of the platform 6. It must be noted that operating costs are one of the reasons that
make Bitcoin’s DLT protocol (i.e., Blockchain) scarcely efficient. In the case of Blockchain,
exchangers require the network (through specific individuals, commonly known as miners) to
validate their transactions in distinct blocks, thus exchanging the service rendered with a small -
chained - fraction of a Bitcoin (from which derives the name “Blockchain”). These validations
absorb huge computational power and thus electricity. Such requirements seem to be consistent
with the fact that the Bitcoin bubble had increased the number of small entrepreneurs or ventures
that set up a mining house in a cold country such as Siberia (as a result, such geographical
concentration may expose users to political complexities which are difficult to predict). Here,
extremely cold winters and cheap electricity, largely powered by the widespread hydroelectric
plants, allowed for good returns on the business. Mining, to a great extent, is performed by vast
sets of graphic cards which must be kept below operating temperature limit in an energy-intensive

6 A clear distinction must be made between decentralized database and distributed database. While the first assumes that
all users act consistently and trust each other (e.g., the case of a distributed central database for a MNE or a large
supermarket chain), the second instead (e.g., Blockchain technology used for Bitcoins) favours security over
performance and usability (Hearn 2016). As we will see, this involves also substantial differences from a legal
standpoint. It is nevertheless understood how decentralised databases are potentially much more exposed to cyber-
attacks.
7
cooling facility. Much of the criticism towards the Bitcoin network lies in its infrastructure
maintenance costs, which have been estimated in 2014 (i.e., approximately 5GW) to be comparable
to the national total electricity consumption of Ireland (Malone and O’Dwyer 2014). This appraisal
also explains some of the reproach on the use of a DLT system like Blockchain for a CBDC within
the matter of ecological sustainability. This assessment suggests that central banks should be
looking to develop an alternative DLT protocol. For example, Corda is arguably one of the most
promising. The Corda Network streamlines the process by discarding the proof-of-work
mechanism and most of its undesirable consequences (Hearn 2016). Another major drawback of a
Blockchain-like distributing technology arises when the maximum quantity of transactions
manageable in a given timeframe is concerned. That is, a Bitcoin-like DLT technology would suffer
from low scalability. That is, since its original release, Bitcoin has been limited at 3,500 transactions
per hour (between 7 and 10 per second) which might even not be sufficient to cover the demand
of a sizable city.

By contrast, other payment processing services such as Visa (a major global payments company)
claim to be capable of handling up to 56,000 transactions/second (Visa 2015), PayPal (an online
payments system company) can reach up to 200 per seconds while Ethereum (another
cryptocurrency, whose protocol was intended to fix some major issues of Bitcoin) is estimated to
reach about twice more than Bitcoin. This leads some scholars to emphasise the greater
convenience of the account-based digital currency, herein referred to as “Type C” (Barrdear and
Kumhof 2016). Moreover, other issues may arise when the CBDC is structured as a pure
cryptocurrency, as it may suffer from a maximum technical number of mined coins and central
banks should be responsible for mining the whole currency before issuing it to the public (as
opposed to the case of Bitcoins, which are still being mined). The main features of these currencies
are summarised in the table below.

Table 1. Currency features description

Type of currency Distribution method Liability of Accessibility Scalability

Type C Centralized Yes

CBDC Central Bank High
Type D Decentralized Unclear

Paper currency Centralized Central Bank Yes (full) High

Other cryptocurrencies (e.g. Unclear

Decentralized No one Yes
Bitcoin) (low for Bitcoin)

8
Finally, it is argued here it would be technologically feasible to centrally emit and manage a digital
currency which is distributed through a decentralised technology but still relies on the traditional
currency (i.e., can substitute paper currency as it has full accessibility, legal tender and is linked to
the value of the national currency) issued by a central bank (Barrdear and Kumhof 2016).

As we will see, the distribution method has an impact on the accessibility of the currency to the
economic agents and therefore on the overall success of such an implementation within an
economy. This distinction will be carried over to the remainder of the chapter.

b. Design and functions of CBDC

The analysis begins by delineating the three basic functions of the currency which are (i) store of
value; (ii) means of exchange; (iii) unit of account (Bordo and Levin 2017). Since (iii) is among the
key features which a CBDC is supposed to achieve in order to be actually considered (and used as)
a currency by consumers, enterprises and institutions, the topic will be pivotal to the rest of the
chapter.

Store of value: Three options: (i) constant nominal value (as for paper currency), (ii) constant
real value (indexed to price level), (iii) earn interest like short-term government securities.
The first aspect analysed here is the ability of such currency to act as a store of value. For the
purpose of this analysis, it will be assumed that such an asset could either be not-interest-bearing
or vice versa. In the first case, which would involve a less radical change inside the macroeconomic
and financial framework, the new currency would not earn any interest. Within this option the
CBDC could either have: (i) a constant nominal value (equal to its face value, as in the case of cash)
or (ii) it could be indexed to price level as to maintain constant its real value (i.e., controlling for
inflation). While within the former the monetary policy implications would be almost negligible,
with the latter the monetary and banking implications could gain more relevance, as will be
discussed in detail in Chapter 3. As mentioned above, it is interesting to note in this context how
the introduction of a CBDC – considered as a universally accessible sort of asset – could be
compared with “the widening of access to the existing system of reserve accounts offered by central
banks” as outlined by Meaning (Meaning et al. 2017).

For instance, the Venezuelan “Petro” is a cryptocurrency aimed at easing the pressure of inflation
on the national currency (the Venezuelan Bolivar) for citizens. The Petro was designed by the
Maduro regime so as to be backed by the value of a barrel of the country’s oil reserves (Chohan
2018). In this specific case, the asset-backed digital currency is intended to act as complement to
the Bolivar, but the initiative was heavily criticised because of the uncertainty conditions of the
Venezuelan’s overall economy. Another example is the Digital Trade Coin (DTC) which is

9
currently being developed at the MIT. Such a currency is expected to achieve a higher degree of
stability in terms of real value leveraging on its supranational position (e.g., the role played by gold
coins under the Roman Empire) which grants independence from the monetary policy decisions
of central banks (Hardjono and Pentland 2018). This feature, during particularly adverse economic
conditions, could represent in turn a significant threat to the international economic environment.

In the second hypothesis, instead of paper currency and coins which bear no interest, CBDC
deposit accounts of any individual (including firms, financial institutions as well as common
domestic and foreign citizens) would accrue interests just like government securities. The most
significant change entailed here would be the possibility, for the central bank, to set a nominal
negative interest rate in adverse economic conditions, thus eroding the value of deposits. The latter
could widen the scope and the range of suitable actions for central bank monetary policy in low or
close-to-zero inflation scenarios. Within this option of interest bearing CBDC, traditional forms
of paper currencies are most likely to be abolished. This would prevent households from shielding
against negative nominal rates imposed on digital currency deposits by holding cash. Two
outcomes can be outlined. On the one hand, the reduction of paper currency usage is likely to lead
to higher commercial bank deposits. On the other hand, a CBDC earning a positive interest rate is
expected to drive households into increasing digital currency portfolio share, thus forcing banks to
restrain credit access to firms and individuals. This possibility will be further analysed in Chapter
3. It is also argued the opportunity to introduce a framework to differentiate the interest rate level
on the basis of the type of holder (e.g., banks vis-à-vis non-banks such as individuals) given the
importance of the lending role of banks which is a key determinant within the monetary policy
transmission mechanism and therefore would need to earn a much higher interest rate (Meaning
et al. 2017). The spread caused by this differentiation would undoubtedly cause some policy issues,
which will not be covered herein.

Efficient medium of exchange: what do we mean with efficiency and how does CBDC
(and its possible designs) compare within the payment industry?
The section presents a comparison between cash and other payment systems in their efficiency and
social costs. An analysis carried out by Schmiedel et al. finds the social costs incurred by the
different payment means (Schmiedel, Kostova, and Ruttenberg 2013). Eventually, two different
types of costs must be distinguished: private and social costs. The former expression refers to costs
incurred by the individual participants to the economy (e.g., consumers) and could be further split
into internal and external costs. On one hand transaction fees and tariffs paid within the payment
system are referred to as external costs, on the other hand internal costs include the resources and
the services involved in the payment chain (e.g., leased software or POS terminals). The social costs
are the sum of all the private costs borne by individuals within a certain economic system (i.e., one
10
of the 13 EU-countries within the sample analysed). As a result, the study finds that – within the
sample considered – retail payments accounts for 0.96% of the GDP. Although the latter refers to
all kinds of payments (i.e., cash, cheques, debit and credit cards, direct debits and credit transfer),
cash payments alone weigh, on average, 49% of the social costs by instruments. It is also worth
noting – as it is among the variables that are most likely to incur in significant changes in the
CBDC-issuance scenario – how these social costs are split between banks (and infrastructures) and
retailers. The former bear 51% of the total social costs while 46% is borne by the latter. At the end
of the day, central banks share 3% of social costs mainly through the issuance and minting of paper
currency and metal coins. In fact, a 2012 study from the Bank of Italy found that Italy spends
around €8 billion each year into printing and renewing paper and metal currency (Banca d’Italia
2012). If compared to the EU average (0.4% of GDP), 0.52% of the GDP each year is absorbed
to circulating money in the third European economy 7. Another peculiarity for the Euro-area is the
cost of production of some small metal coins, particularly those referred to the 1 and 2-euro cent
coins. These coins cost 4.5 and 5.2-euro cents respectively, which in terms of efficiency as a mean
of exchange results in a poor performance 8. Other major drawbacks of paper currency include its
significant role within the illegal side of the economy (i.e., including but not limited to money
laundering, tax avoidance on illicit goods trades). Finally, it is unclear whether the use of a CBDC
would exacerbate these phenomena or not (the topic will be further discussed in Chapter 4).

It is nevertheless clear, regardless of the distribution method, the CBDC issuance and maintenance
costs are arguably going to decrease as computation power increases and its marginal cost
decreases. It is understood minting costs on the contrary have only decreased slightly.

It goes without saying that different designs of the central bank digital currency would lead to
slightly different outputs in terms of cost efficiency (e.g., “Type D” vs “Type C”9). It is nevertheless
commonly accepted that the release of an electronic CBDC is likely to dramatically lower
transaction costs and consequently social costs, although a more accurate estimate of such amounts
would further illuminate the significance of this conclusion (Böhme et al. 2015). It must be noted
how some scholars argue the opposite (Yermack 2013). In this section the comparison was mainly

7 The relevance of this data is demonstrated by the fact that the EU Commission earlier this year urged the Italian
government to adopt a corrective measure of €3.4 billion (less than a third of what the country spends in managing
paper and metal coins) in order to comply with the public deficit ratio limit.
8 The EU Commission had released a Working Document concerning the embraceable issue of 1 and 2 euro cents

coins in 2013 prompting their uneconomical nature and suggested the inefficiency of their issuance (European
Commission 2003).
9 Here Type D refers to the decentralised DLT-based hypothesis for the CBDC design, while Type C refers to the

central bank’s account-based instead. Refer to paragraph 2.a) for further explanations.
11
focused on the costs-side of the payment system; an extensive benefit-side analysis will be carried
out in the following sections.

Transaction costs can be further split in two types: (i) the cost of verification and (ii) the cost of
networking (Catalini and Gans 2016). The first cost is correlated to the ease of validation of the
details of a certain transaction. The latter will have a significant impact on the scalability of the
platform and its intensity of usage. While the second one, will insist more on the extensity of usage
as it includes the cost of managing the network infrastructure. At the end of the day, one should
bear in mind that also the energetic impact of such platform should be carefully taken into account
as they have a substantial impact in terms of social costs.

For example, Corda protocol, a decentralized database that is an alternative to Blockchain, features
the enhancement of the peer-to-peer cryptographic connection technology through the adoption
of a notary system able to solve transaction conflicts through a variety of potential algorithms
(Hearn 2016). The network of notaries underpinning Corda would replace the central authority
with a network of users enabled to approve transactions. On the benefit side, Corda would
therefore require much less computational power and time to validate exchanges while still holding
to high security standards. The remainder of the section will focus on the features that determine
the efficiency of a currency.

Among the key prerequisites to be considered as an efficient medium of exchange are (i) degree of
acceptability (i.e., limited vs universal), (ii) legal tender (i.e., which may be bound by the issuing
entity is the Central Bank or not), (iii) trust of consumers. The only form of currency which today
is publicly available to all citizens and firms regardless of their characteristics is paper currency (i.e.,
full acceptability, legal tender and therefore enjoys full trust of consumers). In fact, paper currency
shares most of the proposed Type D CBDC characteristics since it is central bank-issued, allows
for zero-commission peer-to-peer exchanges (i.e., without necessarily having to rely on a financial
intermediary such as a commercial bank) although is missing the electronic distribution feature
(Bech and Garratt 2017). In fact, paper currency in European countries still equals to around 11%
of the GDP (Borgonovo et al. 2018). This fact seems to be consistent with the sizable cash demand
increase trend within heterogeneous countries in the Euro Area but also US and Japan over the
past decade. This includes both internal and external money (i.e., stored inside and outside of the
emitting country). A study by Jobst and Stix finds how surprisingly the demand for paper currency
has been increasing constantly since 2001 (Jobst and Stix 2017). Although this trend appears hard
to explain, in light of the non-cash payment technologies expansion (e.g., credit cards, debit cards
and many recently developed private app-based payment systems such as PayPal or Alipay).
Furthermore, the same tendency seems hard to reconcile even with a relative increase of transaction

12
volumes amount. A possible explanation seems to be driven by the last financial crisis: cash demand
appears to be strictly correlated with the transaction magnitude (i.e., a consumer might still prefer
to buy an espresso for 90 euro cents in cash, while he is expected to favour a credit card to buy a
new laptop), demographics (i.e., people with lower incomes pro-capite are usually relatively heavy
cash users) and other characteristics linked to the business type such as the type of credit cards
accepted or the location of the sale (Bagnall et al. 2016)10. That is to say, the two scholars found
that the estimates provided by the model still leave unexplained a significant portion of the increase
in cash demand after the 2008 financial crisis. By considering the bigger picture, it is nevertheless
possible to identify some reasons to explain this slight increase in currency demand by comparing
the past 10 years with other post-crises periods. Following the Great Depression and other banking
crises, economic agents considered bank deposits riskier than holding traditional paper currency
(Brown, Evangelou, and Stix 2018). Past financial crises seem to have a similar effect on consumers
(Jobst and Stix 2017). As a matter of fact, households in the Eurozone that have directly
experienced a banking crisis are more likely to hold cash instead of bank savings (Stix 2013). Finally,
uncertainty is arguably among the most impactful explanatory latent variables (Borgonovo et al.
2018).

For instance, according to a survey developed by the Swedish Riksbank, 97% of households in
Sweden seem to have access to a form of bank card, but only 89% of them has access to cash. The
latter had lost its supremacy even in the small payments (i.e., below 100 SEK ≈ $11) since 2012,
when it was reported to account for 55% of small transactions. Only four years later, in 2016, it
was used in 26% of such sort of payments (less than half the rate of 2014). By contrast, a larger
number of Swedish consumers usually feel “very safe” when using cash (65% of the respondents)
than those using a card (49%) although no significant difference is found in the level of unsafeness
when comparing the two. Surprisingly, Sweden seems to have experienced a slight increase in the
number of households that believe cash decline is not positive: in 2016, 16% had a “very negative”
towards cash usage abandonment while in 2014 it was only 8%. 11

Such considerations, along with cyber threat and privacy concerns (which will be discussed in depth
within Chapter 4) should be carefully taken into consideration by institutions. The drastic
elimination of cash could entail some dangerous side effects especially within those demographic

10 The survey considered 7 countries: Canada (2009), Australia (2010), Austria, France, Germany and Netherlands
(2011) and United States (2012). Results found cross-country differences although there is a general common trend
which is consistent among historical periods.
11 https://www.riksbank.se/en-gb/statistics/payments-notes-and-coins/payment-statistics/

13
categories that still heavily rely on the use of cash such as the elderly and other low-income and/or
low-education individuals (Bordo and Levin 2017).

In order to ease the pressure on such demographic groups, two scholars M. Bordo and A. Levin
describe two different non-excludable action plans (Bordo and Levin 2017). The first involves
public authorities promoting the diffusion of the newly issued CBDC and fostering its adoption
within businesses and households. In order to do so, it is believed that some kind of incentives
would be necessary: for instance, public intervention through a direct public investment into the
IT infrastructure network could potentially pave the way for private actors on both the consumer
side and the business side to quickly adopt the new technology. Furthermore, state subsidies could
allow the distribution of hardware and software required to run the e-wallet at a relatively low price
increasing its adoption rate and widespread diffusion.

The second option focuses on furthering the development of a graduated fees schedule for
converting CBDC into cash. It is understood here that charging a traditional fixed fee (i.e.,
uncorrelated to the amount of the transaction) such as the one currently used in most bank’s ATM
on household withdrawal would result in discouraging the new digital currency adoption rather
than easing the burden on lower-income families. In fact, among the factors that may affect overall
success of the CBDC introduction, as well as its adoption rate, is consumers’ attitudes and
accessibility on a large scale, that is, how much and how fast consumers – and businesses – are
willing to embrace the new technology. This phenomenon is also strictly correlated with the
technical capabilities of small towns and on the basic technological skills that households are
supposed to gain in order to use an e-wallet. The latter consists in an encrypted hardware device
that allows real time exchanges of digital currencies. Even in the “Type C” design type described
in the previous section, citizens will presumably be urged by the public institutions to gain access
to a digital wallet of some kind. Another factor that should be taken into consideration is the
correlation between the likelihood of adoption and the level of income and education as well as
the age of final users. This means higher-income and younger households are expected to be among
the early adopters although this may not be enough, particularly in countries that experience intense
population ageing, to push further the new CBDC. Finally, the adoption of such currency is found
to be subject to consumers behavioural biases such as the loss aversion described by Daniel
Kahneman (Kahneman and Tversky 1979) and personal attitudes or preferences towards the new
digital currency (Borgonovo et al. 2018). The latter seem to suggest the distinction between three
main groups of individuals (lovers, haters and neutrals) which are defined basing also on the
magnitude of their loss aversion (Kahneman and Tversky 1979). The neutral group seems to be

14
capable of influencing the other two clusters by setting a median standard, through a status quo
bias (Borgonovo et al. 2018).

At this point, the remainder of this chapter will focus on the possible designs of such Central Bank
Digital Currency and whether it should be implemented as a complement to traditional cash or
entirely replace it.

Stable unit of account: Aimed at facilitating economic and financial decisions of individuals
and businesses (e.g., spending and saving decision of consumers, determination of prices and
wages).
It is worth noting that the primary objective of the ECB’s monetary policy is to maintain price
stability within the European Single Market12. The idea behind this target is to ease the pressure on
consumers by facilitating the financial and economic households’ decision-making. In other words,
providing a stable unit of account allows households to enhance spending and saving decision
efficiency as well as the determination of wages and prices for businesses and the settlement of
contracts (e.g., setting the rent of a flat). In a market economy, prices are mostly set by private
economic actors (i.e., firms and individuals). Such an environment cannot be deprived of this
freedom, as it would undermine the founding principle of the market economy itself. This explains
why the only way to reach the price stability goal is through the setting of a proper monetary policy.
Even within the aforementioned scenario, where the real value of the CBDC is hold constant, the
central bank would hardly manage to succeed in fixing the value of the currency to a consumer
price index. The central bank is therefore expected to hold on the positive inflation target strategy,
which generally is set to 2 percent (Bordo and Levin 2017). Although with some designs of the
new CBDC this could become less compelling, the latter was proved to grant some desirable buffer
in downturn circumstances (Blanchard, Dell’Ariccia, and Mauro 2010) while some scholars argue
that the target should be raised even higher (Ball 2014). On the other hand, there is a group of
scholars who argue that central banks should instead aim at controlling the general price level
instead of targeting inflation rates (Svensson 1999; Bundesbank 2010; Dittmar, William, and Finn
1999).

First, it will be useful to understand whether a cryptocurrency could co-exist with traditional form
of national currencies in the long run. Because the CBDC phenomenon is still mostly theoretical,
to answer this question we will use a theoretical model by Boel (Boel 2016) which in turn builds
on a previous study (Trejos and Wright 1997). Although these models refer to simple
cryptocurrencies and not specifically to central bank-emitted CBDC, they will constitute the first

12 This objective is specifically set forth within Art 127 (1) of the Treaty on the Functioning of the EU.
15
step of the analysis. The model considers two non-isolated countries (i.e., Country A and Country
B, with no significant trade barriers) with two national currencies (i.e., Currency A and Currency
B) and a cryptocurrency (Currency C). The latter is assumed to be privately issued, but also to have
been recognized as legal tender by both governments. Assuming that the three currencies share the
same volatility σ, countries experience heterogeneous inflation rates (πA, πB for Country A and
Country B respectively). Finally, holding population constant, money supply (i.e., MA and MB
respectively) in both countries is directly proportional to the expected inflation rate and therefore
grows by 𝑀𝑡𝐴 = 𝜋𝑡−1
𝐴 𝐴
𝑀𝑡−1 . The same goes for Currency B while MC grow is assumed to be linked
to the inflation rate of Country A. The author argues that two conclusions regarding
cryptocurrencies can be drawn from the model: (i) considering negligible transaction costs,
Currency C is likely to circulate in both countries only if its inflation rate is expected to be lower
than that experienced by the national countries; (ii) Currency C is likely to survive as long as
transaction costs are low, particularly if compared to international money transfer and exchange
fees.

The first conclusion appears consistent with the widespread diffusion of Bitcoin in countries such
as Venezuela, where the Bolivar has lost 99.9% of its value since 2016 and the country is suffering
hyper-inflation. In fact, according to the IMF, the country is predicted to experience an increase in
consumer average prices of 13,864.6% by the end of 201813.

Furthermore, the second argument leads us to reaffirm the need for the definition of an appropriate
fee structure (described in the previous sections) so as to guarantee a widespread diffusion and
accessibility of such new digital currency. That is to say, exchange fees other than mere transaction
costs incurred by the parties due to the validation process need to be addressed to the extent such
new currency is required to act as an efficient medium of exchange and a stable unit of account.
Finally, the development of a new distribution protocol is expected to lower transaction costs and
commercial banks seignorage.

It is understood here that currently most privately-issued cryptocurrencies are not ready to replace
paper currency because of their lack of stability. This high instability exposes the value of such
currencies to the impetus of changes in the liquidity price and momentum. These considerations
suggest the increased hazard of leverage that threatens investors. That is, as soon as firms and
individuals will begin to involve in financial contracts issued on the basis of the value of a

13 http://www.imf.org/en/Countries/VEN
16
cryptocurrency (Caginalp and Caginalp 2018). For instance, in the case of a lending institution
granting a debt denominated in Bitcoin to a firm or an individual14.

At the end of the day, it is still unclear what will be the outcome of the trade-off between security
and privacy. On the one hand, computational power accelerating increase over cost would suggest
that higher levels of cryptography can be achieved - and successfully implemented on a large scale
- to reduce vulnerability towards cyberattacks. Nevertheless, it is argued that a higher security level
might result in a sharp privacy increase which in turn could facilitate criminal organization
payments and money laundering (Masciandaro 2007; Powell 2017). As far as security is concerned,
however, it is still unclear to what extent the DLT technology could threaten final users’ payments
security. It is argued here that citizens will have less cause for apprehension when storing central
bank-issued digital currencies or paying through an e-wallet (even in the most exposed design
hypothesis, “Type C”) than if they were in the subway during rush hour with their wallet filled with
cash.

Finally, it is hard to predict if and how national (or supranational) CBDC could coexist with other
privately-issued cryptocurrencies in the long run. Here, regulations set forth by public institutions
and central banks will play a key role.

14For example, if a firm bought a new solar plant financed through a BTC 100 million debt issued on 09/02/2011, on
the day Bitcoin first reached the value of a dollar; its nominal value would have been ten thousand times more on
28/11/2017, when Bitcoin hit the value of USD 10,000.
17
 3. Part II: CBDC implications on MP and banking policies
In this chapter, the possible monetary and banking policy effects of the introduction of such new
CBDC are further explained. The remainder of the present chapter is structured as follows: section
(a) labels the implications on the monetary transmission mechanisms and presents new policy
frontiers; section (b) offers an overview of the banking policy perspective.

a. New monetary policy possibilities

Several scholars have long questioned whether the introduction of a digital currency on a large
scale could undermine the effects of the monetary policy measures adopted by central banks, if not
neutralise them. By and large, it is understood that different countries exhibit varying degrees of
openness to the adoption of such as new sovereign digital currency. Thus, a country that has
experienced a cash usage decrease over the past decades, such as Sweden, is more likely to
successfully introduce the CBDC. It is nevertheless understood that the introduction of a CBDC
is not expected to entirely replace paper currency but rather to complement it, at least in a first
introductory stage, nor is it deemed necessary (Goodfriend 2016; Rogoff 2016). Furthermore, the
introduction of digital currency could be enacted by following a gradual scheme to ensure the
stability of the infrastructure and of the economic environment, as argued by Barrdear and Kumhof
(Barrdear and Kumhof 2016).

As mentioned in the previous Chapter, it is useful to recall that central banks are currently held
liable for two types of money: paper currency15 and reserves. The first has full accessibility16 while
the latter, although not available to all citizens, constitute a form of central bank digital currency
essentially similar to the one defined in the previous chapter. It is also predicted that the impact on
the monetary policy will be determined by the extent of the availability and the service functional
range of such digital currency. Although the public’s the desire and will to adopt a new payment
instrument remain unclear, (herein after also “aversion” towards such digital currency), several
scholars question whether it will be possible to replace paper currency in some of its main purposes
(Pfister 2017). This is because many experts believe that some of the distinguishing features of
paper currency would not be easily replaced by the CBDC.

Finally, the deployment of a central bank-issued digital currency could entail that central banks
would become competitors inside the banking sector (Pfister 2017). On the other hand, some

15 According to the Bank of England’s Bankstat statistics database, available on the BoE website, as of February 2016
physical paper currency only accounted for 4% of the overall money circulating in the UK.
16 Accessibility herein refers to the extent to which a given currency (or payment mean) is available to the economic

players inside a given environment.

18
scholars believe that an interest-bearing version of such a currency could allow for considerable
long-run benefits, even in counter cyclicals measures (Barrdear and Kumhof 2016). Finally, a
theoretical framework which provides the basic elements to understand the competition of
sovereign currencies with other privately issued digital currencies will be eventually illustrated
(Fernández-Villaverde 2017; Boel 2016).

i. Monetary transmission mechanism

Firstly, most recent publications seem to confirm that the introduction of new monetary policy
framework could substantially raise the country specific steady state level of GDP by around 3%,
thanks to a drop in real interest rates and would be supported by a reduction in distortionary tax
rates (through an interaction with fiscal policy, as described in the following paragraphs) and finally
also arguably lower transaction costs, as described in the first chapter (Barrdear and Kumhof 2016).
Secondly, as far as the cycle of business stabilization is concerned, the new digital currency is found
to be an alternative and more responsive instrument in the hands of the central policymaker by
controlling quantity and price (i.e., the exchange fee from paper currency and the interests paid on
deposits).

From a portfolio allocation perspective, non-banks private individuals owning CBDC will result,
ceteris paribus, in a contraction of other sorts of asset holdings. Such contraction can either affect
paper currency, government securities (and other types of risk-free assets) or private commercial
bank deposits17. In practice, it is likely that all three of them will decrease (Meaning et al. 2017). It
is worth noting that private, non-banks individuals will have access to CBDC (in the case of a Type
C digital currency, as proposed in the first chapter) directly through their digital wallet, following
the same logic of current banknote withdrawal. In other words, commercial banks will have to hold
a stock of CBDC that will be transferred to the depositor’s account. Note that in this scenario, the
depositor would have to decide only whether to switch between two types of deposits (i.e., bank
deposit vs. CBDC) where once again the distinctive feature is the liability of the issuer: in the case
of bank deposits, commercial bank itself issues the liability, whereas the central bank is held liable
for the CBDC issuance as if it were traditional paper currency. Furthermore, the Type C Scenario
would also empower the central bank to control a new form of monetary transmission mechanism.
Consequently, the overall supply of CBDC could be increased by central banks directly by means

17It is worth stressing how the latter entitles the depositor to withdraw its money from the private commercial bank,
whereas central banks are not held liable for such as deposits. This is also why the creation of an additional layer of
protection for the depositors was deemed necessary (i.e., in Italy since 1987 is active an interbank deposit protection
fund (FITD) which offers a bail-out for deposits under €100,000 and in turn is key to maintain the households
confidence in bank deposits.
19
of purchasing assets from the economy (i.e., both commercial banks and non-banks private actors)
with new digital currency (Meaning et al. 2017). Finally, in the case where the central bank could
be allowed to enact the so-called “helicopter drops” whereby new CBDC could be issued without
any private asset purchase (Turner 2015; Engert and Fung 2017).

One of the most effective instruments for a central bank to control the monetary policy within the
financial markets is achieved through interest rates benchmarks. The importance of such interest
rate benchmarks relies in their guidance role within the economic environment. For example, the
Euro Interbank Offered Rate (EURIBOR) is often used by private actors, including banks but also
businesses and households, so as to guide the setting of a variable interest rate regulating a contract
such as a loan. In practice, such benchmarks can be easily be used as a baseline rate for
remunerating cash pooling deposits for a multinational enterprise or a privately-issued coupon
bond. This explains why interest rate benchmarks play a crucial role within the transmission of the
monetary policy from the central bank. Recently, the ECB published the methodology guidelines
for calculating a new harmonized interest rate benchmark called Euro Short-Term Rate (ESTER),
which is set to constitute the new official interest reference rate18. Before 2008, central banks
managed such monetary transmission instrument by directly acting on the aggregate supply of
electronic money, thus allowing policymakers to expand or compress it during the downturn phase.

It is widely recognised that in the case of the Type C central bank digital currency the whole concept
of secondary market would necessarily have to be reconsidered. In other words, the current lending
market where central banks act in what is commonly referred to as the corridor system will have
to be redesigned, as many of its founding principles are likely to come to an end (e.g., the market is
currently used only by banks and central banks). CBDC could be lent between private agents and
banks and vice versa, though still allowing for traditional interbank lending. It is understood that
such an innovative but unfamiliar currency is not very likely to be fully employed by central banks.
There are two reasons for this: (i) central banks would have to cover and regulate the whole credit
market and (ii) some type of lending (e.g., long-term, involving no collateral, in favour of a
household) appears to be out of scope for a central bank. The new secondary market described,
where there is no single rate (i.e., where each single transaction can be settled at a different rate,
whereas the prevailing rate can be observed a-posteriori) could see significant readjustments on
time horizon – also because the new agents could have different risk profile and needs. On the one
hand, interbank lending is used to mitigate liquidity shocks – which respond to short-term needs.
On the other, households or businesses could use such a market to gain medium-term credit access

18 https://www.ecb.europa.eu/press/pr/date/2018/html/ecb.pr180628.en.html
20
(e.g., to fund the purchase of a flat). Finally, it is generally acknowledged that central banks could
continue to guide interest rates relying on the same mechanisms we observe today (Meaning et al.
2017). Essentially, the CBDC rate would be close to the risk-free rate (rf), thus setting a floor for
all the other rates which will be applied a delta according to their risk, time-horizon and illiquidity
spread.

Finally, much of the impact will be also determined by the degree to which regulators will allow
the issuance of financial instruments denominated in a privately issued digital currency.
Furthermore, a possible future involvement of a DLT framework inside financial markets still
needs to be properly evaluated in terms of benefits and costs arising from the considerably high
initial infrastructure investments and from a risk assessment perspective (Annunziata 2017).

For these purposes, it is worth noting that Blockchain, Bitcoin’s DLT, is described as an open
system in which all users (i.e., miners) can contribute by validating transactions (i.e., often referred
to as a “permission less” framework). By contrast, the DLT which is most likely to be used inside
the financial market would be structured as a permission-based system instead (European Securities
and Markets Authority 2016). For the time being, it is not clear if future regulations are to be based
on such distinction (i.e., “permission based” vs “permission less”), although it is clear how the main
publications from regulation institutions suggest such classification for the future developments
and debates.

ii. Impact on unconventional MP

If the topic of the last section was the impact of CBDC on the conventional instruments of
monetary policy, the following section is the impact of the introduction of such as central bank
digital currency on the unconventional monetary policies enacted by central banks over the past
two decades.

One of the most prominent forms of unconventional monetary policy framework has been the
Quantitative Easing (QE) instrument. This instrument was introduced by the European Central
Bank in March 2015, when the Governing Council of the ECB announced such non-standard asset
purchase programme. Its ultimate aim was to pursue the 2% inflation goal, whose stability role has
become crucial in the last few years. From a technical standpoint, the Central Bank commits to
buying a given amount of bonds each month from private commercial banks within the European
countries, according to a predefined rate and category. This asset purchase programme targets
sovereign bonds issued either by national governments of the Euro area or European agencies or
institutions in the secondary market, so as to introduce new liquidity in the market. One of the

21
main objectives of Quantitative Easing is to ease the pressure on households and businesses, which
is achieved through an overall lowering of interest rates, including loans and mortgages.

Currently, households cannot sell government securities directly to central banks. However, an
asset purchase programme such as the Quantitative Easing, performed using paper currency to buy
assets from non-bank private entities, appears to be both hard to accomplish in practice and
desirable by neither of the parties involved. At the end of the day, this means that commercial
banks must now be involved as intermediaries and that the expansionary policy effects on
households complicates the overall liquidity of the banking system (Meaning et al. 2017).

Many of the indirect consequences of a monetary policy such as the Quantitative Easing will
depend on the changing role of the banking system and its trust from households and, generally
speaking, depositors. This topic is usually referred to as “portfolio allocation” or “portfolio
rebalancing” (Borgonovo et al. 2018). That is, how much non-bank private depositors are willing
to replace cash (and other assets) with CBDC. In practice, this is likely to be heavily influenced by
the CBDC design options, as discussed in the first chapter. For instance, in the case of a risk-
bearing CBDC, such a currency would not seem like a perfect substitute for cash, as it enables to
hold a central bank liability (risk free, just like paper currency) but also to accrue interests, which
of course would be not be left unaffected19.

Finally, it is generally agreed that an asset purchase mechanism conducted by means of a CBDC
could be much more efficient in terms of the portfolio rebalancing channel of transmission.

iii. New MP frontiers

Among the new monetary policy possibilities brought to light by the introduction of a central bank
digital currency, two main arguments are key to understanding this novelty. First, adopting a
sovereign digital currency, regardless of its characteristics, is likely to ease the potential downsides
of other privately issued crypto currencies. Secondly, it has been argued that the CBDC would
eliminate the zero-lower bound constraint in circumstances where expansionary measures were
prolongedly used. This can represent a real issue for central banks such as the ECB within the
European economy.

19 This explains why many scholars theorized an interest bearing CBDC where such rate depends on the type of
currency-holder. For example, a privately issued bond pays off the same coupon regardless of the characteristics of its
bondholder and the same goes for sovereign bonds. By contrast, to preserve and pledge the lending role of commercial
banks, many scholars have raised the case for central banks to apply different interest rates on their digital currency.
This would mean that non-banks would be entitled to a lower rate, whereas the bank rate would play the same role of
nowadays policy rate (Meaning et al. 2017). At the end of the day, central banks certainly would not want to get
involved in the common lending mechanism, nor does it appear desirable that they should do so.
22
In order to fully assess the impact of digital currencies on the monetary policy, it must be noted
that the one of the underlying technologies proposed, the DLT, appears to have the most
significant outcomes. As discussed in the previous pages, many of the efficiency gains introduced
with the DLT technology concern the possibility to reduce settlement and transaction cost. This
was definitely not the case for Bitcoin, whereby transactions are still slow, costly and suffer low
scalability.

However, from a monetary policy perspective, such latent improved efficiency is expected to
strengthen the overall trust in the economic environment and monetary system from businesses
and households (Stevens 2017). Needless to say, such an outcome would depend by the design
chosen by the central bank for its CBDC.

First of all, the positive constraint on nominal market interest rates (so-called “zero lower bound
problem”) is mainly due to the technological and practical impossibility to set an interest rate on
paper currency (Stevens 2017; Haldane 2015). Thus, cash cannot currently be imposed as either
negative or positive, as opposed to the electronic banks deposits. The latter can accrue positive
interest in favour of central banks but can also pay negative interest on the short term in particular
circumstances. This extreme measure is likely to be subject to a dangerous political constraint which
could limit its efficacy (Raskin and Yermack 2016). That is, a negative nominal interest rate would
be hard to explain to certain groups of economic agents and could foster the adoption of alternative
currencies such as private cryptocurrencies, which are, of course, outside of the control of central
bank. Furthermore, it is understood that if central banks were to limit the depth of negative interest
rates in downturns, this would renovate lower bound-related issues. On the one hand, households
(and non-banks individuals) would prefer not to submit to exceedingly high negative rates,
conversely central banks should avoid the possibility that digital currency should not be
remunerated – as paper currency is – thus suffering from rising effective lower bound issues (ELB).
As submitted by Broadbent, the ELB would be solved only if cash were to be fully replaced by the
digital currency or the central bank was able to set an exchange rate for paper currency (Pfister
2017; Stevens 2017; Broadbent 2016).

Thus arises the key question of why this eventuality should be considered a threat, given that CBDC
could also gradually replace cash in some countries, since it has always existed after the creation of
fiduciary money. According to some scholars, in fact, the current framework of extremely low
interest trends seems to be deeply rooted into structural characteristics of the European monetary
system, not only due to the outcome of the latest financial recession (Buiter and Rahbari 2015).
From a monetary perspective, such trend can be explained through three main arguments: (i)
expected inflation, (ii) real term risk premium (which in turn, incorporates inflation), (iii) short-

23
term real interest rate20. Furthermore, other macroeconomic trends such as worsening
demographics (Ferrero, Gross, and Neri 2017) as well as lower growth expectations (even in
emerging countries) appear to have a considerable impact. That is to say, many alternative measures
have been analysed by central banks in order to alleviate the burden of the lower bound but none
of them has been implemented. Such as measures – which include a (variable) commission fee on
withdrawals, the setting of a higher inflation rate target, a stamp tax for cash or ultimately its
abolition – have not yet been enacted because of their potential downsides and other side effects.
It is worth recalling that the cash abolition seems neither feasible in the short-run nor desirable,
especially within some demographic clusters. Finally, the removal of governmental seignorage
revenues from paper currency would need to be balanced with a new tax, therefore raising
distortionary fiscal effects.

Some scholars have also discussed how with a publicly available sovereign digital currency, central
banks could aim at obtaining the goal of null average inflation rate in the long-run (Bordo and
Levin 2017). This would imply that the design of the CBDC should allow central banks to impose
an interest rate on such digital currency (i.e., be it positive or negative). On the one hand, there
appear to be many other reasons why a positive inflation target would be more advisable including
but not limiting to a better price stability; on the other hand, without the technical possibility to
effectively remunerate deposits would justify aiming at a negative inflation target instead (Friedman
1965), thus in the end a slightly higher target (closer to zero) seems to constitute a good fit (Pfister
2017).

Nevertheless, the causality between the presence of a lower bound effect and the reduced
operability of the monetary policy, to date, is not clearly demonstrated (Swanson and Williams
2014). That is to say, central banks seem to be capable of guiding long-term rates through non-
conventional MP instruments, though their effectiveness remains still uncertain.

In addition to that, it is argued how the introduction of such sovereign digital currency could allow
developing a strategy to enact the so-called “helicopter money” tool. Such expression refers to a
famous description by Milton Friedman where he described “helicopter drop of money” (Friedman
2009). This would essentially entitle each citizen to receive a certain amount of cash for free (from
which derives the allusion to the helicopter drop) and is believed to be a powerful instrument in
deflationary scenarios (Rogoff 2016). From a monetary perspective, this involves the government
to issue new debt in order to distribute such cash. Further developments have suggested how

20 https://www.ecb.europa.eu/press/key/date/2016/html/sp160615.en.html
24
distributing cash to namely every citizen would risk to end up neutralizing some of its desired
effects. This probably points out how a precise sociodemographic targeting for such drops would
arguably benefit the economic environment much more – often referred to as “drone money”
(Rogoff 2016).

On top of this, it is interesting to note that the introduction of a CBDC, though complement to
cash and not fully substitute, would be able to ease the pressure imposed by the lower bound
anyway (Rogoff 2016; Stevens 2017). This aim would also be pursued through the abolition of the
largest denomination of paper currency, which boasts minimum carrying costs and is widely used
in money laundering and other illegal activities (Masciandaro 2007; Stevens 2017; Bordo and Levin
2017).

b. Impact on banking policies

When dealing with the consequences of the introduction of a CBDC in the banking sector, it is
worth noting how the different proposed designs of such a digital currency are likely to produce
slightly different outcomes. Particularly, the Type C (as defined in Chapter 2) proposal for a central
bank digital currency is likely to compete directly with paper currency and, as long as they are
allowed to accrue some interest, traditional commercial bank deposits. In practice, one of the most
significant consequences is a switch between commercial bank deposit accounts and central bank
accounts followed by both households and businesses.

The structural framework of the modern banking system envisages the so-called “fractional
reserve” system. That is, commercial banks oversee the lending role within the economic
environment. This is performed by issuing new money which corresponds to a private liability of
the private bank and is covered only in a small fraction by central bank deposits. Private non-bank
depositors are willing to store excess liquidity into a bank account, which is typically recognised as
short-term, that pledges to pay an interest 21. In turn, commercial banks, when issuing credit to
entrepreneurs and businesses, commit to open a line of private credit for investments, which
typically require a long-term maturity. Needless to say, such role truly represents a key component
of the economic environment and is likely to embody the engine of the economic and financial
recovery. Furthermore, banks by and large manage to leverage on such maturity mismatch by
effectively managing credit and liquidity risk thus yielding a margin. On the one hand, this trend
suggests that the adoption of the CBDC would lessen credit and solvency risk associated with the

21This appears to be inconsistent with the current practice where, to date, commercial banks barely offer a small
remuneration only on big deposits and mostly against a term restriction (e.g., 6/12 months deposits).
25
fractional system. On the other hand, as commercial banks liability would decline and central banks
would see an increase in their liability side but at the end of the day it is still uncertain which variable
would be most likely to balance such disbalances (Stevens 2017).

It is worth recalling that a DLT technology is predicted to be able to dramatically lower transaction
costs, although this conclusion is still uncertain and would heavily depend on the design adopted
for such a CBDC. In the context the lending market, the latter expenses include the friction costs,
negative externalities related but not limited to a misalignment of incentives and other behavioural
biases (Rogoff 2016). Frictions are commonly reduced by an intermediary. This is also true for the
insurance market where adverse selection and moral hazard can represent a tough challenge. It is
not clear to what extent DLT technologies would be ready to change such financial services (FSB
2017).

From an economic perspective, if one was to break-down the value of a privately issued
cryptocurrency, the great majority would rely on its expected adoption rate. In other words, the
intrinsic value of a currency – recalling its three main functions of a store of value, medium of
exchange and unit of account – heavily stems from network effects (Motamedi 2014). In the end,
much of the rising positive expectations on Bitcoin over the past year were arguably caused by two
main drivers. First, although mostly unfoundedly – at least from a purely financial perspective -,
people were convinced they would have been able to resell it to a higher price after a short time
span. Secondly, a less prevalent opinion among investors was probably that as the currency was
gaining popularity it would further a significant rise in value22. In fact, much like a social network
or a standard file format such as the PDF, it is clear how a currency value can arguably be defined
as positively correlated to the number of its users – at least as far as the medium of exchange
characteristic is concerned.

It is understood here, the vulnerability of the privately issued cryptocurrency from a banking
perspective plays a key role to understanding central banks alarms towards their widespread
adoption. The rationale behind the purchase of such an asset can be found in the faith of non-
bank agents into their convertibility with the dollar (or any other sovereign currency). For example,
as long as casino players have faith in a hypothetical Las Vegas Central Casino, they are likely to
attend its events and exchange their dollars (i.e., a central bank liability) with the casino’s tokens
(i.e., a private liability which is not covered by any asset reserve). Furthermore, whenever a casino

22 Another reason for that appears to be elicited by a general trend of rising desirability for popular control in the
aftermath of the financial crisis. Such trend, in fact, is consistent with the latest exploit experienced by European
populist political areas (e.g., in Spain, Germany, France and, not least, Italy).
26
of the Las Vegas area would go bankrupt, by and large we could expect the average casino’s user
to reduce its trust in the sector and thus its use of casino’s tokens 23. The same could be arguably
assumed to be for any privately issued cryptocurrency. This seems to be consistent with the high
correlation revealed between Bitcoin and other cryptocurrencies. The figure below (Figure 1),
shows a comparison between the price of a set of privately issued digital currency and Bitcoin,
plotted in red, during the last six years. Such set is composed by the top 10 cryptocurrencies by
capitalization as of August 2018.

Figure 1. Evolution of privately issued digital currency compared to Bitcoin24

Bitcoin's contagious uptrend

$1600.0 $20000.0
$1400.0
$1200.0 $15000.0
$1000.0
$800.0 $10000.0
$600.0
$400.0 $5000.0
$200.0
$.0 $.0
Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18

Ethereum Tether Litecoin Monero

BTC XRP Bitcoin Cash EOS
Stellar Cardano

From a banking perspective, all of today’s start-ups and ventures operating in the cryptocurrency
sector can be thought as a new kind of private bank which only operate with private digital
currencies (herein after also “crypto-banks”). Conversely, the fractional reserve mechanism
described above, such crypto-banks are only allowed to operate on the basis of a 1:1 reserve ratio
(i.e., so-called “full reserve” banking). In other words, they are not capable of extending credit,
though denominated in a private digital currency, unless someone else has pledged the same exact
amount of money. This mechanism becomes even more hazardous whereby the credit is
denominated, say, in dollars. That is to say, to date, the business model and the monetary
functioning of a crypto-bank is still to be defined. In the end, many scholars agree that
cryptocurrencies would need a central supervision.

The following provides a quick overview of the main conceivable scenarios to date from a balance
sheet view. The first possible scenario would bring the most positive outcome, often referred to as

23 Unfortunately, and for the sake of simplicity, this does not consider gambling addiction or any other indirect
exogenous factor that may still induce such average economic agent to do gambling.
24 Source: coinmarketcap.com. Note that the secondary axis on the right refers only to the quotation of Bitcoin.

27
“narrow banking” scenario, banks are indifferent, in their liability side, between cash deposits and
other more illiquid source of financing such as higher equity stake (Stevens 2017; Bech and Garratt
2017). Here, the expression “narrow banking” refers to the enhanced match in the structure of
liquidity of the assets and liabilities of the commercial banks’ balance sheets (ECB 2016). In
practice, this would render the banking sector more stable and reliable, thus not impacting
negatively on the lending capabilities either. At the end of the day, this scenario is likely to imply
that banks are constrained to operate with a lower fractional reserve ratio, limiting their economies
of scale and efficiency in performing the economy booster role, though not having to wind down
their current assets.

In a second, less beneficial scenario, the reliability and strength of commercial banks’ lending role
would be seriously compromised and thus shrink the credit market (Stevens 2017). Such scenario
would risk to hold a country subject to serious long-term structural damages to the economic
environment depending on its reliance on the commercial banks credit offerings. In such an
outcome, agency problems within commercial banks equity funding would harm the sector’s
reliability.

The latter brings us to consider a third scenario, in which the central bank would be required to
enter the credit market in order to fill the gap caused by the lowered involvement of private banks
caused by the narrowed banking effect described above on the liability side (Stevens 2017).
Furthermore, on the one hand such outcome would cause a shift from seignorage income from
the private to the public sector, on the other hand it is questioned whether a central bank
interventionism on these issues should be desirable and beneficial from an economic perspective.

Finally, the fourth scenario refers to the less-advantageous case for the economic environment. In
this scenario, the overall financial stability would be seriously harmed, the banking sector would
suffer from a credibility drop. Furthermore, the substitution of bank deposits with CBDC would
also translate into a highly volatile credit market (with higher demanded risk premiums, thus higher
interest rates) and a rise in alternatives to the banking sector such as privately-issued
cryptocurrencies or other shadow banking initiatives. Although the latter would provide an
alternative to the traditional lending role performed by private banks, such alternatives would range
outside of the prudential supervision area of central banks, thus perpetuating serious reliability and
riskiness issues. These four trends would strengthen a vicious circle set to weaken the banking
sector and monetary stability.

28
 4. Part III: CBDC and legal issues
This last chapter will eventually deal with a third aspect that should be considered when analysing
the consequences of the introduction of a central bank digital currency, that is all those topics that
pertain to the legal area. The remainder of the chapter is organized as follows: section (a) provides
an overview of privacy-related concerns, section (b) examines cyber threat, privacy and security
concerns, section (c) considers regulation matters and section (d) glimpses recent real deployments;
finally, section (e) concludes by analysing other related meaningful trends.

a. Privacy and anonymity concerns

One of the first and most debated issues relating to digital currencies pertains to the privacy and
anonymity sphere. It is widely recognised, in fact, that money is a critical store of information
(Borgonovo et al. 2018). The latter role is definitely set to be included in the standard set of basic
functions of a currency (as discussed in Chapter 1). At the same time, among the variables that
could foster adoption of the CBDC within households, and thus allowing to expand its
functionalities to the economic environment as a whole, there is the rising demand for greater
concern with privacy.

Before going into any further details, it is argued here that is still largely uncertain whether privacy
can be considered as a first priority across the different demographics of potential users, assuming
they are not concerned with criminal activities (Bech and Garratt 2017). In other words, it is unclear
how much ordinary economic agents actually value anonymity itself (Borgonovo et al. 2018; Athey,
Catalini, and Tucker 2017). This seems to be related to the fact that younger generations, and
particularly millennials, appear to be less concerned by the idea of not being capable to enjoy full
anonymity.

It is understood here how the old-fashioned paper currency is not the only kind of arrangement
that is able to provide full anonymity but is the one which is most widely practicable. This seems
to be consistent with the fact that most of illegal activities and money laundering are often
described as cash intensive25. For example, a third-party private intermediary is able to provide the
seller and the buyer with complete anonymity. Let us imagine a pilgrim along the ancient “Via
Francigena” on his way to Vatican City. In such as circumstances, the pilgrim would be supposedly
willing to pay 10€ for a satisfying lunch and, assuming he would pay cash, this would occur without
having to disclose its identity to the restaurateur nor the source of such money. The use of paper

25 This will be further analysed in section (c) of the present chapter.

29
currency in such situation appears to be significantly more efficient than the use of a credit line
would be, assuming the pilgrim is not using counterfeit cash and that the restaurateur is inclined to
issue a receipt for tax purposes. Moreover, it also addresses information asymmetries by ensuring
the restaurant is getting paid with close to zero solvency risk (given cash nature of granting
unconditional credit to its bearer).

On the demand side, such dynamics are often referred to as censorship resistance and the “demand
for trustlessness” (Pagnotta and Buraschi 2018; Borgonovo et al. 2018). The latter being a type of
network in which the agents are not required to know each other, nor that they trust the
counterparty. This description finds its best exemplification in a market in which transactions are
carried out in cash or gold. On the one hand, when used as a means of payment, cash and gold, do
not require two participants to trust each other. In fact, the two agents could even be complete
strangers, but still efficaciously close the deal with limited risks – assuming the buyer is not offering
counterfeit money or non-pure gold. Despite such similarities, gold cannot be treated as a perfect
substitute of a cryptocurrency such as Bitcoin (Pagnotta and Buraschi 2018). There are many
reasons for this, primarily gold’s impractical divisibility and transportability, in addition to its
commodity qualification. In other words, despite the fact that gold was proven to have better store
of value and unit of account capabilities, yet it could not replace neither physical nor digital cash,
such as a central bank digital currency.

It should be noted however, that there are circumstances that appear to be characterized by an
increasing demand for anonymity. For example, recent advertising techniques such as web ads
based on users’ navigation tracking is causing bothersome telephone advertising and telemarketing
in many countries. All of this, together with the recent personal data leaks experienced by some
tech giants over the past years is causing an increasing demand for privacy protection within
consumers. To address such privacy concerns, the European Parliament has voted in favour of the
Regulation (EU) 2016/679, also known as the General Data Protection Regulation (GDPR), which
eventually became legally binding on 25/05/201826.

As a matter of fact, Bitcoin, arguably one of the most recognised cryptocurrencies to date, was
designed and structured as a peer-to-peer electronic currency which allows for anonymous
transactions. As already mentioned, every transaction ever made with Bitcoins is recorded inside
its blockchain, which acts as a public shared registry, using the public IDs of both the seller and
the buyer. Specifically, Bitcoin enjoys counterparty anonymity whereby the identity of the sender

26 https://eur-lex.europa.eu/legal-content/en/TXT/HTML/?uri=CELEX:32016R0679
30
is not disclosed to anyone not involved in the transaction (Bech and Garratt 2017). Moreover, it is
also accurate that Bitcoin transactions are also secured by a third-party anonymity. In other words,
any economic agent that holds a BTC or has access to its blockchain is not able to know the identity
of neither the sender nor the recipient of any transaction ever made27.

From a technical standpoint, this is often referred to as “pseudonymous privacy”. This translates
into a solid anonymity protection, as long as your public ID – the pseudonym – is kept confidential.
In fact, as soon as someone exposes the link between you and your public pseudonym, every
purchase or money transfer you have ever made would be effortlessly accessible in full. In such an
instance, the public blockchain could become a mixed blessing as it would be hard to shield against
any kind of violation from (say) undesired access for criminal purposes. It is understood here that
the Type C scenario, although losing out some of the key enhancements brought by the digital
currencies’ distribution ledger technology, would debatably offer a more reliable solution in terms
of privacy protection. That is to say, information would be centrally stored within the central bank
where nobody is allowed to access private transaction data except in cases of criminal investigations
or tax verification from the designated national or supranational agencies.

By looking at the most recent web tracking techniques which make intense use of cookies, it seems
that Bitcoin transactions operated by a private economic agent might not be as anonymous as one
would be tempted to assume. The use of cookies, for example, would perhaps in some cases
provide adequate elements to figure the connection between the public address and the identity of
the user. Needless to say, there are numerous ways through which an agent can reduce the
effectiveness of such tracking tools, although this goes beyond the scope of our dissertation.

A recently published research paper, aimed at assessing the behaviour of a group of students who
were given a $100 worth of Bitcoins towards privacy concerns, found some inconsistencies
between the respondents’ stated preferences and their actual behaviours (Athey, Catalini, and
Tucker 2017). The analysis reported two other key findings. First, it was assumed that the subset
of undergraduate students who participated to this experiment were consistent with a survey run
by the NCSA28 where consumers ranked their contact list as their second most confidential
information, after their social security number. In practice, students when asked to provide a friend
contact (e.g., in this case the e-mail address) were often convinced to do so against a small incentive

27 One can merely see the public address keys of both the agents. Perhaps this may not be enough to grant full
secureness to the parties. Much like if a user protects all of its online accounts with the same password, if someone
discovers such keyword she/he would get access to every other account.
28 National Cyber Security Alliance, https://staysafeonline.org/about-us/news/results-of-consumer-data-privacy-

survey-reveal-critical-need-for-all-digital-citizens-to-participate-in-data-privacy-day
31
(as low as the cost of a pizza). This appeared to be clearly not consistent with their declared
preferences. Second, people were willing to sacrifice privacy whenever there was a trade-off with
money (i.e., higher cost of the platform) or better UI of the platform. That is, people seemed to
value less privacy when having to manage their digital wallets through a much worse UI platform
or a costlier one. In particular, on a treatment group on encryption, students were found to be even
less worried by privacy concerns and thus less-likely to adopt privacy-enhancing behaviours (MIT
2017).

That is to say, thanks to its strong privacy protection capabilities, Bitcoin was found to have been
offering a solid alternative to cash to those individuals involved in some illicit activities. This fact
was among the reasons why its anonymity distinguishing feature was highly questioned.

Yet a full transparency platform (say) under a Type C scheme would not come undisputed as central
banks would have unlimited access to the full transaction log of every citizen. Similarly, a credit
card issuer and a commercial bank, although seemingly under privacy protection regulations, can
have direct access to a huge amount of information contained in the characteristics and the value
of the transaction carried out by the single user. Needless to say, confidential information held by
(say) credit card issuer enterprise or a private bank on the amount, the date, the location and the
type of transaction carried out by an economic agent should deserve the enterprise best efforts to
be kept as such. Nevertheless, one could rationally assume that a public institution such as a central
bank would not risk its reputation and would be willing to implement appropriate safety measures.
To put this in concrete terms, some scholars struggle to believe that politics would not dare to
interfere with depositors’ privacy rights. In the end, this concern would need to be properly
considered in the case of a complete cash replacement.

b. Cyber threat, privacy and security concerns

It is finally argued here that the threat of cyber-attacks would not be enough to drop any
development for a central bank digital currency. In other words, the threat of cyber-attacks
undermining the security and overall reliability of an e-wallet platform appears not to be an
insurmountable restraint for its development and diffusion. This assumption would hold true only
in some specific scenarios and within a limited set of currency design proposals, as will be discussed
in the following paragraphs.

It is worth noting that, according to many experts, the decentralized property of a DLT (e.g., under
a Type D scenario) would entail a substantially higher security standard for its users (Stevens 2017).
This can be explained with the stronger security against transaction record corruption, given that
it is distributed (i.e., shared) between all its users. Essentially, a cyber-attack would need to

32
consistently modify every copy of the blockchain in a short time span. Such attack, with current
computational capabilities, cannot easily be achieved nor it seems to be achievable in the near
future. However, this same distinctive feature seems to have turned out to be a mixed blessing for
Bitcoin expansion (Raskin and Yermack 2016). In other words, the lack of a stable leadership within
its community is in turn harming its own growth prospects.

This theory on the higher security entailed by a CBDC can be supported with two main arguments.
First, current commercial banks appear to have implemented insufficient precautionary measures
with satisfactory results, although with relatively lower financial means (if compared to those of a
central bank). Secondly, as far as a central bank sovereign digital currency is concerned, such an
institution would not deploy a platform without having properly tested its security and privacy
characteristics. It should be noted, however, that it was not the case for some of the biggest online
exchange platforms that have repeatedly suffered from cyber-attacks attempts. Such efforts have
sometimes resulted in a trading suspension or, ultimately, in the permanent shut-down of the
platform itself.

As long as security standards are concerned, it is finally understood that many scholars seem to
suggest that an open source protocol standard for the exchange platform could perhaps provide
higher security levels if compared to proprietary environment (Serrão, Neves, and Trezentos 2002).
Much like a researcher, who is willing to circulate its findings on an open platform to allow other
scholars from around the world to check the validity of his work. Similarly, an open-source
software which is tested and reviewed by a group of developers which is a hundred times bigger
than the size of an average software house could allow to reach higher levels of security.

c. Regulation issues

It is questioned here whether should be advisable to enact tighter regulations on private

cryptocurrencies from a social benefit perspective. As a matter of facts, privately issued
cryptocurrencies currently represent one of the largest unregulated market available to the public.
Despite numerous advantageous nuances of the decentralized management of a currency, the lack
of adequate surveillance due to a higher anonymity and privacy shielding make cryptocurrencies
fits many illegal usages like a glove. It is estimated that 25% of Bitcoin users, accounting for almost
51% of the overall transaction value, are associated with some sort of unlawful activity (Foley,
Karlsen, and Putniņš 2018). In other words, the latest data available points out that approximately
$72 billion worth of transactions related to unlawful activity involved Bitcoin. To put such figure
in context, the number is not far away from the overall size of the illicit drugs trafficking market

33
of both USA and Europe combined. This trend has caused rising interest for the phenomenon of
the so-called “black e-commerce”.

It is considered here the example of Bitcoin as a proxy to understand the main drivers for illegal
activities to be carried through cryptocurrencies. From a technical perspective, each economic
agent operating within the Bitcoin blockchain is protected by a pseudonym-based anonymity. This
means, there is a 26-35 alphanumeric string which encrypts the real identity of the wallet owner.
The record of all the transactions ever made with BTC is publicly available and allows to make
such as elaborations and could be key to implement surveillance tools by (say) central or
independent institutions.

Over the past 4 years, it has been recorded a slight reduction of Bitcoin proportional involvement
in unlawful activities. This can be supported with three arguments. First, the growing popularity of
the currency has attracted much attention from the market authorities, fiscal and custom authorities
as well as central banks and governmental agencies. This of course represents a threat to the safety
and anonymity of such as users, as the possibility of tighter regulation and controls becomes more
likely. Secondly, as a result of the growing value of the currency itself and of its overall transaction
amount, the currency has experienced a proportional decrease of involvement inside those
underground markets. Lastly, as new types of cryptocurrencies emerge these can have a better fit
with anonymity and privacy shields (e.g., Dash, Monero, etc.) and so such black e-commerce
activities can quickly adopt them. Despite all of this, in absolute terms, the volume of Bitcoin
transaction involving unlawful activities inside the black market further increases and remains at
record high levels. By and large, it can be assumed that illegal agents make more transactions, with
a lower average amount but mostly with the same counterparty whereas generally hold a lower
average stock of currency. These are eventually found to be powerful predictors for such users
involved in illicit activities.

By analysing one of the possible outcomes of the Type C scenario, it seems clear that further
regulation matters would arise. Perhaps, if central banks were to compete with commercial banks
by collecting deposits from the public, this would lead to a conflict of interest. To put this into
concrete terms, the regulatory role of central banks is would be irreconcilable with the position of
a public centralized deposit bank.

Another related trend worth mentioning, is often referred to as the issue of the largest paper
currency denomination, namely the $100 and €500 bills. As mentioned earlier in this chapter,
transaction and storage costs are key to understanding some of the most relevant trends in cash
usage, including those involved with illicit activities. It would be reasonable to assume that the
elimination of large-denomination bills would pose a challenge to economic agents involved in the
34
underground economy. The rationale behind this hypothesis relies in the fact that high
transportation and storage costs would compromise paper currency’s expediency. That is to say
that the weight of carrying a million dollars (stored in $100 bills) is approximately equal to 22kg,
which together would form a pile 109cm high (Rogoff 2016). This would substantially mean that
one could easily carry a million dollar inside a decently sized bag without attracting too much
attention. By contrast, assuming the largest denomination bill available from the central bank was
the $50 bill, such figures would have to be doubled. This would be proportionally much more
expensive, especially if considering the cost to count the banknotes and verify their authenticity.
In such as circumstances, economic agents involved in disreputable or illicit activities would have
to find an alternative to cash. For these purposes, any other means of payment which does not
provide anonymity would be rejected (McAndrews 2017). Similarly, such substitute would have to
be chosen also on the grounds of its convenience of use. Whenever anonymity is not granted by a
means of payment, such group of agents would try to recourse to secrecy (McAndrews 2017). In
other words, they would try to achieve third party anonymity outside of a restricted subset of the
population in which they operate. It is somewhat clear that secrecy is not achievable if such subset
reaches the magnitude of the entire economic environment. Finally, it is considered fairly
improbable that criminals would eventually recourse to barter (McAndrews 2017; Rogoff 2016).
As already mentioned in the first chapter, money was found to be a convenient replacement for
barter.

Here the bottom line is that illegal economic agents are not the only group of users concerned by
anonymity and privacy, but they certainly regard such characteristics as essential. In fact, as
mentioned in subparagraph a), certain demographics appear to feel less worried by lower privacy
protection standards. In conclusion, the replacement of cash would not be straightforward as illegal
drivers may not be the only reason for its usage.

d. A review of real deployments

It is finally reported here a brief overview of the results of one of the most recent real-world
deployments for a central bank digital currency: the e-Peso pilot test project (Masciandaro and
Gnan 2018; Ponce 2018). The e-Peso was designed to feature legal tender and substitutability with
the Uruguayan Peso. In fact, the e-Peso was the digital version of the traditional paper currency
issued by the BCU (Banco Central del Uruguay). Such experimental project lasted 6 months
between November 2017 and April 2018. The volume of e-Pesos released was 20 million e-Pesos29

29 Such amount, to date, corresponds to € 550,000.

35
which were collected by the central bank at the end of the pilot test and exchanged with traditional
currency. The aim of the test was to evaluate the technical feasibility of such digital currency and
assess the economic agents’ feedback. From a monetary perspective, needless to say, the impact
was neutral. For the purpose of such pilot test, the BCU distributed the digital currency directly
through a digital wallet framework (which was technically managed by a national TLC company
along with other 4 business partners), thus following the Type C characteristics described in the
first chapter. Despite the small number of users involved (i.e., just 10,000), the initiative turned out
to be positive from the legal, security and technology perspectives. As for the legal framework, the
latter was found to be ready for such as introduction of a complementary digital currency.
Furthermore, from a user security perspective, cyber-threat and informational risk were effectively
controlled. Anonymity was granted to all users, by allowing the central bank to look at the
characteristics of the transactions but not to know the identity of the users triggering them. Such
conditions were demanded by the experimental nature of the pilot test and will eventually
constitute grounds for further research and future development decisions. However, in a real-world
environment public authority would debatably need to be granted the power to access the book of
the transaction of a given user in case of well-evidenced judicial needs30. Lastly, from a technology
perspective, the infrastructure was reported to have provided a successful testing of the technical
environment’s components and good margins for operability. The technology enabled users to
operate instantaneously settled transactions with the sole GSM connection (i.e., no need for a high-
speed internet connection). Although, to date, this is not seen as a conspicuous problem given the
wide market penetration of mobile phones (which is expected to reach five billion users by 201931),
yet it was debatably considered as a potential blocker to a CBDC diffusion.

In conclusion, it seems that the legal and technological base would be arguably ready for the
introduction of a central bank digital currency, at least as far as the complementary Type C form is
concerned. In order to fully assess the risks and threats of such framework, further studies would
be deemed necessary.

30 It is worth mentioning how other companies in the past have refused to provide access to the public authorities to
a private locked device despite repeated requests from the police. On one hand, this is expected to be much different
as long as central banks holds is directly in charge of managing such infrastructures (i.e., the system is not run by a
private entity). On the other hand, this would pose a challenge for the regulators to accurately discipline the
circumstances in which such access would need to be granted.
31 https://www.statista.com/statistics/274774/forecast-of-mobile-phone-users-worldwide/

36
 e. Other tendencies towards decentralization

It is finally argued here, by looking at the bigger picture, that the tendency towards decentralization
is spreading across many developed economies (e.g., USA, France, Germany, UK, Spain and, not
least, Italy) in other sectors including politics. This phenomenon is often referred to as a
legitimation crisis of traditional money, payment systems and most importantly of the institutions
behind them (Weber 2015). For example, over the past decade Europe has seen a sharp rise in
populist movements consensus as well as newly created political parties featuring populistic
rhetoric or authoritarianism (see Figure 2 below).

Among the most significant characteristics of such as political movements, there is the tendency
towards decentralization32. It is widely recognised, in fact, that populist leaders favour direct forms
of democratic participation through referendums, opinion polls and plebiscites in order to express
the so-called “silent-majority” point of view (Inglehart and Norris 2016). Essentially, the three core
characteristics of those movements are (i) the anti-establishment route, (ii) authoritarianism and
(iii) nativism (Inglehart and Norris 2016). From a political perspective, the first feature can perhaps
be correlated with the refusal of central banks money. In other words, political leaders gain
consensus by theorising the superiority of ordinary citizens over the existing political parties and
authorities. Moreover, such as political movements are likely to be against a Type C scenario as this
would increase the scope of central banks activity.

The citizens’ demand for higher involvement in politics and their distrust in the existing political
parties and leaders is found to be correlated with two different narratives: first, the economic
insecurity in the aftermath of the latest financial crisis and second, the so-called cultural backlash
theory (Inglehart and Norris 2016). Such topics can be considered to conceivably reflect the rising
popular interest for privately issued, non-proprietary cryptocurrencies. In the end, it is
acknowledged that the actual driver explaining such trend is usually a blend of the two effects. In
other words, the two effects cannot easily be analytically isolated although they appear to have been
involved consistently as structural changes in the labour market and other globalization trends led
to a higher economic uncertainty. To put this into concrete terms, such populist movements across
Europe seem to share a demand for the so-called “short-term protection” (Masciandaro and
Passarelli 2018).

32This refers to the attempts to establish online platforms aimed at collecting the voters’ direct participation even after
the national elections. Such platforms have been implemented in many countries including Spain and Italy, although
with different outcomes.
37
Figure 2. Populist movements consensus in European countries 33

The figure above represents the rise of populist anti-establishment movements in Europe (namely
their ∆% since 2014 in terms of votes at the latest elections) and their level of populistic rhetoric.
On the vertical axis, is shown the variation of votes obtained since 2014 when compared to the
latest available election data. A positive value corresponds to a positive variation (expressed in
percentage) and vice versa. On the horizontal axis instead, is presented the populism index which
is a proxy for the populistic programmes and rhetoric presented by such parties. The table shows
all European parties with a value of such index of 50 or higher (i.e., strongly signalling populistic
features and rhetoric). The dimension of the circle further represents the %-share of votes obtained
during the most recent election round, whereas the colour of such circle expresses the left-right
wing orientation of the parties (see the scale reported in Figure 2).

It is interesting to note perhaps how the vast majority of the populist parties has gained more
consensus over the past 4 years. Such trend is consistent among parties whose populism index is
above 80. Furthermore, many of these parties are currently part of the government either as a
leading entity or as part of the coalition.

33 Elaboration of the author based on work by R. Inglehart and P. Norris (Inglehart and Norris 2016).
38
Finally, it is argued the impact on the public management and government efficiency of a new
governmental instrument to allow some form of higher involvement of the voters is, for the time
being, uncertain. It is nevertheless acknowledged here, a form of direct democracy, much like the
form of citizens’ direct participation carried out during the fifth century BC in the Athens polis,
should – arguably – neither be advisable although probably technically feasible (e.g., perhaps a DLT-
based platform like Blockchain could help develop such tools)34.

34 It must be noted how most of the new direct participation tools presented until today seem to lack the required
transparency and reliability which would be advisable and deemed necessary by the public in order to be effectively
used.
39
 5. Conclusions
In conclusion, the institution of a central bank digital currency would need to be matched by
sufficient changes in the monetary policy but on the other hand would constitute an opportunity
for central banks to take advantage of such as currency as a new valuable monetary tool. It is worth
noting that a widespread diffusion of privately-issued cryptocurrencies would instead harm the
supervision efficacy of the central bank. Among the reasons for this loss of efficacy there is the
fact that such institution would imply a substantial transformation of portfolio allocation within
households and businesses. The circulation of cryptocurrencies should be taken into proper
consideration when analysing the possible outcomes. In other words, when assessing pros and cons
for central banks to engage or abstain from instituting such new sovereign digital currency. As
explained in Chapter 1, the possibility of a widespread replacement of sovereign money with
cryptocurrencies appears to have a limited chance to become concrete as there are many concerns
for private agents. To name a few, such private digital currencies would not properly function as a
store of value nor as a unit of account as their introduction is most likely to cause severe financial
and monetary risks (e.g., high variability in the exchange rate, no long-term stability guarantee and,
to date, slow and costly scalability due to uncertain public receptiveness towards such revolution).
Moreover, the central bank lender of last resort role efficacy could be heavily compromised and
last, but not least, the currency role of store of information would have to be properly pondered.
To put this in concrete terms, it is understood that in any case anonymity (at least counterparty
anonymity) would constitute a decisive element for the public adoption of such CBDC (Borgonovo
et al. 2018).

It is interesting to mention how households would be willing to switch currency, abandoning their
sovereign national currency, only in case of profound disbelief in the currency itself and the
institutions governing it (Broadbent 2016). It should be noted, however, that mid and long-term
impact of the introduction of a sovereign digital currency on the banking and financial environment
stability are hard to fully predict and yet remain mostly uncertain. This explains why it seems
rational that the introduction of a CBDC should not be imposed by central banks as a substitute
for paper currency while rather it seems like the latter will gradually become obsolescent as argued
by Levin (Masciandaro and Gnan 2018). Such obsolescence would discourage paper currency-
based illicit activities including tax evasion and money laundering (Bordo and Levin 2017).

At the end of the day, there is a set of circumstances in which a decentralization seems to be
advisable and brings to a Pareto improvement. In other words, this would imply that the overall
cost and benefit analysis show there isn’t a group of agents which is damaged by such
decentralization whereas there is at least one which instead benefits from it. For example, in the
40
case of an international sale of goods, a third-party intermediary allows on the one hand the buyer
(say) to be sure that the seller is in full possession of the goods requested (i.e., conformity of the
goods). On the other hand, the seller takes advantage of the trusted escrow provided by the
intermediary, thus reducing the risk of solvency. In other circumstances, such as in the case of a
MNE’s marketing office, it seems that it would be much more convenient to centrally manage the
marketing and advertisements strategy also on behalf of the local national entities and branches,
assuming they all share the core brands’ name – or at least they are clearly identifiable as part of it.

Finally, it is acknowledged here there might be an important role in the future of monetary policy
for central banks digital currencies and for the protocol underlying such new disruptive technology.
That is to say, as far as such new asset can be remunerated (i.e., interest bearing) it can effectively
address the zero lower bound issue. However, it is worth recalling that the lending role of
commercial banks should be carefully taken into consideration, assuming central banks would not
want to involve in such area, especially in the Type C scenario whereby central banks would directly
compete with private banks.

From a banking policy perspective, it is understood that in case of a banking crisis a bank run
would be somewhat more probable (Borgonovo et al. 2018). As suggested by many scholars, it
should be advisable for central banks to not only tolerate the diffusion of digital currencies, while
accurately monitoring its usages, but also to proactively assess potential aggregate net benefits for
the economic environment. While on the one hand the Type C seems to be much more practicable
for the time being, on the other hand the Type D should offer an improved solution on the longer-
term. The latter would hold true, assuming the development of a DLT protocol which best fits the
role of enabling real-time exchanges on a large scale with a relatively lower transaction cost as well
as an overall lower energetic impact.

41
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