Who Is Going to Use CBDCs?

W hen asked his opinion on a restaurant, former baseball player and manager Yogi Berra infamously replied, “Nobody goes there anymore. It’s too crowded.” When it comes to central-bank digital currencies (CBDCs), much of the debate reads in a similar way: CBDCs are going to be so great, nobody will use them.

A CBDC is a form of digital-money balance offered by the central bank. Although these balances are often spoken of in the same breath as Bitcoin and other cryptocurrencies, the similarities end with their digital nature. Bitcoin transactions are peer-to-peer and recorded on a digital ledger called a blockchain. The ledger is maintained by a decentralized network of nodes that make sure transactions are valid. Some of these nodes compete to write the next block of transactions on the ledger. These nodes are rewarded with new bitcoin and transaction fees. By contrast, CBDCs would not be peer-to-peer, nor decentralized, and would have no use for a blockchain.

A better analogy for CBDCs is a checking account. Customers can log in to their bank’s website or app and see their balance. That balance is entirely digital. However, unlike in the case of a cryptocurrency, the bank records the credits to and debits from that account. From the perspective of a depositor, a CBDC account would function much the same way. Instead of an account with a commercial bank, the depositor would simply have an account with the central bank.

Nevertheless, there is one critical difference between these accounts. The digital balance of dollars in an account at a commercial bank is not actually a physical dollar, but rather a claim to a physical dollar. The bank simply offers the convenience of allowing its depositors to come and claim those physical dollars at any time they please. In contrast, the central bank has the authority to create actual dollars rather than claims to dollars. This is an important characteristic, because one never has to worry that the central bank has the physical dollars to back its digital dollars. Currently, digital-dollar balances are only offered to banks. When a commercial bank deposits some of its reserves with the central bank, the central bank adds that to the commercial bank’s digital balance. A CBDC would effectively extend this beyond commercial banks to allow anyone to have deposits with the central bank.

Advocates of CBDCs see this as important. They argue that a CBDC would offer people a safe place to store their money balances and would offer much faster payments than the current alternatives. In fact, in September, the Biden administration released its Policy Objectives for a U.S. Central Bank Digital Currency System. Among the purported benefits listed by the administration are the safety of a CBDC and faster payments.

One might therefore wonder whether the safety and faster payments offered by the CBDC would cause people to abandon their accounts at commercial banks in favor of the CBDC. After all, if the CBDC is safer and faster than a commercial bank account, why would anyone continue to use a commercial bank account? Furthermore, even if people continue to hold balances at the commercial bank, wouldn’t the safety of a CBDC create a new risk? For example, the safety of the CBDC account might cause people to run on commercial banks during bad times in an attempt to move their money to safety. This sort of disintermediation could have significant costs.

No worries. Advocates of a CBDC have a solution to this problem. By setting the interest rate on CBDC balances sufficiently low, the central bank can discourage people from abandoning their commercial bank accounts for the CBDC. But therein lies the contradiction. The CBDC supposedly offers users superior features, but the central bank will make sure the CBDC is not widely used.

Similarly, on the point of financial stability, the argument that we shouldn’t be concerned with a flight to CBDCs during bad times is a bit disingenuous. Consider the case of The Narrow Bank.

In 2017, The Narrow Bank applied for a master account with the Federal Reserve. The Narrow Bank’s business plan was straightforward: Accept deposits, place 100 percent of those funds in a master account at the Fed, collect interest on those funds from the Fed, and pass along some of that interest to its depositors. The Narrow Bank would therefore offer a similar sort of service as a CBDC (although the initial plan was to offer it to institutions and not individuals). It effectively gives depositors access to an account at the central bank, albeit through an intermediary, with all the security that entails. Moreover, the fact that The Narrow Bank would pay an interest rate below the interest rate paid on reserves would mean that these accounts would be nearly the same as the proposal to design CBDC accounts to prevent people from substituting away from traditional commercial banks.

Did the Fed embrace The Narrow Bank with open arms? No. It denied The Narrow Bank’s request for a master account. Many have speculated that the Fed did so on the grounds that The Narrow Bank was too safe. Costly disintermediation and financial instability could result during difficult economic conditions if customers flee commercial banks for the safety of the Fed through The Narrow Bank. This is, of course, the same thing that advocates deem of little concern with regards to a CBDC. Contradictions abound.

We are left to wonder who is going to use a CBDC. The advocates’ argument seems to be that not only is the product great, but it’s so great that it should be designed to minimize its use and all private substitutes must be prohibited. What, then, is the point?