Digital Innovation, Data Revolution and Central Bank Digital Currency Noriyuki Yanagawa* yanagawae.u-tokyo.ac.jp Hiromi Yamaoka** hiromi.yamaokaboj.or.jp No.19-E-2 February 2019 Bank of Japan 2-1-1 Nihonbashi-Hongokucho, Chuo-ku, Tokyo 103-0021, Japan *Professor, University of Tokyo, Graduate School of Economics **Institute for Monetary and Economic Studies Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of the Bank. If you have any comment or question on the working paper series, please contact each author. When making a copy or reproduction of the content for commercial purposes, please contact the Public Relations Department post.prd8boj.or.jp at the Bank in advance to request permission. When making a copy or reproduction, the source, Bank of Japan Working Paper Series, should explicitly be credited. Bank of Japan Working Paper Series 1 Digital Innovation, Data Revolution and Central Bank Digital Currency * Noriyuki Yanagawa † , Hiromi Yamaoka ‡February 2019 Abstract Under the developments of digital innovation, global expansion of cashless payments and the emergence of crypto-assets, some argue that central banks should issue digital currencies that can be used by ordinary people instead of paper-based banknotes. The debates on central bank digital currencies are now gathering great attention from worldwide. Although many of major central banks, including the Bank of Japan, do not have an immediate plan to issue digital currencies that can replace banknotes, some central banks are seriously considering whether they should issue digital currencies in the near future or have already issued them as pilot studies. The debates on central bank digital currencies cover broad issues, such as their possible impacts on payment efficiency, banks’ fund intermediation, liquidity crises and the transmission mechanism of monetary policy. All of these issues have important implications for the functions of money as well as its future. Digital innovation expands the possibility of money and enables new types of money with a variety of functions to emerge. These functions may include not only traditional payments but also processing various ination and data attached to payments as well as cuting transactions. In order to consider the pros and cons of central bank digital currencies as well as the future of money, it is needed to assess their possible impacts not only on payment efficiency but also on financial structure and the overall economy. It is also important to examine their impacts on effective utilization of data and the dynamics of “networks externality”, which is one of major characteristics of payment infrastructure. Keywords central bank digital currency, innovation, payment, negative interest rate *The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the University of Tokyo or the Bank of Japan. †Professor, University of Tokyo, Graduate School of Economics E-mail address yanagawae.u-tokyo.ac.jp ‡Bank of Japan, Institute for Monetary and Economic Studies E-mail address hiromi.yamaokaboj.or.jp 2 1. Introduction - What are central bank digital currencies- The term “Central Bank Digital Currency CBDC” usually means “digitalized instruments for payments and settlements issued by central banks as their liabilities central bank money” 1 . There exist two types of central bank money base money issued by the central bank as their liabilities, which are a banknotes and b central bank deposits including reserve deposits. Banknotes, which are paper-based, can be used 365 days a year and 24 hours a day by anyone for daily transactions. On the other hand, central bank deposits, which were erly managed through paper-based central bank ledgers, have already been digitized in most countries. Central bank deposits are mainly used for large-value-settlement by banks, and their availability is under constraints of the operating hours of central bank settlement systems and the eligibility of direct participants to central bank accounts. In parallel with these two categories of central bank money, CBDCs can be categorized into two types, as below. Bank for International Settlements 【2018】 introduced similar classification 2 . a CBDCs used by general public for daily transactions instead of banknotes b CBDCs for large-value settlements, which are based on central bank deposits and adopt new technologies such as distributed ledger technology DLT At this juncture, central banks generally allow only a limited number of entities such as banks to directly access to central bank accounts. In this regard, if CBDCs in the er a category are issued through central bank accounts, the issuance of CBDCs will be similar to widening the access to central bank accounts also to ordinary people and operating central bank settlement systems on 24/7 basis. The issuance of CBDCs in the er a category may accompany wide-ranging issues 1Central bank deposits such as deposits in reserve accounts have already been digitized in most countries. Nonetheless, they are not categorized as CBDC. 2Bank for International Settlements 2018 categorized CBDCs into “General Purpose CBDC” and “Wholesale CBDC”. 3 to be carefully examined. These issues may involve, for example, the risk of crowding-out of bank deposits and squeezing banks’ financial intermediation, as well as the risk of accelerating the shift of funds from bank deposits to CBDC through “flight to quality” in stressed circumstances. On the other hand, CBDCs in the latter b category can be regarded as an evolved of central bank deposits, which have already been digitized, through the adoption of new technologies to enhance their utility. In this regard, CBDCs in the latter b category may not involve many brand-new issues, although CBDCs in the er a category may accompany various new and fundamental issues to be carefully examined. Therefore, this paper will focus mainly on CBDC in the er a category and their relevant issues, unless otherwise noted 3 . 【Chart 1】Relationship between Central Bank Money and Two Types of CBDCs Central Bank Money CBDCs ・Banknotes ・ CBDCs used by general public for daily transactions ・Central Bank Deposits ・ CBDCs for wholesale settlements 2. Thoughts behind Proposals to Issue CBDCs Recently, CBDCs and their relevant issues have been gathering great attention in various international forums, due to the following factors and interests. 2.1. Enhancing Efficiency and Reducing Costs of Payments through Applying New Digital Technologies Growing interests in CBDCs have been supported by recent developments of digital technologies and expansion of cashless payments in many countries. In view of these 3In addition, there are many legal issues regarding CBDCs. For example, in many jurisdictions banknotes are treated as “legal tender”, and it will be needed to consider whether CBDCs should also be defined as legal tender and consequently be given special status as payment instruments. 4 developments, more scholars and practitioners have come to ask whether central banks can and should also make use of new digital technologies in order to enhance the efficiency and the utility of their own payment and settlement infrastructure. Since the birth of iPhone in 2007, the number of smartphones has skyrocketed worldwide within just a decade. Accordingly, mobile payments have been growing rapidly in many countries. In addition, there have been traditional cashless payment instruments such as credit cards, debit cards and e-money, which have also generally been spreading. Besides, new types of decentralized technologies such as blockchain and distributed ledger technology DLT were born a decade ago. Nevertheless, banknotes are still based on paper-based technologies. Therefore, if ordinary people want to use central bank money for their transactions in order to avoid credit risks, they have to use paper-based banknotes as the only available option. Consequently, they have to bear the costs for storing and conveying banknotes as well as various costs for keeping them safe. In view of these costs, some people, especially academia, argue that central banks should also make use of digital technologies to enhance the utility of central bank money. They argue that the issuance of CBDCs will enable general public to use risk-free and digitized payment instruments for daily transactions, believing that wider use of risk-free, digitized CBDC for broad transactions will enhance efficiency and safety of payments and reduce overall costs of economic transactions 4 . 2.2. Decrease of Cash in Some Countries and Financial Inclusion In Scandinavian countries such as Sweden, the volume of cash has recently been substantially declining, partly due to the developments of private-based mobile payment instruments. Governor Ingves of Sveriges Riksbank explained in his speech 4There are also proposals that private entities issue digitized payment instruments backed up by safe assets. For example, some commercial banks have expressed the idea of issuing “utility settlement coins”, based on blockchain and DLT. 5 that the number of shops accepting cash was decreasing in Sweden, and that it would continue to decline also in the near future. Payment instruments generally have strong “network externality”, in which the expansion of user network increases the utility of these instruments for each user 5 . For example, if some payment instruments are accepted by more shops, the utility of these instruments for the user will increase. Governor Ingves in his speech referred to the possibility that cash was losing its network externality, and pointed out the risk that some people would face difficulty in obtaining cash in the near future. Governor Ingves also explained that Sveriges Riksbank is doing comprehensive studies on whether it should issue digital-based currencies e-krona or not, in order to fulfill its responsibility as the nation’s central bank to provide risk-free payment instruments to general public. Managing Director Lagarde of the International Monetary Fund pointed out the promotion of financial inclusion as one of the possible benefit of issuing CBDCs, in a sense that CBDCs will provide the opportunities to many people to use risk-free payment instruments 6 . In addition, several policymakers in public authorities, including Governor Ingves and Managing Director Lagarde, also referred to the risk that payment markets could be dominated by a limited number of big private firms in accordance with the decline in cash as well as the expansion of private-based digital payment instruments. They generally support deeper studies of CBDCs also in terms of containing the problems and risks stemming from monopolization or oligopolization of payment markets by private entities. In addition, some scholars argue that central banks will be able to continue raising the seigniorage by issuing CBDCs, even though physical banknotes are replaced by digital payment instruments. 5For example, if more shops accept credit card payments, the utility for each consumer to carry credit cards will increase. On the other hand, if more consumers carry credit cards, the utility for each shop to accept credit card payments will increase. Nowadays various payment instruments are competing with each other to expand their networks. They are trying to expand their networks because they understand the importance of “network externality” in payment businesses. 6Lagarde 2018 6 2.3. Blockchain, Distributed Ledger Technology and Crypto-assets A decade ago, blockchain and distributed ledger technology DLT were introduced by the article written by Satoshi Nakamoto 7 . Based on these technologies, Bitcoin, the first crypto-asset, was issued in 2009. The emergence of these de-centralized technologies and crypto-assets has also encouraged wider entities to be interested in the concept of CBDCs. Since the issuance of Bitcoin, various types of crypto-assets have been issued. Although these crypto-assets were originally born as digitized payment instruments, many of them have actually been used as speculative investment tools. Accordingly, cautious views against crypto-assets have been also growing from a viewpoint of consumer protection. In view of such developments of crypto-assets, some people also support the idea of issuing CBDCs, believing that the CBDC will discourage speculation on crypto-assets. They argued that consumers would be less interested in crypto-assets as digitized payment instruments, if they can always use CBDCs instead 8 . “Anonymity” is also an important issue on this front. Banknotes carry only the ination of “value”, and even central banks, the issuers of banknotes, cannot know who possesses them. In this regard, banknotes have anonymity as payment instruments. On the other hand, the issuers of private-based digital payment instruments are often able to obtain various ination and data attached to payments and transactions. Accordingly, as private-based digital payment instruments extend the possibility of utilizing ination and data linked to payments, they also raise privacy issues. In this regard, some people expect that CBDC, through applying blockchain, DLT and encryption technologies, could realize anonymity similar to banknotes on a digital basis, in order to protect privacy of the users. 7Nakamoto 2009 8Crypto-Assets do not use sovereign currency units such as JPY and USD. In this regard, CBDCs are not categorized as crypto-assets. 7 2.4. Crime Prevention and Anti-Money Laundering There are also arguments for supporting the issuance of CBDCs from a different perspective. The opinions in the previous section support “anonymous” CBDCs. On the other hand, some people support CBDCs because CBDCs could rather reduce the level of anonymity. They argue that banknotes, due to their anonymity, tend to be used for criminal activities, tax evasion and money laundering. They think that it is better to encourage general public to use CBDCs, instead of banknotes, for high-value transactions in order to prevent criminal activities, tax evasion and money laundering, on the condition that the level of anonymity of CBDCs is lower than that of banknotes. For example, the People’s Bank of China announced on January 20, 2016 that it had a plan to issue CBDCs in future, and pointed out the prevention of tax evasion as one of the possible benefits of issuing CBDCs 9 . The arguments described in the previous section try to create digital payment instruments with anonymity, like paper-based banknotes, through applying de-centralized technologies to CBDCs. On the contrary, the arguments illustrated in this section aim at creating digital payment instruments wit