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Central Bank Digital Currency: A Provocation of a Paradigm

Advances in digital currencies are not limited to cypherpunk anarchists. Central banks are exploring this technology too. They were catalyzed by the reinvigorated discussion of monetary systems pushed into the zeitgeist by those cypherpunks. Aside from the pragmatic improvements in efficiency, transparency, and access, central bank digital currency (CBDC) has the potential to fundamentally alter our conception of the entire financial system. CBDC could disintermediate commercial banks as a necessary interface between those who create the money, central banks, and those who use it, individuals.


Central banks were long ago given monopolies on the management of the money supplies by their national governments. They increase or decrease the base money which is typically associated with notes and coins but also includes a more ephemeral category: reserves. These reserves are allocated to depository institutions that have accounts with the central banks. These reserves are used to settle aggregate imbalances among the depository institutions. Reserves don’t require physical counterparts but instead exist already in a virtual reality.

The approximate $3.2 trillion of base money[1] may exhibit some artificialness but that’s only the tip of the iceberg. Can that provide the financial lubrication to sustain the world’s largest economy with a GDP of $21 trillion as well as dollar-dominated global one of $80 trillion?[2] It doesn’t. Commercial bank money enables higher levels of effective money supplies through credit creation. As the Federal Reserve Bank of Chicago notes, “the actual process of money creation takes place primarily in banks…checkable liabilities of banks are money.”[3]

Let’s imagine an old-timey banker storing gold for his customers centuries ago. He noticed that there was rarely any period where his customers withdrew 100% of their deposits at any one time. Gold would sit dormant in his vaults until an idea was hatched. If he needed at most 50% of gold reserves to satisfy customer withdrawals, he could use the other half to lend to borrowers at interest. Fractional reserve banking was invented and displaced simple storage services.

The crucial thing to understand is that a customer doesn’t register their deposits getting lent. As far as they are concerned, all the money is still there and they will operate in the economy under the presumption of that total amount. Similarly, the borrower considers that money in their account and spends it. The effective money supply was increased by 50%. Commercial banks may not be able to create base money but, for all intents and purposes, share in the ability to create effective money. This is conventionally known as the money multiplier effect.

Modernity loosened the constraints of how much commercial bank money could be created. Physical settlement of gold or base money became rare and updates to accounting ledgers sufficed. Capital flows that remained inside the same bank or banking network required even less tethering to the physicality constraint. This enabled banks to reduce their reserve percentages down to single digits. Over time through market discovery and government regulations, banks typically average a 10% reserve ratio. Economists estimate this total effective money at $15 trillion and define it as M3. The previous estimate of base money, defined as M0, is unsurprisingly about 20% of M3.

What does this tell us? It tells us that, in contrast to popular discourse, commercial banks manage at least 80% of the money supply. It also reveals that most of our money supply is existent only in the commercial bank ledgers and thus virtual. Considering the use of physical cash is diminishing at less than 9% of transaction volume,[4] individuals are becoming more and more reliant on commercial bank money. This fossilizes the intermediary role of commercial banks between individuals and their central banks.

So wait? Don’t we already have these digital currencies? Sort of. The central banks’ discussion around digital currencies is often portrayed as a new innovation inspired by decentralized cryptocurrencies, although a CBDC doesn’t have to utilize blockchain technology. With this in mind, it’s helpful to distinguish digital currencies from virtual currencies: the progressive result of communication technologies’ impact on fractional reserve banking.

CBDC would increase the percentage of M0 that is not constrained by physicality and in certain cases would eliminate physical notes and coins altogether. In principle, individuals should have the ability to interface directly with the central banks as they do with physical money and not be forced to use commercial banks. Even if consumers voluntarily choose to perform a majority of their financial interactions through commercial banks, the option to exit the relationship should be maintained. Otherwise, the government would be removing consumer choice and mandating patronage of a highly concentrated sector.

In order to retain the “to bank or not to bank” principle, the introduction of CBDC would require individual deposit accounts at central banks rather than exclusively granting commercial banks and other depository institutions that privilege. This is the paradigm shift. If such a system were enabled, commercial banks would lose their grip on a beholden populace.

The Concept

This dynamic would provide consumers with a choice of depositing money with the super safe central bank or the riskier commercial banks. It appears obvious as to where the flows of deposits would settle. In the short term, demand for commercial banks for storage and payment facilitation would be reduced with the increased competition. In a domino-like fashion, commercial bank reserves would be reduced followed by a decrease in levels of credit. This doesn’t conclude that those services would be eliminated, but instead, commercial banks would be incentivized to provide a better choice. Consumers will not be losing choices but gaining them. As researchers at the St. Louis Fed explained:

“to attract deposits, they would need to alter their business model…to compensate users for the additional risk they assume…the banks must make their business models more secure by, for example, taking fewer risks or by holding more reserves and capital, or they must offer higher interest rates.”[5]

While the short-term effects are articulable, it is unclear whether this increased market pressure would cause improvements in the commercial banking sector that will lead to increases in demand to offset or possibly even increase levels of credit.

Lending is the primary responsibility of banks. Conventional economic theory describes the bank’s role as an intermediary between savers and borrowers. Their comparative advantage is risk analysis. The holding of deposits and coordination of simple transfers, especially in a digital context, is a dissimilar activity. A common refrain from central banks researching CBDC is that they emphatically don’t want to perform that risk analysis to extend credit and exclusively are focusing on the storage and payment use cases. Understandably, the economic calculation problems of the credit markets are too complicated for the central banks leaving those markets free to the competitive discovery process by commercial banks.

Those effects appear of a lesser intensity than the initial shock of the premise however the following ones might seem more proportional. The introduction of a CBDC removes the commercial banks as middle-men between the central bank and individuals. As noted above, this creates a lack of demand for commercial banks, downplays their reliance on the passivity of depositors, and prompts more credit conservatism. With the adoption of CBDC accounts at the central bank, the hostage-scenario like threat of major economic collapse and individual depositor losses, if commercial banks are not bailed out for malinvestment, is weakened. A traditional sector wide bank run crashes the system whereas a CBDC bank run funnels money to the central bank. Financial flows would remain operable and commercial banks would be punished by the market. The CBDC safety net underscores the infeasibility of bailing out bad banks and promotes creative destruction for better banks to take their place. The stranglehold of “too big to fail” bankster capitalism would be removed leading to healthier economies that protect the entire national population as opposed to a tiny international elite class of speculators.

Central banks and governments could use CBDC to go even further in economic tinkering. Remember those classifications of money like M0 and M3? CBDC could replace that composite. This would largely abolish fractional reserve banking and induce commercial banks to be 100% reserve backed. Commercial banks would then be the same as an individual that invests in a stock understanding that he has forfeited money to the company issuing the stock. They would no longer have the privilege of multiplying money. As financial writer, Frances Coppola, puts it, “central banks would have taken control of both money creation and payments.”[6] The creation of CBDC would only nudge towards an approximation of a full reserve system but governments could make it official by making CBDC exclusively payable in taxes and legal tender. This would make commercial bank deposits far less liquid. The dominant share of the money supply would be shifted back towards the central bank allowing for more effective monetary policy than currently employed.


Specific examples of central banks exploring CBDC are limited to research literature, small experiments, and conventional upgrades. The Swedish Riksbank has optimistically written on the possibilities of an e-krona.[7] It highlights the nuances of account-based, closed central bank network, and value-based, open network, models of CBDC. The People’s Bank of China has prototyped[8] the concept showing initiative to move past thought experiments in contrast to others. The U.S. Federal Reserve wants to improve the settlement process with FedNow[9] which could process payments instantly and anytime. This technology, however, would only be available for depository institutions securing the middle-men position of commercial banks. The infrastructure is either already built or being developed for most central banks. It’s a subjective policy decision to not allow individual accounts rather than one based on technological limitations. Central banks could also delegate operational aspects to local public entities. India mutated its postal service to enable adoption of its UPI payment system.[10] This exhibits how CBDC can be distributed rather than bottle-necked. According to the Bank of International Settlements’ CBDC survey, “in the short term, over 85% of central banks see themselves as either somewhat unlikely or very unlikely to issue any type of CBDC.”[11] For more information on other examples, I recommend reviewing IMF’s John Kiff’s list.


Criticisms of CBDC policy include privacy and access concerns. CBDC would provide more efficient monitoring of financial transactions than could be sporadically done through diverse banks or almost impossibly in cash transactions. It would also strengthen calls to remove physical money as it would be seen as less needed and a nuisance for law enforcement. An individual’s ability to freely transfer CBDC is also circumscribed by the central bank and government which could remove financial services altogether from a target. The programmable capability of digitization could limit freedom and enable a top-down central plan on auto-pilot. For example, a farmer might be unable to process transactions for certain seed purchases in favor of others or an employer might not be able to process a wage transaction to an employee account below a minimum floor.

While these criticisms should be heavily considered, it’s worth comparing them to the present-day reality. Governments already have unprecedented ability to monitor and freeze financial flows in collaboration with the private sector with only the difference being that it is not optimally efficient and runs into international snags outside its authority. In the context of commercial banks financially excluding individuals based on free speech, there’s even an argument to suggest a public payment infrastructure like a CBDC would improve access and protect the rights of citizens to freely express themselves without retribution. Physical cash, as noted above, is a dwindling tool as consumers are voluntarily shifting towards digitization. CBDCs don’t prohibit physical money outright and the two tools could exist in a complementary fashion. Many policy makers support passing laws that would require retailers to accept physical cash which is largely used by those of lower socio-economic status. Governments have long directed financial flows through policy and, while programmability might update the process, government will still have no trouble without it.


The advent of CBDC doesn’t diminish the future of decentralized cryptocurrencies. Many central banks and economists see both co-existing and allowing consumers to ameliorate the previous criticisms. For advocates of new technological solutions to problems of archaic speculative malinvestment, CBDC represents a more achievable objective than the tumultuous ups and downs of decentralized cryptocurrencies. It is unclear whether the latter will actually succeed in the near future whereas the former only requires policy makers to click a few buttons and scale existing infrastructure to the masses. Such a small step represents a grand evolution of the financial system into new theoretical territory on par with the invention of bills of exchange, double-entry bookkeeping, and fiat currency. This would indeed be a provocation of special interests that would lobby against such a proposal. Policy makers that authentically want to avoid future financial crises, stabilize the economy, and promote a fair market for all should consider the benefits of CBDC could far outweigh the costs of provoking the few who exploit the many.



[1] Board of Governors of the Federal Reserve System (US), Monetary Base; Total [BOGMBASE], retrieved from FRED, Federal Reserve Bank of St. Louis;

[2] The World Factbook 2019. Washington, DC: Central Intelligence Agency, 2019.

[3] Nichols, Dorothy M. Modern Money Mechanics: a Workbook on Deposits Currency and Bank Reserves. Federal Reserve Bank of Chicago, 1982.

[4] Matheny, Wendy. “The State of Cash: Preliminary Findings from the 2015 Diary of Consumer Payment Choice.” Federal Reserve Bank of San Francisco, 3 Nov. 2016,

[5] Aleksander Berentsen and Fabian Schar, "The Case for Central Bank Electronic Money and the Non-case for Central Bank Cryptocurrencies," Federal Reserve Bank of St. Louis Review, Second Quarter 2018, pp. 97-106.

[6] Coppola, Frances. “Central Banks Are Considering Their Own Digital Currencies for Global Payments.” | American Express,

[7] Riksbanken. “E-Krona.” Sveriges Riksbank,

[8] Knight, Will. “China's Central Bank Has Begun Cautiously Testing a Digital Currency.” MIT Technology Review, MIT Technology Review, 28 Aug. 2017,

[9] Board of Governors of the Federal Reserve System,

[10] “About IPPB.” India Post Payments Bank,

[11] Barontini, Christian, and Henry Holden. “BIS Papers No 101 Proceeding with Caution – a Survey on Central Bank Digital Currency .” Bank of International Settlements, Jan. 2019,


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