The Bank of Canada is exploring a digital version of cash. Here’s what it could mean for you

For the last few years, the Bank of Canada has been working on the logistics of a potential Central Bank Digital Currency: a purely digital form of the Canadian dollar. While the choice to launch a CBDC rests with the federal government, the central bank said it wants to be prepared for the possibility — especially as Canadians increasingly use digital payment methods in their daily lives.

Here’s how a CBDC might work, and why the Bank of Canada is considering one.

What is a central bank digital currency?

A retail CBDC is essentially a digital version of physical cash. Like cash, CBDCs are issued by central banks, and their value is tied to a national currency. One Canadian CBDC will equal one Canadian dollar, and it can be used for personal and online purchases, as well as payments between businesses. It can also be transmitted between people.

Most money is already digital, and there are many electronic payment systems available. Think of the numbers on the screen when you check your bank account balance, or the money transferred from your account to the grocery store’s account when you swipe your debit card. There are also cryptocurrencies, a form of digital money that is not backed by a central bank.

CBDCs differ from these other digital forms of money because they are a direct claim on the central bank – like a physical dollar bill. They do not require a bank account, although financial institutions may still play a role in distributing CBDCs and handling transactions, such as with cash, depending on the design of the digital currency.

“As with banknotes, Canadians must not disclose identification, a bank account or private information to conduct basic financial transactions,” says the Bank of Canada website.

Bank of Canada says potential digital dollar won’t pay interest or require identification

Why is Canada looking at digital currency?

In one form or another, the Bank of Canada has been evaluating the risks and benefits of implementing a national digital currency for several years, especially as digital marketplaces and cashless payments have grown in popularity. The COVID-19 pandemic has only accelerated this trend, with more Canadians going online to do their shopping while staying at home.

“Since COVID-19 hit, we’ve seen a growing reluctance in Canada to use cash,” Timothy Lane, then-deputy governor of the Bank of Canada, said in 2021. “Even though Canadians hold more cash than ever, cash cannot currently circulate as much.”

The bank also responds to developments in computer technology. Cryptocurrencies, such as Bitcoin, are not commonly used as a form of payment; they are essentially speculative assets. But the technology that underpins cryptocurrencies could still have a significant impact on how payments work, and the central bank wants to stay abreast of these new developments.

Central bankers are also wary of private forms of digital money displacing national currencies in online marketplaces. Most cryptocurrencies are far too volatile to be used in everyday payments. But other types of digital assets, including “stablecoins” — whose value is typically tied to something more stable, such as national currencies or the price of gold — may grow in popularity.

In 2019, Facebook (now called Meta) announced plans for its own digital currency called Libra (later renamed Diem). The plan was dismissed in 2022. But it has raised the stakes for central bankers who guard their place at the center of the payments system.

How will digital currency work?

The Bank of Canada has not yet announced any specific details on how a Canadian CBDC would work, but has mentioned a few ideas. In a 2019 article, the bank said it could be either account-based, where Canadians can open an account to transfer their money in a digital currency form, or value-based, where money is transferred directly from your bank to a physical card can be. , a digital wallet or a phone app – similar to managing a Paypal account, or using a prepaid credit card.

The bank said it received feedback from several groups that a Canadian CBDC should not require an internet connection to be used. If the bank goes that route, your digital wallet will be stored directly on a card, account or phone app, which you’ll be able to use to transfer money to other users, or pay businesses directly. Users will also not need any identification or a bank account to interact with a Canadian digital currency.

Will a digital currency replace physical cash?

Although their research into CBDCs was prompted by the declining use of physical currency in payments, the Bank of Canada said it has no plans to phase out cash as it remains the best currency available in terms of security, accessibility and privacy . A Canadian digital currency is intended to bring some of those benefits to those situations where cash cannot be used, such as in online shopping or at cashless businesses.

“Our responsibility is to provide Canadian banknotes they can trust,” the bank said. “We’ve done this for almost 90 years, and we’re committed to issuing banknotes for as long as Canadians want them.”

What are other countries doing with digital currency?

A few countries around the world have adopted a central digital currency in one form or another. In 2020, the Bahamas became the first country to launch a modern CBDC, which it dubbed the “Sand Dollar”. Another 10 countries have launched CBDCs and 21 others – including India, China, Australia and Sweden – have begun testing digital currencies through pilot projects.

Reports from the Bahamas say that their Sand Dollar is still not used very often. According to a 2022 report by the International Monetary Fund, only 0.1 percent of the currency used in the country is their CBDC, and very few vendors accept it. Nigeria’s eNaira digital currency, which launched in 2021, is seeing similarly low adoption and usage numbers.

What has been the reception of the Bank of Canada’s research on digital currencies?

Federal Conservative Leader Pierre Poilievre has been outspoken against the idea of ​​a Canadian digital currency, saying he would not introduce a CBDC if his party forms government. He has come out as a supporter of private cryptocurrencies like Bitcoin in the past.

In an online survey published by the Bank of Canada in November, a majority of respondents said they were concerned about the privacy of a digital currency, compared to the anonymous benefits of physical cash. The bank said it is looking at options for a CBDC that does not require a user to disclose personal information or have a bank account.

Last December, the Canadian Bankers Association said that the objectives and benefits of a Canadian CBDC have not yet been clearly established, and could pose potential risks to the financial sector. Critics have questioned the need for a CBDC in Canada, especially since many of its benefits and potential services are already accomplished by private banks — including in the form of e-transfers, online purchases, digital payments.

The biggest concern for commercial banks is that CBDCs could undermine their business model. Currently, banks rely on deposits for a large portion of the money they lend to make a profit. If Canadians keep most of their savings in the form of a CBDC, rather than in a bank account, this could affect bank financing and potentially increase the cost and reduce the availability of loans. To reduce the likelihood of CBDCs competing with bank deposits, the Bank of Canada said a potential digital dollar would not pay interest.

Another concern is that CBDCs could increase the risk of bank runs, where people rush to withdraw their money from commercial banks when they think the banks have become unstable. In their 2019 article, the Bank of Canada said that in theory, CBDCs could make these runs faster and more frequent, as they could make it easier for customers to withdraw their money.

“We could end up in a situation where a central bank digital currency, instead of making the financial system more stable, makes it less,” said Stephen Murchison, a Bank of Canada adviser. “Fortunately, runs on the entire banking system are extremely rare in modern times. In fact, Canada has never had one.”

What’s next?

Despite all their research and public reports, the Bank of Canada is not launching a CBDC until a Canadian government votes on the project and approves it, which is not currently being discussed. That may never happen, but the bank says it wants to be prepared in case priorities evolve. Within the bank itself, researchers are still looking into whether a CBDC will even solve the issues they are presented with.

“Ultimately, Canadians will decide – through their representatives in Parliament – whether a digital dollar should be issued,” the bank says on its website.