Central Banks are Weighing Digital Currencies – What That Means for Investors

A vast majority (~80%) of global central banks are conducting studies on digital currencies, with some already taking steps to launch them. Several questions likely come to mind for consumers and investors when considering the prospect of a digital currency. Does this mean cash is going away? Will money be held in bank accounts, or somewhere else? Are there investment implications for banks or other large financial institutions?

The Bank of England (BOE) has weighed in on some of these key questions as it recently issued proposals for a digital currency, which some have dubbed “Britcoin.” The Bank of England’s Treasury chief, Jeremy Hunt, emphasized that while Britcoin insinuates some connection to Bitcoin, the BOE’s digital currency should not be compared to a cryptocurrency.¹

Bitcoin and other cryptocurrencies trade on exchanges, often with volatile daily price changes. Conversely, a digital currency (in this case Britcoin) would be denominated in pounds; would have stable value; and finally, would be backed by the Bank of England. None of these safeguards apply to cryptocurrency.

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Put simply, 100 pounds of a digital currency would always equal 100 pounds of cash. The British pound does fluctuate in value relative to the dollar, euro, and other currencies, but those daily price changes are hardly of the magnitude experienced in the cryptocurrency markets.

As for storage/accounts, digital currencies would be held in a digital wallet (also backed by the Bank of England but secured by a financial institution), so that consumers could pay for goods and services electronically, either by computer or with a mobile device. This form of payment already exists to an extent with Apple Pay, Google Pay, and others.

The U.S. Federal Reserve is also in the process of conducting studies on a digital currency here in the U.S., which they have termed a central bank digital currency, or CBDC. The Fed’s focus is on whether a digital currency could improve upon the already efficient and largely safe domestic payments system. At present, physical currency or cash is the only type of central bank money issued to the general public, but adding a digital currency would allow for more payment options without increasing or introducing credit or liquidity risks, according to the Fed.

Perhaps the best way to think about the implications of a digital currency is to consider the potential benefits and risks. The Federal Reserve details their views in a paper titled, Money and Payments: The U.S. Dollar in the Age of Digital Transformation.

Potential Benefits of a Digital Currency:

• It would offer the general public broad access to digital money without introducing credit risk and liquidity risk. As a result, it would create a strong foundation for private-sector innovations (fintech) to expand what’s possible in payment services.
• Adding to the previous point, a digital currency would also open the door to private sector innovation for companies of all sizes, not just the major players with access to partner banks.
• A digital currency in the U.S. would arguably preserve the dollar’s status as the world’s most-used currency. If another digital currency is launched and is easier to trade and use, it could decrease the global use of the dollar.

Potential Risks of a Digital Currency:

• At the most fundamental level, a digital currency could change the structure of the U.S. financial system, where banks in the private sector and the Fed have different roles than they do today. Banks largely rely on deposits to fund their loans, but with the introduction of a digital currency, consumers would not necessarily need to hold money at a bank – especially if the digital currency was interest-bearing. To the extent that deposits are reduced as a result of a digital currency, it could increase bank funding expenses, and reduce credit availability or raise credit costs for households and businesses, according to the Fed.
• An interest-bearing digital currency could also shift assets away from money market funds, Treasuries, and other short-term instruments – which could similarly “reduce credit availability or raise credit costs for businesses and governments. These concerns could potentially be mitigated by CBDC design choices.”
• How monetary policy works could also be a risk central banks need to consider. A digital currency could alter the supply of reserves in the banking system, which may affect how the Federal Reserve controls the federal funds rate and other short-term interest rates.

Bottom Line for Investors

The overarching conclusion, for now, is that cash is not going away anytime soon, so consumers are not likely to be forced into adopting digital currencies as a new form of payment and safe storage of money. According to a 2020 survey completed by the Fed, U.S. consumers used cash for about 20% of purchases, which is down from 40% just a decade earlier. Nevertheless, the Fed remains committed to making cash available even if a digital currency is introduced.

The notion that an introduction of a digital currency is vindication for cryptocurrency or perhaps even a thesis to buy cryptocurrency is off-base. Digital currencies essentially have little in common with cryptocurrencies, and the two should not be compared. As for financial institutions and the financial sector, large banks appear to be the players most at risk from a digital currency, as it may have implications for the levels of deposits held, which influences loan activity. This will be a factor to watch going forward.

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¹ AP News. February 6, 2023.

² Zacks Investment Management may amend or rescind the A Better Way Forward: Actively Managing Passive Index Funds guide offer for any reason and at Zacks Investment Management’s discretion.

³ Zacks Investment Management may amend or rescind the A Better Way Forward: Actively Managing Passive Index Funds guide offer for any reason and at Zacks Investment Management’s discretion.

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