Digital currencies may alter the size and composition of central bank assets Most of my remarks today have focused on the potential implications of digital currencies for central bank liabilities. But of course, for every liability, there also has to be an asset. Whether those assets are, in total, any larger than today depends, in part, on whether new digital currencies cause a net increase in demand for central bank liabilities, or simply substitute for reserves or banknotes. A narrow digital currency that largely cannibalised banknote demand, for example, might have little or no impact. By contrast, a broad digital currency with many attractive payments features could materially increase the demand for central bank liabilities. The impact of any increase in demand on the size and composition of central bank assets depends on whether, and how, central banks choose to accommodate that demand. I’ve already noted that, in systems like the UK’s, digital currencies may cause some banks whose deposit bases have been partially disintermediated to increase their borrowing from market-wide facilities. A more interesting case could arise if the central bank chooses instead to back persistently higher demand with more long-lasting assets, for example to reduce rollover risk. At modest size, that may look little different to today’s banknote programmes.
But, to take one example proposed by some, if a systemic stablecoin were required to be fully backed by deposits at the central bank, the implications for central bank balance sheets could be very similar to CBDC (Chart 4). This would also be the case if a ‘narrow bank’ chose to issue its own tokenised deposits and put all the proceeds into holdings at the central bank. Indeed, arguably any stablecoin with a credible link to fiat currency relies ultimately on settlement in central bank money. Of course, that does not mean that it is central bank money: even fully-backed, regulated stablecoins would remain the liabilities of private sector companies, and hence pose a range of risks not associated with CBDCs. 4  See Record of the Financial Policy Committee - 13 December 2019 (bankofengland.co.uk) and https://www.bankofengland.co.uk/financial-policy-summary-and-record/2022/march-2022 5 As proposed by the UK Treasury in O-S_Stablecoins_consultation_response.pdf (publishing.service.gov.uk). Bank of England  Page 7  3. Digital currencies may alter the transmission mechanism for monetary policy A key unknown in assessing the impact of digital currencies lies in judging the extent to which they may affect the flow, and pricing, of money and credit in the economy – which in turn has implications for the transmission mechanism for monetary policy. When a bank creates a new loan, it must retain or attract sufficient deposits to fund it.6 Digital currencies do not fund credit creation, but they do increase the competition for, and hence the cost of, deposits, with knock-on implications for the price and availability of credit.