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Researcher S. Mohammad R. Davoodalhosseini of the Bank of Canada, the country’s central bank, published a working paper regarding the potential benefits of central bank-issued digital currencies (CBDCs). He reviews the state of CBDCs and offers a model to study the coexistence of a CBDC and a fiat currency.

Davoodalhosseini begins his paper by contextualizing CBDCs. He notes, “There has been a great deal of discussion in recent years about the effects of introducing [CBDCs] into economies and whether cash should be eliminated.” He provides the examples of Sweden and China, which are considering their own CBDCs.

As part of this discussion, he asks the following questions:

“Should central banks eliminate cash from circulation? What would be the optimal (i.e., welfare-maximizing) monetary policy if agents [consumers] can choose between cash and CBDC? And quantitatively, what are the welfare gains of introducing CBDC into the economy?”

To answer these questions, Davoodalhosseini builds a model whereby both cash and a CBDC are available to consumers, and compares it to cash-only and CBDC-only systems.

According to Davoodalhosseini, each scheme would yield different results. The CBDC-only plan, for example, would allow more allocations and the ability to earn nonlinear interest, but there would be a loss in economic welfare resulting from the costs associated with carrying a CBDC (such as consumers’ lack of anonymity).

When both cash and a CBDC are available, the interplay is a bit complicated. Davoodalhosseini notes that a CBDC would impose “a constraint” in reaching optimal monetary policy. If such a constraint were too rigid, “then the central bank would prefer to have only one means of payment used by” consumers, either fiat or a CBDC. Conversely, if the constraint were somewhat lax, “then the central bank would have both cash and CBDC circulating in the economy.”

The coexistence approach also comes with a caveat. Davoodalhosseini suggests that cash inflation could only be positive within this arrangement because a CBDC “would not be adopted under a negative cash inflation rate.”

Further, the inclusion of both cash and a CBDC may also contribute to a loss in economic welfare. He attributes this loss, in part, to possible tax evasion by those who would use cash to avoid CBDC-related taxes. This evasion could cause an underutilization of CBDC interest gains. However, according to Davoodalhosseini, coexistence would ultimately be determined by how well each payment method acted as a substitute for the other (his conclusions assume perfect substitution).

Despite the disadvantages inherent in the CBDC-related schemes, Davoodalhosseini indicates that the introduction of a CBDC could still help the economy. His model demonstrates that a CBDC could increase Canadian consumption up to 0.064 percent or US consumption up to 1.6 percent, as opposed to cash-only economies.

Davoodalhosseini concludes his paper with a suggestion to implement a CBDC by using a central bank-run debit card system. He notes that consumers could have accounts with central banks and that individuals could access the bank’s balance sheet, thereby creating transparency among transactions.

This report is the third cryptocurrency- or blockchain-related study released by the Bank of Canada this month. The other two are a working paper addressing double spending on blockchain systems and a staff analytical note pointing toward increased bitcoin awareness within the country.

Daniel Putney is a full-time writer for ETHNews. He received his bachelor’s degree in English writing from the University of Nevada, Reno, where he also studied journalism and queer theory. In his free time, he writes poetry, plays the piano, and fangirls over fictional characters. He lives with his partner, three dogs, and two cats in the middle of nowhere, Nevada.

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