Central banks that don't issue their own digital tokens could see demand for their currencies drop - CBDCs could even be part of their policy toolkit, Bank of America says

• Central banks could see demand for their physical currency drop unless they issue CBDCs, Bank of America says.
• The strategists said central banks could even make digital currencies part of their monetary policy toolkit.
• Central banks of major global economies are currently researching or testing digital currencies.

Central banks that don't issue their own digital currency will face a dropoff in demand for their physical currency, with the US dollar and euro especially at risk of losing their leading global role, Bank of America analysts have warned.

The widespread adoption and usage of central bank digital currencies, or CBDCs, is inevitable, they said in a research note last week. Such CBDCs would be used as digital cash, rather than a store of value, and could also play a part in monetary policy toolkits, they argued.

Not having a CBDC creates the risk of losing out to countries that do have one, as well as to private actors or companies launching tokens, the Bank of America strategists believe. Much of this is linked to the surge in popularity in private, blockchain-based cryptocurrencies such as bitcoin.

The usefulness of digital cash could prompt people to adopt a CBDC from a foreign institution to carry out transactions, if their own central bank fails to act.

"In some cases, countries without CBDCs could be 'dollarized' as their citizens start using another country's CBDC, and potentially see the value of their currency drop sharply," the analysts said in the Wednesday note.

That could have an impact on the status of countries in the global financial system. If the US and EU don't digitize their currencies, then the dollar risks losing its dominance and the euro's role in global transactions and in reserves, the strategists argued.

The declining use of physical cash by consumers, the threat of losing control of monetary matters, the increasing use of blockchain by businesses are factors driving central banks toward their own digital currency.

While many major economies are at various stages of developing a central bank digital currency, China is leading the way and its digital yuan is could be available for international visitors at the 2022 Winter Olympic games in Beijing. Meanwhile, the EU said last week it is moving forward with development of a digital euro, and the US central bank is exploring a digital dollar.

Digitization has other benefits for central banks, beyond ensuring their currencies stay relevant in global financial markets and securing the value of those fiat currencies.

"In practice, central banks could utilize features of CBDCs in the future as part of an enhanced monetary policy toolkit if needed, particularly in response to a shock or a crisis," the analysts said.

They noted that central banks could see monetary control slip away if their country's inhabitants turn to a global cryptocurrency or another country's CBDC, both beyond the institution's reach. That would make cooling inflation harder to achieve.