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 about whether to launch a CBDC rests with the federal government, the central bank has said it wants to be prepared for the possibility — especially as Canadians increasingly use digital methods of payment 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 would equal one Canadian dollar, and it could be used for in-person and online purchases, as well as payments between businesses. It could also be transferred between people.

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

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

“As with bank notes, Canadians shouldn’t need identification, a bank account or to disclose private information to perform basic financial transactions,” the Bank of Canada site says.

Why is Canada looking into 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 risen in popularity. The COVID-19 pandemic only accelerated this trend, with more Canadians going online to do their shopping as they stayed home.

“Since COVID-19 hit, we’ve seen a growing hesitancy in Canada to use cash,” said Timothy Lane, then-deputy governor of the Bank of Canada, in 2021. “Although Canadians are holding more cash than ever, cash may not currently be circulating as much.”

The bank is also responding to developments in computer technology. Cryptocurrencies, such as Bitcoin, are not widely used as a form of payment; they are essentially speculative assets. But the technology that supports cryptocurrencies could still have a significant impact on how payments work, and the central bank wants to stay on top 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 pegged to something more stable, like 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 shelved in 2022. But it raised the stakes for central bankers who guard their place at the centre of the payments system.

How would digital currency work?

The Bank of Canada has not yet announced any specific details for how a Canadian CBDC would work, but have mentioned a few ideas. In a 2019 article, the bank said it could either be account-based, where Canadians could open an account to transfer their money into a digital currency form, or value-based, where money could be transferred from your bank directly to a physical card, 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 various groups that a Canadian CBDC shouldn’t require an internet connection to be used. If the bank goes that route, your digital wallet would be stored directly on a card, account or phone app, which you would be able to use to transfer money to other users, or pay businesses directly. Users also would not require any identification or a bank account to interact with a Canadian digital currency.

Will a digital currency replace physical cash?

Though 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’s still the best currency available in terms of safety, accessibility and privacy. A Canadian digital currency is intended to bring some of those benefits into the situations where cash can’t be used, such as in online shopping or at cashless businesses.

“Our responsibility is to provide Canadians with bank notes they can trust,” the bank said. “We’ve done this for almost 90 years, and we’re committed to issuing bank notes 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 some 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 per cent of currency used in the country is their CBDC, and very few vendors accept it. Nigeria’s eNaira digital currency, launched in 2021, is seeing similarly low adoption and usage numbers.

What has been the reception to the Bank of Canada’s digital currency research?

Federal Conservative Leader Pierre Poilievre has been vocally opposed to the idea of a Canadian digital currency, and has said he would not introduce a CBDC if his party forms government. He’s come out in the past as a supporter of private cryptocurrencies like Bitcoin.

In an online survey published in November by the Bank of Canada, a majority of respondents said they were concerned about the privacy of a digital currency, compared with the anonymous benefits of physical cash. The bank said it is looking into options for a CBDC that would not require a user to divulge 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 it could bring potential risks to the financial sector. Critics have doubted the need for a CBDC in Canada, especially since many of its benefits and potential services are already being accomplished by private banks — including in the form of e-transfers, online purchases, digital payments.

The main concern for commercial banks is that CBDCs could undermine their business model. Right now, banks rely on deposits for a large portion of the money that they loan out to make a profit. If Canadians kept most of their savings in the form of a CBDC, rather than in a bank account, that could impact bank funding and potentially increase the cost and decrease the availability of loans. To reduce the likelihood that CBDCs would compete with bank deposits, the Bank of Canada has said that 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 quicker and more frequent, since it could make it easier for clients to transfer their money out.

“We could end up in a situation where a central bank digital currency, instead of making the financial system more stable, makes it less so,” said Stephen Murchison, a Bank of Canada adviser. “Thankfully, 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 isn’t launching a CBDC until a Canadian government votes on and approves the project, which isn’t currently being discussed. Potentially, it could never happen, but the bank says they want to be prepared in case priorities evolve. Within the bank itself, researchers are still looking into whether a CBDC would even solve the issues they’re presented with.

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