Jens Weidmann, president of Germany's central bank, said the "classic bank run" on Northern Rock bank in 2007 would have had an even bigger impact on financial stability had it involved virtual currency.
"The biggest threat in terms of financial stability [from central banks issuing their own virtual currency] is the possibility of a digital bank run," Weidmann said at a conference in Frankfurt organised by Deutsche Bundesbank. "Of course, the analogue world has seen the odd bank run – an image of long queues forming in front of branches of the UK bank Northern Rock in 2007 springs to mind. But a digital bank run would be different."
"In a classic bank run, customers have to find another way of storing the money that they withdraw, and this entails either risk or costs. In a digital bank run, all it takes is a few mouse clicks to transfer savings out of the private financial system and into a central bank account. Customers are less likely to think twice about doing that. It is fairly safe to say that, had such an option been available back then, it would not have been just Northern Rock's customers but also those of other UK banks that would have wanted to place their savings out of harm's way at the central bank just in case, and precisely this action would have completely destabilised the entire banking system," he said.
However, banking expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said he does not believe that having a digital currency issued by a central bank as an alternative to cash would exacerbate a run on a commercial bank at a time of financial crisis.
"Whilst it may be easier to transfer funds held at a commercial bank into digital currency held at a central bank, in reality this would be no different to extracting the funds in the form of cash from the bank in question," Anderson said. "A digital currency issued by a central bank is by definition tied to the value of the underling fiat currency. Whilst depositor protection is guaranteed by the relevant government, currently up to £85,000 in the UK under the Financial Services Compensation Scheme, there would be little incentive for individual depositors to place deposits in the form of digital currency at the relevant central bank."
"The prospect of any government being willing to hold deposits for individuals in a digital currency issued by a central bank seems extremely remote logistically. With some central banks currently attaching negative interest rates to such deposits, it also seems extremely unattractive for depositors compared to another well capitalised and liquid commercial bank," he said.
Weidmann used his speech to outline his opposition to "abolishing cash for monetary policy reasons". He said that would be "wrong and an entirely disproportionate response to the monetary policy challenges close to the zero lower bound".
He said that because "digital central bank money" would "enter into direct competition with bank deposits" it could see banks increase interest rates to "stop their customers rolling bank deposits over into digital central bank money".
"This would cause a further fall in margins in the deposit/lending business, which could have repercussions on financial stability," Weidmann said.
Charlie Clarence-Smith of Pinsent Masons, a specialist in digital currencies and their regulation, said that while alternative payment systems are continuing to grow, in most jurisdictions those systems "will only ever complement cash, rather than replace it" until such time as there is "significant government involvement to create a cashless society".
"We have seen, however, noteworthy government intervention already, particularly in Sweden which is now almost cashless and in India where the 500 and 1,000 rupee bank notes were recently withdrawn in an effort to fight tax evasion. It will be interesting to see how many countries follow suit in the next five to 10 years," he said.
In his speech, Weidmann said that central banks can resist calls to issue their own virtual currency if they "ensure that the technology behind payment transactions is always up to date". He highlighted efforts across the euro system to introduce real-time payments before the end of 2018 as an example of ongoing work in this respect.
Weidmann said that cash also still "has an important role to play in today's payments landscape", despite acknowledging that improving technology has "made cashless payments more convenient and efficient".
"I do not share the fear expressed by some that digital money, which is currently a subject of growing debate, is set to become a serious competitor for cash or bank deposits in the foreseeable future," Weidmann said.
Anderson said: "I agree that fiat currency issued as cash is still important to the robustness of a nation’s economy particularly for liquidity purposes. This view is vindicated by the results of the Bundesbank's recent survey which highlights that the majority of transactions in Germany are still conducted in physical cash rather than alternative payment methods such as debit cards or mobile banking. Crucially, 88% of respondents to the survey then went on to voice a preference for the use of cash now and in the future whilst strongly rejecting the idea of abolishing cash or limiting its use in the future."
Weidmann compared the "confidence" created by a central bank issuing cash to the decentralised way in which virtual currencies such as Bitcoin operate. He described Bitcoin as "inefficient, both economically and environmentally".
"The value of crypto tokens is highly volatile, as we have seen over the past few weeks," he said. "Indeed, even amid the market turbulence we have experienced recently, Bitcoin is currently around six times more volatile than the S&P 500, and 13 times more so than gold. That naturally makes it less than ideal as a means of payment. After all, if you've got a payment instrument that's soaring in value, you'll want to keep it for yourself, and if its value is plummeting, you'll be hard pressed to find any takers."
Clarence-Smith said: "There is a lot of confusion around the difference between cryptocurrencies issued on a centralised distributed ledger versus a decentralised distributed ledger. A cryptocurrency issued solely by a central bank on a centralised distributed ledger is controlled by a central authority, the central bank. This is very different to a decentralised cryptocurrency controlled by the multiple participants of the network – i.e. no central authority – such as bitcoin or ether."
"With regard to volatility, a 'crypto-pound' for example, issued by the Bank of England, would be pegged to British pound-sterling and would, therefore, share the same level of low-volatility, nothing like bitcoin. The 'crypto-pound' would, in theory, be an acceptable means of payment but I cannot foresee any additional benefits to traditional digital payments. From a government perspective in high-cash societies, however, cryptocurrencies issued by their prospective central banks might be beneficial in providing a way to track the circulation of funds, which is much harder to do with cash," he said.