B. What could be the impact on the financial system of a CBDC, and how could this affect financial stability?

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1 Primary questins Frm the full list belw we have highlighted sme primary questins which will frm the cre f the Bank s research, reflecting ur respnsibility fr mnetary and financial stability. The purpse f ding s is t prvide guidance t external researchers n the Bank s pririties amngst all the tpics n the lng list. A. What culd be the ecnmic impact f a CBDC? Macrecnmics Hw culd it impact the level, grwth and vlatility f ecnmic utput and ther macrecnmic variables? Thrugh what channels wuld this ccur? What attributes wuld CBDC need t have in rder t realise these effects? Hw des the way CBDC enters the ecnmy (by being spent, lent, r sld by the central bank) influence the effect f CBDC n the ecnmy in the intrductin phase, steady-state and crisis perids? What is the estimated magnitude f the macrecnmic effects f a CBDC? What attributes wuld a CBDC need t have in rder t achieve these effects? This questin is addressed in Barrdear and Kumhff (2016), which als sets ut useful empirical extensins t their apprach. B. What culd be the impact n the financial system f a CBDC, and hw culd this affect financial stability? Financial system T what degree wuld hldings f mney (and near mney substitutes) shift frm banks depsits t CBDC? What wuld be the likely dynamics f shifts between bank depsits and CBDC in any intrductin phase, in steady-state and crisis? Hw is this affected by the characteristics f the CBDC itself (e.g. hw it enters the ecnmy, wh hlds it, its functinality and relative price)? What factrs affect the prpensity t substitute int CBDC, and the flws between bank depsits and CBDC? Hw culd relative demand fr bank depsits and CBDC be managed? What is the percentage change in demand fr bank depsits due t a given percentage pint change in its interest rate (i.e. the semi-elasticity)? Similarly, in the presence f a CBDC, what wuld be the change in demand fr CBDC 1

2 relative t bank depsits due t a change the rate n bank depsits, the rate n CBDC and t the CBDC-bank depsit interest rate spread? Hw wuld this vary ver different hlders f bank depsits? Hw d the characteristics and functinality f the CBDC affect these semi-elasticities? Hw wuld the presence f CBDC affect bank funding and the cst and prvisin f credit in the ecnmy? Hw else might a CBDC affect cmmercial banks activities? Hw wuld this affect the stability and resilience f banks? What are the implicatins fr verall financial system stability? C. Hw wuld a CBDC interact with mnetary, financial stability and fiscal plicy? Hw culd it be used as a new plicy tl? Mnetary and financial stability What new mnetary plicy tls culd the CBDC ffer? What is their transmissin mechanism and hw wuld they perate? What are their welfare prperties? Hw culd a CBDC interact with existing mnetary plicy tls? Hw wuld the intrductin r steady-state presence f CBDC interact with the unwinding f Quantitative Easing? What financial stability tls culd a CBDC ffer? Hw culd CBDC interact with existing financial stability tls (including gvernment backed depsit insurance, cuntercyclical capital buffers, and the lender f last resrt functin)? D. Hw culd CBDC be technically implemented? Hw culd this be cnfigured t meet the requirements f a CBDC? Is the technlgy sufficiently scalable fr a CBDC? Culd a system cpe with the required transactin thrugh-put and frequency? Hw is the perfrmance f the system affected as the scale increases? Hw shuld the security and resilience f CBDC be assured? What degree f centralisatin is ptimal fr systemic security? What are the ptential vulnerabilities f distributed systems? Hw resilient are different mdels? What happens if multiple ndes are absent, malicius r faulty? Hw secure are varius cnsensus prcesses? Are cllusins pssible? What cryptgraphic techniques are apprpriate? Can the system be designed t be future prf against develpments in cryptgraphic 2

3 techniques? Shuld pst-quantum cryptgraphic techniques be cnsidered? Hw can interperability be implemented? Is it pssible fr blckchain-based systems t functin alngside existing infrastructure? Hw culd interperability between ther distributed ledgers, and als with existing systems, be achieved? Is there a need t intrduce standards fr distributed ledger technlgy (DLT)? Culd a natinal platfrm fr distributed recrd keeping be created, t supprt numerus gvernment-sectr activities, ptentially including the issuance f a (r several) natinal digital currencies? 3

4 All questins A. What culd be ecnmic impact f a CBDC? i. Macrecnmic a. Hw culd it impact the level, grwth and vlatility f ecnmic utput and ther macrecnmic variables? Thrugh what channels wuld this ccur? What attributes wuld CBDC need t have in rder t realise these effects? b. Hw des the way CBDC enters the ecnmy (by being spent, lent, r sld by the central bank) influence the effect f CBDC n the ecnmy in the intrductin phase, steady-state and crisis perids? c. Hw culd a CBDC (r multiple CBDCs) affect capital flws, exchange rates and trade expsed sectrs f the ecnmy? d. What is the estimated magnitude f the macrecnmic effects f a CBDC? What attributes wuld a CBDC need t have in rder t achieve these effects? This questin is addressed in Barrdear and Kumhff (2016), which als sets ut useful empirical extensins t their apprach. ii. Micrecnmic a. Hw culd a CBDC affect cmpetitin and efficiency in the ecnmy? What new business mdels may emerge? What business mdels may becme bslete? Hw will CBDC affect different industries? What attributes wuld CBDC need t have in rder t realise these effects? B. What culd be the impact n the financial system f a CBDC? Hw culd this affect financial stability? i. T what degree wuld hldings f mney (and near mney substitutes) shift frm banks depsits t CBDC? What wuld be the likely dynamics f shifts between bank depsits and CBDC in any intrductin phase, in steady-state and crisis? Hw is this affected by the characteristics f the CBDC itself (e.g. hw it enters the ecnmy, wh hlds it, its functinality and relative price)?what factrs affect the prpensity t substitute int CBDC, and the flws between bank depsits and CBDC? b. Hw culd relative demand fr bank depsits and CBDC be managed? c. What is the percentage change in demand fr bank depsits due t a given percentage pint change in its interest rate (i.e. the semi-elasticity)? Similarly, in the presence f a CBDC, what wuld be the change in demand fr CBDC relative t bank depsits due t a change the rate n bank depsits, the rate n CBDC and t the CBDC-bank depsit interest rate spread? Hw wuld this vary ver different hlders f bank depsits? 4

5 Hw d the characteristics and functinality f the CBDC affect these semi-elasticities? d. Hw wuld the presence f CBDC affect bank funding and the cst and prvisin f credit in the ecnmy? ii. iii. Hw else might a CBDC affect cmmercial banks activities? Hw wuld this affect the stability and resilience f banks? What are the implicatins fr verall financial system stability? What culd be the impact f CBDC n financial markets? a. What wuld be the likely impact n mney markets? b. What wuld be the likely impact f instantaneus settlement n financial markets? Is instantaneus settlement desirable? Des this change if it is instantaneus settlement achieved with r withut CBDC? Is there enugh liquidity in the system fr real time grss settlement f all payments? c. What impact wuld issuing CBDC have n market frictins? iv. Hw culd CBDC impact the verall structure f the financial system (including the payment system)? What benefits wuld be intrduced? a. Hw culd the presence f CBDC affect the reslutin f a financial institutin r financial market infrastructure? b. Wuld the intrductin f a CBDC make the financial system mre/less stable and resilient t shcks? v. Hw des the way CBDC enters the ecnmy (by being spent, lent, r sld the central bank and t whm?) affect the financial stability in the transitin phase, steady state and in crisis? vi. What are the risks t financial and mnetary stability f an alternative digital currency (private r ther natinal CBDC, fiat r nn-fiat linked) being used in the UK? Hw wuld the presence f a UK CBDC affect this risk? C. Hw wuld a CBDC interact with mnetary, financial stability and fiscal plicy? Hw culd it be used as a new plicy tl? i. What new mnetary plicy tls culd the CBDC ffer? What is their transmissin mechanism and hw wuld they perate? What are their welfare prperties? ii. iii. Hw culd a CBDC interact with existing mnetary plicy tls? Hw wuld the intrductin r steady-state presence f CBDC interact with the unwinding f Quantitative Easing? 5

6 iv. What financial stability tls culd a CBDC ffer? Hw culd CBDC interact with existing financial stability tls (including gvernment backed depsit insurance, cuntercyclical capital buffers, and the lender f last resrt functin)? v. What, if any, are the trade-ffs between using a CBDC tl fr mnetary versus financial stability plicy? vi. Hw culd CBDC interact with fiscal plicy? D. Hw culd CBDC be technically implemented? Is a frm f distributed ledger the mst apprpriate methd? Hw culd this be cnfigured t meet the requirements f a CBDC? i. Is DLT the mst apprpriate technlgy fr a CBDC? Are there alternative technlgies which prvide the required features and resiliency fr a digital currency? ii. If using DLT, wuld a permissined r permissinless system be mre apprpriate? What mechanism culd transactin verifiers (ndes) use t arrive at cnsensus, and hw des this differ fr permissined and permissinless systems? a. In a permissinless system, are there cnsensus mechanisms which enable genuine decentralisatin, whilst maintaining security and withut resulting in an verinvestment in cmputing resurces r high cncentratin f mining pwer? b. If using a permissined system, culd a versin f practical byzantine fault tlerance (PBFT) r tw-phase cmmit be used? What are the benefits and the risks in terms f scalability, security and privacy? What ther cnsensus mechanisms might be apprpriate? iii. Hw can apprpriate privacy levels be implemented technically? a. Can a system be designed withut the full ledger being visible t external transactin verifiers? Is it pssible t enable full privacy whilst als achieving the resiliency benefits f distributin? Are there cryptgraphic techniques that culd help enable this (e.g. zer knwledge prfs)? b. Hw lng shuld data be stred fr? Can a system be designed s that data is nly kept fr the apprpriate perid f time? iv. Is the technlgy sufficiently scalable fr a CBDC? a. Culd a system cpe with the required transactin thrugh-put and frequency? b. Hw is the perfrmance f the system affected as the scale increases? 6

7 v. Hw shuld the security and resilience f CBDC be assured? a. What degree f centralisatin is ptimal fr systemic security? What are the ptential vulnerabilities f distributed systems? b. Hw resilient are different mdels? What happens if multiple ndes are absent, malicius r faulty? c. Hw secure are varius cnsensus prcesses? Are cllusins pssible? d. What cryptgraphic techniques are apprpriate? Can the system be designed t be future prf against develpments in cryptgraphic techniques? Shuld pst-quantum cryptgraphic techniques be cnsidered? vi. Hw can interperability be implemented? Is it pssible fr blckchain-based systems t functin alngside existing infrastructure? a. Hw culd interperability between ther distributed ledgers, and als with existing systems, be achieved? Is there a need t intrduce standards fr DLT? b. Culd a natinal platfrm fr distributed recrd keeping be created, t supprt numerus gvernment-sectr activities, ptentially including the issuance f a (r several) natinal digital currencies? vii. Hw culd the system implement the functins f a central bank? a. Hw culd the central bank cntrl the supply f narrw mney (the issuance and withdrawal f currency)? b. Hw culd the central bank apply interest t hldings f currency? c. Culd plicy be implemented dynamically thrugh autmatic rules? (e.g. changing the interest rate depending n flws r the state f the financial system?) E. Wh shuld be the participants f a CBDC system, what shuld be their rles and hw culd incentives be aligned? i. What is the apprpriate rle f the central bank in the system, and what functins f the system culd r shuld be perfrmed by third parties? (Fr example, mdificatin t the surce cde, nde peratin, strage f the ledger, transactin verificatin, exchange prvisin, wallet prvisin.) a. What is the business mdel ratinale fr these third parties? Hw will they make mney and will this detract frm any f the efficiency and disintermediatin benefits that might have been identified in the macrecnmic research? 7

8 ii. Hw, and by whm, are transactins initiated, validated and prcessed? Hw shuld the csts f transactin verificatin be dispersed t the users f the system? iii. Hw shuld users interact with the system? (e.g. shuld they be able t directly hld CBDC thugh accunts at the central bank and/r have indirect hldings thrugh custdial third-party wallet prviders?) iv. Hw much data shuld be available t varius parties (e.g. transactin verifiers, central bank, gvernment authrities), and what culd it be used fr? a. Hw culd data analytics techniques be applied t CBDC data t aid existing analysis (e.g. fr regulatin, risk management, credit ratings, crime preventin, research)? What new analysis culd be pssible with CBDC? Culd data be aggregated fr analytical purpses? Hw shuld data be structured? v. Hw culd participants in a CBDC be incentivised? a. What incentive structures culd ensure wallet prviders and users priritise wallet security r encurage peratinal resilience? b. What incentive structure encurages efficient use f the system? 8