According to a new IMF report, Central Bank Digital Currencies (CBDCs) are set to transform central banks’ operations.

These digital currencies, issued by central banks, could replace cash, bank deposits, or reserves, offering a glimpse into a new era of monetary policy.

The report highlights three scenarios of CBDC adoption. They could replace cash, bank deposits, or interbank reserves.

Each scenario brings unique challenges, including liquidity management issues, pressure on interest rates, and the need for seamless interoperability.

One potential benefit of CBDCs is modernization. They promise faster payments and greater financial inclusion. However, they also introduce risks that central banks must carefully manage to avoid destabilizing the financial system.

Real-world experiments provide some insights. Cambodia’s Bakong system shows how digital payment platforms can cause volatility.

The IMF notes that Bakong’s digital balances are 36 times more volatile than cash, posing significant liquidity management challenges.

Kenya’s M-Pesa platform illustrates how digital payments can transform economies.

Since its launch in 2007, cash usage relative to GDP has halved, while the money multiplier—broad money divided by central bank money—has doubled. CBDCs could have similar effects.

The design of CBDCs will be crucial to their success. Countries like the Bahamas and the EU are already experimenting with holding limits to prevent financial instability.

The Bahamas’ Sand Dollar caps basic user wallets at $500, while the EU proposes limits of €3,000–€4,000 for its digital euro.

China has taken a different approach with its e-CNY, which doesn’t pay interest. This ensures it’s used for transactions rather than savings, reducing competition with traditional bank deposits. These design choices reflect the balancing act central banks face.

The IMF warns that CBDCs could make liquidity forecasting more complex.

Digital demand can fluctuate unpredictably, forcing central banks to intervene more frequently in financial markets. This could expand their balance sheets and expose them to additional risks.

International impacts are also a concern. Foreign access to CBDCs could increase demand for a country’s currency, raising its value and causing exchange rate volatility. For countries with strict monetary policies, this could disrupt traditional economic models.

The IMF remains cautiously optimistic about CBDCs.

While they present challenges, they also offer opportunities to modernize payments and strengthen monetary policy. However, success will depend on thoughtful planning and careful execution.

“CBDCs represent a paradigm shift,” the report concludes. “They offer immense potential but demand equally significant foresight.”