Canada’s central bank will likely need a digital currency someday to maintain monetary sovereignty and financial stability, according to a new Bank of Canada discussion paper.

The research paper, published Wednesday and authored by Bank of Canada researchers Francisco Rivadeneyra, Scott Hendry and Alejandro García, argues that the decline of cash—due to digital payments, the rise of cryptocurrencies and other forces—is eroding the central bank’s power to conduct monetary policy and manage crises. If this trend continues, the paper argues, regulatory interventions will not be enough. They propose a retail central bank digital currency (CBDC)—effectively a chequing account with the Bank of Canada that’s available to all Canadians.

“It is likely that a digital form of cash, a CBDC, will be needed in order to maintain the status quo,” the paper said. “The digital economy is likely to eventually overpower the physical one where cash is economically relevant.”

Though it doesn’t represent the Bank of Canada’s official position, the report is the strongest statement yet from Bank of Canada staff on the eventual need for a CBDC. It also makes the clearest argument to date for why the central bank is so concerned about the decline of cash.

The Bank of Canada has been conducting research on a possible CBDC for years—the report is the latest of 24 on the topic since 2020. The central bank’s line on the subject has been that there is currently no compelling case for a CBDC, but the organization is keeping its eye on two scenarios that might change that—a significant decline in the use of cash, or a significant increase in the use of non-central bank-issued cryptocurrencies.

The report stresses those two scenarios are still likely decades away, but will probably come to pass. In comparison, a 2021 report with two of the same authors states the digitalization of the economy “could” lead to competition problems and a CBDC “could be necessary in the future.”

Paul Badertscher, a spokesperson for the Bank of Canada, said “staff research does not necessarily represent the view of the Bank of Canada” and the central bank typically does not comment on it. He referenced remarks by Ron Morrow, the bank’s executive director of payments, at the Payments Canada Summit in May, in which he said CBDC research is “part of our core function to ensure a safe and secure supply of public money.”

By way of explaining why cash is important and why a CBDC might be necessary to replace it, the research paper lays out a hypothetical scenario in which cash availability dwindles or disappears. Customers who would then want to get their money out of their banks would not be able to withdraw it in cash, leaving financial assets like stocks, commodities like gold or foreign currencies as their only options.

Since deposits would be effectively stuck, banks would be able to hike fees and reduce service quality, the paper argues. Credit card networks and other forms of digital payments would also be able to hike fees.

In another scenario, private forms of money—such as cryptocurrencies and digital wallets created by tech platforms—might become more widely used. If Canadians can’t withdraw that money as cash, the operators of such private currencies would have little reason to keep fees low, or to make it easier for users to move their funds from one place to another, or even to follow laws and regulations at all, the paper argues. 

A CBDC could prevent these scenarios by promoting competition and monetary sovereignty, functions that cash performs today, according to the paper. Even if ATMs disappeared and banks stopped making cash available, people could still withdraw their money from digital services and crypto assets at any time by converting it into the Bank of Canada’s digital loonies. They could also exit the private banking system by moving money from their accounts into a CBDC, just as they can do so now by withdrawing their money in cash.

Katrin Tinn and Kyoung Jin Choi, finance professors who study CBDCs at McGill and the University of Calgary respectively, both said the paper is notable for its focus on the importance of making a digital loonie available to the public.

“There has been a little bit of ping-pong among central banks about whether they are considering a retail CBDC, or only wholesale,” Tinn said—a wholesale CBDC being one that is only used for transfers between financial institutions. “It is a very welcome development, talking about a retail CBDC.”

Choi said the Bank of Canada’s cautious statements on CBDCs bely its interest. The central bank is at the forefront of CBDC development in the world, he said.

While Canada is taking CBDC research and development seriously, other countries are further along on the path to actually releasing one. Three countries have launched a CBDC and 36 other nations and blocs—including China, Australia and the European Union—are in the pilot phase, according to the Atlantic Council’s CBDC Tracker. China’s digital currency, dubbed the e-CNY, is the world’s largest pilot, reaching 260 million wallets in 25 cities, according to the Atlantic Council, a U.S. think tank.

Choi said he suspects the Bank of Canada is waiting for another wealthy country to issue one first and act as a test case.

“As the report argued, it is unavoidable at some point,” Choi said.