Comparing three competing digital payment instruments
The competing digital payment instruments that Jon Frost, Jean-Charles Rochet, Hyun Song Shin, and Marianne Verdier compare in this paper are: bank deposits, digital platform tokens, and central bank digital currencies (CBDCs). The authors develop a theoretical model that integrates two-sided market theory with payment economics. The framework employs a Hotelling competition model where payment intermediaries (a bank and a digital platform) compete for consumers and merchants who are distributed along a line representing their preferences. Key modeling assumptions include:
- Consumers and merchants incur transport costs when opening accounts with intermediaries that don’t perfectly match their preferences
- Merchants “single-home” by choosing either physical (brick-and-mortar) or digital (online) trading
- The market is covered on the merchant side but not necessarily on the consumer side, allowing for financial exclusion
- Trading generates surplus divided between consumers and merchants based on relative bargaining power
The model examines three scenarios: walled gardens (where payment systems are non-interoperable), introduction of a fast payment system (FPS) that enables interoperability, and implementation of a retail CBDC.
The paper demonstrates several key results:
- Under walled gardens, access to accounts and trade volumes are inefficiently low, leading to financial exclusion of consumers who find transport costs prohibitive.
- With a fast payment system, financial exclusion disappears as all consumers gain access to electronic payment instruments. However, this comes with disintermediation—incumbent intermediaries lose market share to non-bank payment service providers (PSPs). Counterintuitively, merchant fees increase because demand for incumbent services becomes less elastic, though overall social welfare improves.
- CBDCs and FPS are essentially equivalent for the industrial organization of the payment system. Both public options can increase financial inclusion and improve social welfare, though they may lead to some degree of disintermediation.
The authors conclude that even with potential disintermediation effects, public payment infrastructures like FPS or CBDCs can contribute meaningfully to financial inclusion and welfare improvements compared to a laissez-faire approach with competing private walled gardens.
Competing digital monies
Authors: Jon Frost, Jean-Charles Rochet, Hyun Song Shin, Marianne Verdier
From: Bank for International Settlements, Toulouse School of Economics, Université Paris-Panthéon-Assas
Digital money and monetary fragmentation
This paper by Benjamin Hemingway develops a three-period banking model to study monetary singleness—the concept that all forms of money should trade at par and share a common unit of account- in the presence of rapid innovation in digital payments. The model features two regions, each with a bank, laborer, and artisan. Banks choose both the unit of account for their debt and whether it can be used as a medium of exchange.
Findings
The paper finds that small deviations from a common unit of account may still be consistent with efficient allocation, but inefficient equilibria are more likely when new digital money is issued by entities with distinct business models from incumbent financial institutions. Specifically:
- A common unit of account is not necessary for efficiency, though it often coincides with first-best equilibria
- Inefficient equilibria are more likely when monetary instruments are backed by heterogeneous asset portfolios, particularly relevant for stablecoins and privately issued digital money
- Cash plays a stabilizing role as a universally accepted medium of exchange that serves as a backstop when full interoperability of private monies is impaired
- Central bank reserves can reduce variance in banks’ output and increase the likelihood of efficient equilibria
- When units of account diverge significantly, banks may charge interbank transfer fees or restrict transfers altogether, leading to monetary fragmentation
A Model of Monetary Singleness
Author: Benjamin Hemingway
From: Bank of England
