The Rise of Digital Money

In only ten years since the creation of bitcoin, cryptocurrencies have made the leap from niche academic concept to a reality of increasing relevance to consumers, investors and policymakers - with the potential to revolutionize the banking and financial system. A recent IMF paper (in the new series of FinTech Notes) by Tobias Adrian (Financial Counsellor and Director, Monetary and Capital Markets Department) and Tommaso Mancini-Griffoli (Deputy Division Chief, Monetary and Capital Markets Department) analyses the interplay between new forms of money and the banking sector, with a focus on financial stability.

The paper argues that the two most common forms of money today – cash and bank deposits – will face intense competition in the near future from different types of electronic currencies and could even be made obsolete. The paper proposes answers to three key questions on the impact of electronic money on the financial system – What? When? How? It also adds notes on what Central Banks may potentially do about it.

Figure 1: The "money tree"

Source: Adrian and Mancini-Griffoli (2019)
Notes: CBDC = Central bank digial currency


At the core of the understanding that the paper proposes is the “money tree” taxonomy of monies (see Figure 1: The "money tree"), based on four attributes of a means of payment:

  1. Type – either an object or a claim. For example, cash or bitcoin can be thought of as physical or electronic objects. The other option is to transfer a claim on value existing elsewhere (e.g. a debit card payment).
  2. Value - i.e. whether the redemption of a claim in currency is at fixed or variable value. A claim with a non-fixed value can be thought of as an equity-like instrument with upside and downside risks.
  3. Backstop - i.e. whether the government provides a guarantee to redemption rights or instead solely relies on prudent business practices.
  4. Technology – either a centralised or decentralised (e.g. Distributed Ledger Technology - DLT) settlement.

In the money tree, the paper focuses on three forms of money:

  • B-money - the most common claim-based money existent is based around commercial bank deposits, supported by the complex infrastructure of card payments.
  • E-money - i.e. cryptocurrencies that issue claims that can be redeemed in currency at face value upon demand (e.g. Alipay and WeChat Pay in China, Paytm in India, and M-Pesa in East Africa). This is like b-money, except that redemption guarantees are not backstopped by governments.
  • I-money - a potential new means of payment. I-money is equivalent to e-money, except that it offers variable value redemptions into currency, as an equity-like instrument. I-money entails a claim on assets, typically a commodity such as gold or shares of a portfolio. Examples of i-money are Digital Swiss Gold (DSG), Novem (gold-backed) and probably Libra (portfolio of assets-backed).

These three forms of electronic money offer very different profiles in terms of their risk-return characteristics. For example, e-money does not benefit from government backstops in the same way that b-money does, and hence is exposed to liquidity and market risks. I-money is exposed to market and exchange rate risks due to the nature of the collaterals.


Despite the potential risks, the authors argue that the adoption of e-money may grow rapidly due to six mutually reinforcing factors: (i) convenience, (ii) ubiquity, (iii) complementarity, (iv) low transaction costs, (v) relative trust in countries with weak financial systems, and (vi) network effects.

Rapid adoption would entail potentially large risks from a policymaker’s perspective: (i) banking disintermediation with the obliteration of the traditional financial sector; (ii) market contestability and the creation of monopolistic powers from large players; and connected to this (iii) risks to the privacy of consumers. Moreover, financial disintermediation would induce a drop in sovereign currency demand and hence a loss of monetary policy transmission, of monetary seigniorage, as well as of relevant information on financial flows. Finally, the loss of financial integrity due to decentralised technologies can raise challenges to the enforcement of anti-money-laundering (AML) and counter-terrorism financing (CFT) obligations.


Three scenarios are possible. The first scenario would see the coexistence of e-money and b-money. The challenge to banks may drive gains for consumers in terms of higher rates on deposits, greater operational efficiency, better services and lower profits. A second scenario could see the e-money providers complement commercial banks. This essentially what is happening in emerging markets where the fintech sector is providing banking to a large non-banked part of the society, familiarising them to the financial sector and encouraging them to migrate towards more traditional forms of banking. The third and less likely scenario is a takeover in which the financial sector is radically transformed. Commercial banks’ deposit-taking and credit functions are split - deposits for payment would migrate to e-money while savings could be channelled to mutual funds, hedge funds and capital markets for the allocation of credit.

What could Central Banks do about it?

A key policy observation in the paper is that central banks could offer deposit facilities and settlement services to e-money providers, conditional on certain criteria being satisfied and supervised. This would at the same time facilitate the integration of e-money in the financial system and ensure full accountability and stability of the whole system.

The authors observe that this would be a major policy decision accelerating the transformation of the financial system, with several advantages but also potential downside risks. One important consequence is particularly relevant – the de facto creation of a form of central bank digital currency (CBDC). In fact, if e-money providers had access to central banks’ reserves that are protected against counterparty risks and if e-money were issued one for one for reserves – in a narrow banking manner – then, essentially, e-money transactions would happen in central bank liability.


Adrian, T. and Mancini-Griffoli, T (2019), The Rise of Digital Money, IMF paper



The material provided in this article is being provided for general informational purposes. Aaro Capital Limited does not provide, and does not hold itself out as providing, investment advice and the information provided in this article should not be relied upon or form the basis of any investment decision nor for the potential suitability of any particular investment. The figures shown in this article refer to the past or are provided as examples only. Past performance is not reliable indicator of future results.

This article may contain information about cryptoassets. Cryptoassets are at a developmental stage and anyone thinking about investing into these types of assets should be cautious and take appropriate advice in relation to the risks associated with these assets including (without limitation) volatility, total capital loss, and lack of regulation over certain market participants. While the directors of Aaro Capital Limited have used their reasonable endeavours to ensure the accuracy of the information contained in this article, neither Aaro Capital Limited nor its directors give any warranty or guarantee as to the accuracy and completeness of such information.

Please be sure to consult your own appropriately qualified financial advisor when making decisions regarding your own investments.