BANK OF JAPAN: CENTRAL BANK DIGITAL CURRENCIES COULD DESTABILIZE EXISTING FINANCIAL SYSTEM

The potential ramifications of central bank digital currencies (CBDCs) are a hot topic of debate worldwide, and Japan is no exception. The nbsp;Bank of Japan has completed its two-year proof-of-concept research for its prospective central bank digital currency (CBDC) nbsp;and has now launched a pilot program. This makes Japan one of the largest economies in the world to advance to the pilot stage of CBDC development. nbsp;Financial experts predict nbsp;that $5 trillion in CBDCs will be circulating through the hands of up to 4While many tout the benefits of CBDCs – increased efficiency, financial inclusion, and enhanced payment innovation – the Bank of Japan (BOJ) has voiced concerns about their potential to disrupt the existing financial order.Specifically, high-ranking officials at the BOJ, including the Deputy Governor, have cautioned that the introduction of a digital yen could destabilize the current financial ecosystem.This raises important questions about the future of money in Japan, a nation where cash remains surprisingly resilient despite the global surge in cashless payments. Central Bank Digital Currency Experiments: Progress on the Pilot Program (April 2025) [PDF 1,273KB] : Central Bank Digital Currency Experiments: Results and Findings from Proof of Concept Phase 2 [PDF 1,646KB] Feb. 17, 2025: Commencement of Central Bank Digital Currency Experiments: Pilot Program [PDF 534KB]This article will delve into the BOJ's perspective, exploring the potential risks and challenges associated with CBDCs in Japan, while also examining the country's ongoing experiments and pilot programs in this rapidly evolving space. Central bank digital currencies (CBDCs) are increasingly becoming a subject matter for a variety of stakeholders in the economy as a whole. In this paper, we will first analyse the nature of CBDCs to show that it is essentially a digital liability of central banks, like today s settlement balances that banks use in their own transactions.We'll analyze the factors contributing to Japan's unique relationship with cash and how these dynamics might influence the adoption and impact of a digital yen.

The Bank of Japan's Cautious Approach to Digital Currencies

Unlike some nations aggressively pushing for CBDC implementation, the Bank of Japan has adopted a more measured and cautious approach. The Bank of Japan s (BOJ) deputy governor spoke negatively about the effects of central bank-issued digital currencies (CBDC) on the current financial system in closing remarks at a fintechSeveral factors contribute to this hesitancy, primarily centered around the potential disruption to the current financial system.

Concerns about Financial Stability

A significant worry is the possibility of large-scale fund outflows from commercial banks to a CBDC. In Brief. In Japan, cash remains popular despite the rise of cashless payments due to the ageing population and economic factors. The Bank of Japan is exploring the use of Central Bank Digital Currencies (CBDCs) but their benefits for domestic use are limited due to the existing banking infrastructure.If individuals and businesses perceive a digital yen as a safer or more convenient store of value, they might transfer a substantial portion of their deposits from traditional banks to the CBDC. TOKYO (Reuters) -Japan currently has no plan to issue a central bank digital currency (CBDC) but must continue innovating its payment and settlement system in an increasingly cash-less society, aThis ""disintermediation"" of banks could lead to:

• Reduced lending capacity for banks, impacting their ability to finance economic growth.
• Increased reliance on central bank funding by commercial banks, potentially creating moral hazard.
• A contraction in the money supply, if the central bank doesn't adequately compensate for the shift.

The Deputy Governor of the BOJ highlighted these concerns in his closing remarks at the ""Fintech Central Bank Digital Currency Experiments: Progress on the Pilot Program"" event, emphasizing the need for careful consideration of the potential unintended consequences of CBDCs on the existing financial landscape.

Limited Benefits in the Japanese Context

Another reason for the BOJ's caution stems from the already well-developed and efficient banking infrastructure in Japan.While CBDCs are often touted as a solution for improving financial inclusion and payment efficiency, these problems are less pronounced in Japan compared to many other countries.

The existing system of electronic payments and banking services already provides:

• Widespread access to financial services, even in rural areas.
• Relatively low transaction costs for digital payments.
• A high degree of trust in the banking system.

Therefore, the potential benefits of introducing a CBDC in Japan may not outweigh the risks, particularly given the established strength of the current financial infrastructure.

Japan's Unique Relationship with Cash

Despite the global trend toward cashless payments, Japan maintains a strong preference for cash.This is a crucial factor to consider when evaluating the potential impact of a digital yen.

The Enduring Appeal of Physical Currency

Several factors contribute to the continued popularity of cash in Japan:

• An Aging Population: Older generations often prefer cash due to its familiarity and ease of use. In Japan, the Bank of Japan announced The Bank of Japan s Approach to Central Bank Digital Currency in Oct ober 2025. Since April 2025, the BOJ has been working on technical experiments on CBDC through their proof-of-concepts and pilot program. On J, the Cabinet decided the Basic Policy on Economic andThey may be less comfortable with digital payment technologies.
• Low Interest Rates: With interest rates near zero for many years, there's little incentive to deposit cash in banks.Holding physical currency doesn't incur a significant opportunity cost.
• Concerns about Privacy: Some individuals prefer cash for its anonymity, as it doesn't leave a digital trail.
• Resilience to System Failures: Cash provides a reliable payment method during power outages or system glitches, which can disrupt electronic payment systems.

These factors suggest that even with the introduction of a CBDC, cash might continue to play a significant role in the Japanese economy, limiting the adoption and impact of a digital yen.

Implications for CBDC Adoption

The continued prevalence of cash in Japan has important implications for the design and implementation of a CBDC.To encourage adoption, the digital yen would need to offer significant advantages over cash, such as:

• Enhanced convenience and speed for certain types of transactions.
• Integration with existing digital payment platforms.
• Features that address privacy concerns.
• Incentives for users to switch from cash to the digital currency.

Without these features, a digital yen might struggle to gain traction in Japan, potentially rendering it ineffective and failing to justify the risks associated with its introduction.

The Bank of Japan's CBDC Experiments and Pilot Program

Despite its cautious stance, the Bank of Japan is actively exploring the potential of CBDCs through a series of experiments and pilot programs.This reflects a recognition of the need to stay abreast of technological developments and to prepare for a future where digital currencies may play a more prominent role.

Proof-of-Concept Phases

The BOJ has conducted two phases of proof-of-concept (PoC) experiments to assess the technical feasibility of a CBDC.These experiments focused on:

• The core functions of a CBDC system, such as issuance, distribution, and redemption.
• The technical infrastructure required to support a digital yen, including the underlying technology platform and cybersecurity measures.
• The potential for integrating a CBDC with existing payment systems.

The results of these PoC phases provided valuable insights into the technical challenges and opportunities associated with CBDCs.They also helped the BOJ identify areas where further research and development are needed.

Commencement of the Pilot Program

Following the PoC phases, the BOJ launched a pilot program in April 2025 to test the practical application of a CBDC in a real-world environment.This pilot program involves:

• Working with private companies and financial institutions to explore potential use cases for a digital yen.
• Testing the interoperability of a CBDC with existing payment systems.
• Assessing the impact of a CBDC on consumer behavior and business operations.

The pilot program is a crucial step in the BOJ's CBDC exploration, allowing it to gather real-world data and insights that will inform its future decisions regarding the potential issuance of a digital yen.

Navigating the Future of Digital Currency in Japan

The future of digital currency in Japan remains uncertain.The Bank of Japan faces the challenge of balancing the potential benefits of CBDCs with the risks they pose to the existing financial system.This balancing act will require careful consideration of several key factors.

Key Considerations for CBDC Implementation

If the BOJ decides to move forward with a CBDC, it will need to address the following critical issues:

• Financial Stability: Implementing measures to mitigate the risk of large-scale fund outflows from commercial banks.This could involve limiting the amount of CBDC that individuals and businesses can hold, or offering incentives for keeping deposits in traditional banks.
• Privacy: Striking a balance between privacy and the need to combat illicit activities.A digital yen that is completely anonymous could be used for money laundering and other illegal purposes, while a CBDC that is too easily traceable could raise concerns about government surveillance.
• Interoperability: Ensuring that a CBDC can seamlessly interact with existing payment systems and other digital currencies.This will be crucial for promoting widespread adoption.
• Cybersecurity: Protecting the CBDC system from cyberattacks and ensuring the security of user data.This will require robust cybersecurity measures and ongoing monitoring of the system.

The Importance of Public Dialogue

Ultimately, the decision of whether or not to issue a CBDC in Japan should be based on a broad consensus among stakeholders, including the government, the financial industry, and the public.Open and transparent dialogue is essential to ensure that the potential benefits and risks of a digital yen are fully understood and that the public's concerns are addressed.

Potential Use Cases

While widespread adoption is still questionable, there are potential use cases for CBDCs that could be beneficial in Japan:

• Disaster Relief: A CBDC could facilitate rapid distribution of aid during natural disasters.
• Targeted Stimulus: The government could distribute stimulus payments directly to citizens through a CBDC.
• Reduced Transaction Costs for Specific Services: Cross border transactions could be streamlined.

Conclusion: A Deliberate Path Forward for Japan and CBDCs

The Bank of Japan's approach to central bank digital currencies is characterized by careful deliberation and a strong focus on preserving the stability of the existing financial system.While recognizing the potential benefits of CBDCs, the BOJ remains cautious about the risks they pose, particularly in the context of Japan's unique relationship with cash and its well-developed banking infrastructure.The Bank of Japan's experiments and pilot programs are crucial steps in understanding the potential of a digital yen.The future of CBDCs in Japan hinges on addressing key challenges related to financial stability, privacy, interoperability, and cybersecurity, while fostering a broad consensus among stakeholders.Japan will likely move at a deliberate pace, carefully weighing the pros and cons before making any decisions about the widespread implementation of a digital currency.Ultimately, the decision will depend on whether the benefits of a digital yen outweigh the risks to Japan's financial system and its unique cultural preference for cash.