If Central Banks Issue Cash, They Can Issue Cryptocurrencies
Central banks and cryptocurrencies seem to come from different planets. While monetary authorities are the guardians of price and financial stability, the likes of bitcoin and ethereum have ignited a speculative frenzy mirroring the tulip mania of the 17th century.
Yet, from Singapore to Sweden, central bankers are taking a close interest in digital currencies. They are right to do so. The reason is not financial stability: the market for bitcoin, while growing, is not sufficiently interconnected to risk causing systemic effects. But the technology behind cryptocurrencies has an extraordinary potential and is one which monetary authorities should learn to master for the future.
Monetary exchanges have evolved over time, moving from cash to digital transactions. However, notes and coins offer a key feature which bank transfers have been unable to replicate: anonymity. This has helped cash remain salient in spite of the growing digitization of our lives. Yves Mersch, a member of the European Central Bank's executive board, has noted that in Europe 80 percent of point-of-sale transactions are still made in cash, representing more than half of the total value.
The defining feature of cryptocurrencies is to replicate anonymity at the digital level. Satoshi Nakamoto, the inventor of bitcoin, defined it as a "peer-to-peer version of electronic cash." This characteristic has made bitcoin attractive to drug dealers and money launderers. However, to the extent that central banks continue to supply cash, it is not clear why they should not also issue cryptocurrencies.
Much like bitcoin, a central bank cryptocurrency would be universally accessible, electronic and exchanged peer-to-peer. A helpful taxonomy devised by Morten Bech and Rodney Garatt at the Bank for International Settlements (BIS) suggests it should be issued by the central bank itself, rather than via a privately run algorithm. This is a crucial difference: Only the monetary authority would be able to create and destroy this “official” cryptocurrency, which would be fully convertible with cash or bank reserves.
As Ruth Wandhoefer, global head of regulatory and market strategy at Citigroup, has underlined in a recent study, an official cryptocurrency would pose new risks that would have to be addressed. In a world where consumers are able to make sizable peer-to-peer digital transactions without the need to hold deposits, banks would be deprived of an important source of funding. Cybersecurity, to prevent the theft of digital currencies, would become of paramount importance. Regulators may also want to cap the maximum amount which can be paid via cryptocurrencies to prevent large-scale criminal transactions. Or they may decide to ban private cryptocurrencies.
Still, as the digitization of payment services grows, consumers will increasingly search for alternatives to bank transfers that allows them to remain anonymous. Central banks must be ready to provide an official alternative to bitcoin in order to maintain control over the money supply and preserve trust in their legal tenders.
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