The money market, as we know it today, has a tremendous unmet demand for a liquid asset that allows transactions to happen outside of the private financial sector. Central banks could offer such an asset by enabling end-users to open accounts with them. Physical money usage has considerably decreased over time, demanding new digital solutions to resolve users’ needs in a digital era.
This economic problem could be solved with cryptocurrencies. Two potential forms of central bank cryptocurrencies can develop over time: open access and other restricted banks, although economists have different perspectives on how this can or why it should not be done.
In recent years, venture capitalists and financial institutions are increasingly interested in distributed ledger technology projects (DLT) that aim to provide new financial services and deliver old ones more efficiently. Many countries are shifting their monetary systems; one example is Sweden, where the demand for cash has depleted considerably over the past decade. Currently, many stores do not accept cash, and some bank branches no longer disburse or collect cash.
Cryptocurrencies are becoming popular among these new alternative payments; they are electronic, do not represent a liability of anyone; and feature peer-to-peer exchange. The idea of central bank crypto- or digital currencies is attracting considerable attention. A cryptocurrency’s most innovative features are its automatization through computer processing, where a noncentralized developer community manages its security, reliability, and maintenance.
The creation of cryptocurrencies is based on digital tokens for wholesale payments and distributed ledger technology. Bitcoin relies explicitly on the blockchain, and it is operated anonymously by computers linked worldwide.
Bitcoin is the most famous cryptocurrency today, ruled by a monetary policy that ensures the supply of bitcoin by converging a finite upper limit. This payment system is viewed as a protocol for debiting and crediting accounts. Money, on the other hand, is considered a recordkeeping device, and the monetary policy is a protocol designed to manage the supply of money over time.
Bitcoin is considered to be potentially a better long-run store of value than non-interest-bearing USD; nonetheless, it has almost the same characteristics as stocks, bonds, real estate, and other income-generating assets. The main difference with bitcoin is the volatile and unpredictable rate exchange, therefore making hedging foreign exchange risk costly, a cost that doesn’t exist when the exchange rate is fixed (David Andolfatto).
Previously, peer-to-peer exchange was limited to physical forms of money. Nowadays, they are electronic forms of exchange in a centralized manner, either across a bank or between different banks via the central bank, without disregarding the importance of the feature of other forms of central bank money, accessibility.
This is how the idea of a government-sponsored cryptocurrency is born, “Fedcoin,” as it has been called. This version would have a unique position to fix the exchange rate between Bitcoin and the USD credibly. Users could download free wallet applications, banks or ATMs can serve as exchanges where people can stack their Fedcoin wallets in exchange for USD cash or bank deposits.
Economists suggest that a Fedcoin wallet should be unrestricted and free; even people without proper ID should have access to the product without going through an expensive application process. A Fedcoin could give the government the ability to pay interest on currency, and some even go as far as saying that it is likely that Fedcoin displaces paper money lowering the cost of supplying paper money as part of the payment system. International transactions could theoretically be possible between people with the appropriate software and access to the internet. Moreover, domestic operations would be spare of exchange rate volatility. Given that a Fedcoin can issue as many of these two objects as it needs, it could also be made open-source, primarily for transparency.
Guided by the terms of Fedcoin, the idea of a retail Central Bank Cryptocurrency (CBCC) it’s also been explored. A central Bank Cryptocurrency is an electronic form of central bank money where transactions between the payer and the payee happen without the need of an intermediary.
A CBCC can be made widely available to the public, with a graduated schedule of fees on transfers between cash and CBCC. It counts with real price stability over time in terms of a broad consumer price index, a framework that is sure to encourage the systematic and transparent management of the monetary policy. As with other electronic forms of central bank money, in theory, it is possible to pay interest on a DLT-based CBCC.
On the other hand, if a retail CCBC were to replace cash completely, it would not be easy for depositors to avoid negative interest rates and hold central bank money. Bank runs might happen faster if the public can exchange commercial bank money into risk-free central bank liabilities, which can represent a threat to the business models of commercial banks. They may operate without intermediaries and therefore be less able to fulfill essential economic functions, like monitoring debtors, if consumers decided to dismiss commercial bank deposits in favor of retail CBCCs.
But a Central Bank must consider all the risks, given that cryptocurrencies have the potential to disrupt the payment structure and the financial system (Aleksander Berentsen and Fabian Schär). Overall, it could influence all businesses and government agencies that are in charge of recordkeeping. On the other hand, if they decide to go through with the creation of a CBCC system, central bank electronic money will be the most liquid asset in the economy.
The technological innovation of cryptocurrencies can also arise challenges, the lack of strong governance could increase the customer’s vulnerability to mistakes, thefts, and security breaches, increasing the risks for these banks to become global targets for cyberattacks and money laundering.
China has already started trials for its digital cash early this year. Designed to be an electronic version of a banknote, This central bank digital currency has been used in 3.13 million transactions worth about $162 million so far, triggering concern about a new threat to U.S. financial dominance according to a Bloomberg article.
The race has started, so far, there has been no compelling need for a Fed-issued digital currency, but the implications of a Chinese cryptocurrency has awaken the attention of U.S. economists. Most consumers and businesses already make e-payments using debit and credit cards, applications, and the automated clearinghouse network. Moreover, peer to peer transactions is commonly done through mobile apps.
While the search for assets that could, in the future, improve financial stability, support more innovative, efficient, and reliable payment services, and have more comprehensive applications continues, governments and financial institutions are wondering whether it is better to isolate, regulate or integrate.
Given the fast development of innovations in payments technology and the propagation of digital currencies, participating in the money market’s could be the new tendencies for central banks. If central banks refuse to create a digital currency, they might be losing monetary control, increasing the possibilities of a severe economic downturn.
A central bank digital currency (CBDC/CBCC) could overcome the challenges linked to unsupported assets with no inherent value by replacing the central bank’s direct liability. Moreover, a central bank could develop a transfer mechanism with governance as a substitute for retail banking deposits. Consequently, restrictions on loans for productive economic activities could be imposed and have a material impact on worldwide macroeconomic. This could revolutionize the monetary system and facilitate the efficient and transparent management of the monetary policy. A central bank digital currency can be used as a costless exchange tool, with the ability to guarantee a secure store of value.
Currently, only banks hold central bank money electronically in the form of settlement accounts. The creation of a CBDC would open access to the public. However, due to the current technological shortcomings in distributed ledger technologies and the risks of opening central bank accounts widely available and reliable, the CBDC does not seem likely to reach the market soon.
Moreover, whether it is desirable has yet to be decided by the public consumer, the researchers, and the financial institutions. The Central banks may find themselves liberating commercial banks in regular times and risking the financial system’s destabilization. On the other hand, there are many social concerns related to these currencies, such as the management of privacy rights, the transfer of information, and economic crime avoidance.