What if central banks meddle with cryptocurrencies?

What if central banks meddle with cryptocurrencies?

Cryptocurrencies were set to disrupt and completely revolutionize the use and the very concept of money. Yet, 10 years on from the launch of Bitcoin — the pioneer among cryptocurrencies — cash is still alive and well, and the digital currency revolution is not in sight. The economic institution to revive the hype around digital currencies may be one above any suspicion: the central bank.

Cryptocurrencies have two features that make them resemble cash. They guarantee anonymity and can be exchanged peer to peer. In the practice of daily life, however, Bitcoin & co. miserably fail the three basic textbook definitions for a currency. Because of their extreme volatility, cryptocurrencies can hardly be regarded as a unit of account. As a consequence, they perform extremely bad as a store of value and distinguish themselves for being a rather unstable and ineffective medium of exchange. What’s more, cryptocurrencies are a liability of nobody. The value of physical cash is in fact “guaranteed” by a central bank whose mandate is precisely to prevent the debasement of the currency’s purchasing power. The fatal flaw of cryptocurrencies is that there is no authority accountable for stopping their value from falling to zero.

So, cryptocurrencies arguably lay the foundations for a digital alternative to cash but still don’t warrant reliability. To foster the “digital currency revolution”,  some countries adopted a simple solution: making their central banks accountable for the value of a national digital currency (see Tunisia and Senegal for references). But among the central banks of the major world economies, none has dared to take the plunge and introduce a digital currency open to the general public. The truth is that consumers of developed economies with stable currencies (ie, with low and controlled inflation) still have a strong preference for physical cash. There’s an exception, though: Sweden.

In the Scandinavian kingdom affection for cash has grown cold. In the last years, circulating kronas (the Swedish currency) have been steeply shrinking in absolute and relative terms. Swedes increasingly opt for bank cards or payment apps to settle their purchase transactions. The collapse of the demand for cash has led banks to respond by closing down ATMs. This, in turn, has further weakened the demand for cash, ushering in a circle — virtuous or vicious, go figure.

Such behaviour could have serious consequences on the economy. The traditional channels through which the central bank implements its monetary policy (and thereby keeps inflation in check) are hamstrung by the disappearance of circulating cash. Confronted with the risk of being unable to fulfil its mandate to preserve price and financial stability, the Sveriges Riksbank (Sweden’s central bank) has launched a project plan to study the feasibility and the possible impact of the introduction of an e-krona.

According to its last report, the Riksbank indicates the solution of a value-based e-krona as the most promising. A value-based e-krona would closely resemble cash, insofar as it would be stored on a medium (a prepaid card or an app) and exchanged offline via card readers or specific smartphone technology. This configuration entails a significant involvement of the Riksbank in the payment system. The central bank would trace transactions carried out with the e-krona and would run the digital platform containing the ledger. Before any final decision, however, the Riksbank plans to carry out a pilot project in order to test the collateral risks linked to the e-krona.

The reason why the Swedes are so cautious is that the provision of a digital currency backed by a major central bank is an uncharted territory. A central bank’s digital currency (CBDC) would represent a close substitute for — and, thus, a competitor of — commercial banks’ deposits. A CBDC might exacerbate the risk of bank runs, for it would make much simpler draining one’s bank account. Deposited capital could be transferred on an e-wallet and converted into CBDC, while comfortably sitting on the couch (in the same way as we withdraw from the ATM, converting our deposits into cash). The new system needs therefore clear-cut and thoughtful boundaries, to avoid the emergence of new risks.

Both on the technological and policy sides, the introduction of a CBDC represents a daunting challenge, indeed. The Riksbank has embarked on its brainstorming exercise because of the peculiar domestic situation. Nonetheless, in a continuously digitizing world, can the guardians of our money’s value leave the monopoly of digital money to commercial banks? In today’s financial system, money in electronic format for the general public exists almost exclusively in the form of deposits, ie liabilities of commercial banks. A CBDC, on the contrary, would be by definition a liability of the central bank and, much like cash, represent a risk-free asset always available for electronic payments. Providing a digital alternative to cash might be a gamble, sure. But taking the time to ponder how to best design new monetary tools and anticipating the evolution of the digital and currency worlds might be worth a thought.

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