Digital payments and financial transactions hold the promise of greater convenience, stronger competition, and increased savings to society. But when it comes to digital currencies, central banks – and not free-floating cryptocurrencies or stablecoins – should lead the way.
When Tesla CEO Elon Musk promoted the Dogecoin
and Bitcoin cryptocurrencies, their prices shot up. While some
countries are taking a wait-and-see attitude toward private digital
money, El Salvador has embraced Bitcoin as an official currency. And the New York State Department of Financial Services (NYDFS) has been busy issuing licenses (and collecting fees) to people who want to create and trade cryptocurrencies. Taking the opposite tack, China has recently banned both the mining of cryptocurrencies and their use as a medium of exchange.
Given the diverse policy responses, how
should we assess the social costs and benefits of different types of
digital currency? Let us consider free-floating cryptocurrencies,
stablecoins, and central bank digital currencies (CBDCs). The prices of
free-floating cryptocurrencies – of which Bitcoin is the most famous
example – are not anchored to any other asset. Despite their rapid
growth, it is important to remember that cryptocurrencies have no
intrinsic fundamental value and are therefore vulnerable to price
crashes.
The recent run-up in cryptocurrency prices recalls the seventeenth-century tulip price bubble
in the Netherlands, when an initial price increase attracted more
buyers to the market, pushing up prices further. But, as with the tulip
mania, some seemingly random news in the future could end the
cryptocurrency boom, triggering a downward price spiral as existing
owners rush to the exit. One attraction of cryptocurrencies for
investors and speculators is that they resemble a lottery ticket – while
the potential loss is limited to what you pay for it, the potential
gains could be enormous. Although we lack precise data on who is trading
cryptocurrencies, research on lottery tickets
suggests that less wealthy investors are more likely to be attracted to
this market.
Crypto exchanges like Coinbase have made buying
cryptocurrencies as easy as buying a lottery ticket, with the minimum
trade as low as $2. This means any future price crash is likely to hurt the segment of society least able to afford a drop in their savings.
In contrast to free-floating cryptocurrencies, stablecoins’ value is
pegged to either an official currency such as the US dollar or Japanese
yen, or to a precious commodity like gold or oil, and thus have a
natural anchor for their prices. But investors should first ask whether a
stablecoin issuer is backing their coin fully with the equivalent
amount of underlying assets. Otherwise, the stablecoin’s intrinsic value
should reflect the risk that, in a major market crash, the coin
provider may not have sufficient reserves to convert all their coins to high-quality assets without imposing a haircut on the promised value.
Even stablecoin
providers who promise to hold full collateral should have their reserves
regularly and independently audited. Entities such as NYDFS that issue
operating licenses to coin providers typically do not perform such a
function.
In countries that have a history of high inflation or
hyperinflation, such as some in Latin America and Africa, there may be a
case for using stablecoins as a medium of exchange. But for most
countries with a reasonably well managed monetary policy, stablecoins
could undermine policy effectiveness by making the overall liquidity in
the economy less controllable by central banks. Moreover, both
stablecoins and free-floating cryptocurrencies can be, and have been,
used to launder money and for other illicit financial transactions. Last but not least, national interests may clash.
In December 2020, for example, NYDFS approved
GYEN, a stablecoin pegged to the yen. GYEN is considered by New York
State a digital financial innovation that generates revenue and
employment for the state. But if this stablecoin were to gain
significant traction as a medium of exchange in Japan, then its
potential costs – including a loss of seigniorage revenue and reduced
effectiveness of Japanese monetary policy – would be felt there. CBDCs
are a much better bet. For starters, they can save governments billions
of dollars by removing the need to circulate and maintain notes and
coins. The United States, for example, currently spends more than $1 billion
each year on minting, printing, and maintaining coins and paper notes.
The savings that would result from introducing an official digital
dollar could be deployed for other socially useful programs – such as
providing free Medicaid to the 31.1 million Americans who are not covered by any medical-insurance program, or funding the National Endowment for the Arts five times over.
Because CBDCs are also a means of payment that could be used instead of
a credit card, they can exert pressure on existing payment providers to
become more efficient and reduce their transaction fees. Consumers and
businesses alike will benefit.
Project Syndicate
© Project Syndicate
Key
Hover over the blue highlighted
text to view the acronym meaning
Hover
over these icons for more information
Comments:
No Comments for this Article