The total value of all cryptocurrency in circulation is now almost $100bn. This is roughly double what it was just a few months ago, but it’s still tiny compared to the face value of paper dollars issued by the Federal Reserve, which alone amount to about $1.4trn. We are therefore nowhere near the point yet where cryptocurrencies pose a credible threat of supplanting central-bank-issued money.Nevertheless, it’s worth thinking through some of the implications if something like Bitcoin (which has about a 45 per cent market share) were to wholly or even partially supplant central bank fiat currency. Not least because central banks themselves are thinking about it out loud, and wondering what they might do to avoid being usurped in this way.The agreed protocols that govern Bitcoin are effectively its monetary policy. In exchange for expending computing power to verify the legitimacy of transactions and record them, Bitcoin “miners” get paid in Bitcoin. (This is roughly analogous to seigniorage income.) These rewards increase the supply of Bitcoin, but the growth of the Bitcoin money supply is constrained by the increasing difficulty of verifying transactions. More and more computing power is needed to verify each transaction and create new Bitcoin, which means that the total supply gradually approaches its limit of about 21 million.
Our fiat money has its own protocols that give rise to a different monetary policy: appoint a bunch of clever people and tell them to stabilise inflation using interest rates and bond-buying. The money supply that results from all this is generally ignored.
A strand of monetary nostalgia likes the fixed money supply rule of Bitcoin, which sort of resembles the classical gold standard. But most economists and central bankers long since left this view behind.
You could imagine Bitcoin or other currencies changing the protocols so that monetary policy improved.
You’d need an agreement somehow that the verification rewards for miners depended on the state of the economy in the same way that central bank interest rates are flexible according to conditions. And this could not be hard-coded, any more than central banks could hard-code interest rate policy.
Central banks could simply step in and offer their own digital currency, to pre-empt a Bitcoin takeover. There is such a thing already, of course. It’s what happens whenever central banks buy assets by creating bank reserves. It’s all just digital entries on a spreadsheet. Creating central bank “digital currency” simply means offering existing digital account services to a wider group of entities.
There are other reasons for central banks to offer these services to the broader public, especially if digital central bank money came to replace physical money. It would help combat tax evasion and illegal economic activity.
As Broadbent explains, offering these accounts might well disintermediate retail banks, as depositors pull their money out of banks and opt for central bank accounts instead.
The central bank would become the ‘narrow bank’, backing deposits with government securities. Private-sector lenders would have to fund themselves with non-deposit debt and equity.
foreigners outside the digital central banking country might desert their own banks and deposit directly with the foreign central bank, or indirectly via some local intermediary. The increased ease of shifting deposits into a safe foreign asset might exacerbate the flows of capital in and out according to changing perceptions of the health of the domestic banking system, amplifying the credit cycle in their home country.
In the financial crisis, capital flight from the most afflicted countries was limited by the difficulty and inconvenience of getting hold of and managing cash and by the state of banks in alternative countries. Direct or indirect access to foreign digital money would have none of these drawbacks and potentially facilitate periodic flights to safety.
These problems would be avoided if all monetary authorities acted in concert.
