## MONEY, TRANSFORMED

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### Overview
- The global financial crisis and bailouts renewed skepticism about central banks’ monopoly on currency issuance, fueling the creation of Bitcoin and other crypto assets.
- Twenty years ago, advances in information technology prompted debate over whether central banks would become obsolete (King 1999); crypto assets have rekindled that debate.
- Core question: will monetary policy remain effective in a world without central bank money (Woodford 2000)?

### Characteristics and risks of crypto assets
- Definition: digital representations of value enabled by cryptography and distributed ledger technology; denominated in their own units of account; transferable peer to peer without an intermediary.
- Market value derives from potential exchange for other currencies, payment use, and store-of-value use; value rests on the expectation that others will value and use them.
- Current shortcomings:
  - Too volatile and too risky to pose much of a threat to fiat currencies.
  - Lack the same degree of public trust as fiat currencies; afflicted by fraud, security breaches, operational failures, and association with illicit activities.
  - High price volatility because valuation is largely belief-based and not well anchored.

### Monetary properties and macroeconomic risks
- Some crypto assets (example: Bitcoin) have limited inflation risk because supply is limited, but they lack three critical functions of stable monetary regimes:
  - Protection against the risk of structural deflation.
  - Ability to respond flexibly to temporary shocks to money demand and smooth the business cycle.
  - Capacity to function as a lender of last resort.
- If crypto assets become widely adopted as units of account, demand for central bank money is likely to decline; monetary policy may become less relevant if central bank money no longer defines the unit of account for most economic activities.
- Analogy: dollarization in some developing economies—when a large part of the domestic financial system operates with a foreign currency, monetary policy for the local currency becomes disconnected from the local economy.

### Potential for wider adoption and payment innovation
- Longer track records and better issuance rules (for example, “smart” rules based on artificial intelligence) could reduce volatility and boost adoption.
- “Stable” coins already appearing:
  - Some pegged to existing fiat currencies.
  - Others attempt issuance rules that mimic inflation- or price-targeting policies (“algorithmic central banking”).
- Advantages as a medium of exchange:
  - Offer much of the anonymity of cash while allowing long-distance transactions and greater divisibility—useful for micro payments in the sharing and service-based digital economy.
  - Crypto transactions can be cleared and settled quickly without an intermediary, markedly improving cross-border payment speed from days to seconds by bypassing correspondent banking networks.
- Broader shift: possible movement from account-based payment systems to value- or token-based systems, implying a shift from credit money toward commodity-money-like arrangements.

### Implications for monetary policy and central bank monopoly
- Debate exists over whether loss of monopoly on reserves would deprive central banks of the ability to carry out monetary policy (King 1999) and whether large balance-sheet adjustments would be required to influence interest rates in a crypto-dominated environment.
- Key concern summarized: “how much the central banks’ monetary policies would matter” (Woodford 2000); Benjamin Friedman warns central-bank-set interest rates could become less connected to interest rates and asset prices relevant to ordinary economic transactions (Friedman 2000).

### Policy recommendations and central bank responses
- Continue to run effective monetary policy to maintain fiat currencies as stable units of account; be open to fresh ideas and new demands as economies evolve (paraphrasing Christine Lagarde).
- Leverage technology to improve policymaking:
  - Improve economic forecasts using big data, artificial intelligence, and machine learning.
- Regulatory actions to prevent unfair competitive advantages and regulatory arbitrage by crypto assets:
  - Rigorously apply measures to prevent money laundering and the financing of terrorism.
  - Strengthen consumer protection.
  - Effectively tax crypto transactions.
- Make central bank money attractive as a settlement vehicle:
  - Issue digital tokens of their own (central bank digital currency) to supplement physical cash and bank reserves; such tokens could be exchanged peer to peer in a decentralized manner.

### Central bank digital currency (CBDC): functions and trade-offs
- Potential benefits of CBDC:
  - Counter monopoly power from private payment networks driven by strong network externalities.
  - Reduce transaction costs for individuals and small businesses with limited or costly banking access.
  - Enable long-distance transactions and avoid the denomination limits of cash.
  - Interest-carrying CBDC could help transmit the policy interest rate to the rest of the economy when demand for reserves diminishes.
  - Help central banks continue to earn income from currency issuance, allowing them to finance operations and distribute profits to governments; for many emerging market and developing economies, seigniorage is the main source of revenue and an important safeguard of central bank independence.
- Design trade-offs and risks to consider:
  - Avoid increasing the risk of bank runs due to the convenience of digital cash.
  - Balance of benefits and risks will differ across countries depending on financial and technological development.

### Conclusion
- There are both challenges and opportunities for central banks in the digital age.
- Central banks must maintain the public’s trust in fiat currencies and stay relevant by:
  - Providing more stable units of account than crypto assets.
  - Making central bank money attractive as a medium of exchange in the digital economy.
- Some crypto assets could become more widely adopted and fulfill more monetary functions in certain regions or private e-commerce networks, but central banks can and should act to preserve the effectiveness of monetary policy and the attractiveness of fiat money.

*Dong He, deputy director of the IMF’s Monetary and Capital Markets Department; article draws on “Virtual Currencies and Beyond: Initial Considerations,” January 2016 IMF Staff Discussion Note 16/03, and references cited in the text.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2018/june/he.pdf_