## A NEW ERA FOR MONEY

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### Transformation of money and financial intermediation
- Physical currency (cash) is drawing to an end; the age of digital currencies has begun.
- Digital technologies are enabling new private-sector payment systems, online banks, and web-based platforms (for example, platforms capable of directly connecting savers and borrowers), intensifying competition, promoting innovation, and reducing costs.
- Benefits for users:
  - Savers gain access to a broader array of saving, credit, and insurance products.
  - Small-scale entrepreneurs can secure financing from nonbank sources, avoiding stringent loan-underwriting and collateral requirements.
  - Domestic and international payments are becoming cheaper and quicker, benefiting consumers, businesses, and remittance flows.
- Risks:
  - Technologies could intensify concentration of economic power and enable greater corporate and governmental intrusion into financial and private lives.
  - Traditional banks face threats to their business models as digital lending platforms and platform-based intermediation weaken banks’ role in mediating between savers and borrowers.

### Stability concerns: cryptocurrencies, stablecoins, and CBDCs
- Cryptocurrencies such as Bitcoin:
  - Initially appeared likely to revolutionize payments by cutting out central bank money and trusted intermediaries.
  - Volatile prices and transaction throughput constraints have rendered them ineffective as mediums of exchange.
- Stablecoins:
  - New forms of cryptocurrencies that typically derive stable value by being backed by stores of central bank money and government securities.
  - Have gained more traction as means of payment.
- Blockchain technology:
  - Catalyzing far-reaching changes by enabling secure ownership of purely digital objects and fostering new digital assets such as non-fungible tokens.
- Central bank digital currencies (CBDCs):
  - Being considered by central banks for retail payments to broaden financial inclusion and provide a public payment option as a backstop to private systems (the role now played by cash).
  - Potential benefits:
    - Hinder illegal activities that rely on anonymous cash transactions (drug deals, money laundering, terrorism financing).
    - Bring economic activity into the formal economy and make tax evasion harder.
    - Reduce transaction costs for small businesses and eliminate hassles/risks of handling cash.
  - Potential disadvantages:
    - Risk to banking system if households move deposits into central bank digital wallets, possibly starving commercial banks of deposits and forcing central banks into credit allocation.
    - Could squelch private-sector innovations aimed at cheaper and quicker digital payments.
    - Potential loss of privacy because central banks may keep verifiable transaction records to ensure legitimate use.

### Risk of runs and monetary policy transmission
- Deposit migration risk:
  - If households perceive CBDC wallets as safer and move funds out of bank deposits, commercial banks could be deprived of funding needed to create and distribute credit.
  - This could force a central bank into direct credit allocation decisions.
- Monetary policy transmission uncertainties:
  - If digital lending platforms diminish banks’ role, the conventional channel through which central bank interest-rate changes affect deposit and loan rates may weaken, making it unclear how monetary policy will operate.

### Currency competition and the nature of money
- Digital currencies and technologies separate money’s functions (unit of account, medium of exchange, store of value) and create direct competition with fiat currencies in some dimensions.
- Likely outcomes:
  - Central-bank-issued money will likely retain importance as a store of value and, where issued digitally, as a medium of exchange.
  - Privately intermediated payment systems will gain importance, intensifying competition between private money and central bank money as mediums of exchange.
  - Market concentration risk: if left unchecked, some issuers of money and payment technology providers could become dominant.

### International money flows and the international monetary system
- Cross-border transactions will become faster, cheaper, and more transparent, benefiting:
  - Investors seeking diversification.
  - Firms raising money in global capital markets.
  - Economic migrants sending remittances.
  - Trade, particularly for emerging market and developing economies that rely on export revenues.
- New channels will also:
  - Facilitate illicit financial flows, complicating regulation and enforcement.
  - Make it harder for governments to control legitimate capital flows across borders, increasing vulnerability of emerging markets to sudden outflows triggered by major central banks’ policy actions.
- Reserve currency dynamics:
  - Lower direct transaction costs between emerging market currency pairs reduce the need for vehicle currencies (such as the dollar and the euro) for transactions.
  - Major reserve currencies, especially the dollar, are likely to retain dominance as stores of value because that dominance rests on economic size, financial market depth, and institutional foundations (independent central bank and rule of law) that technology cannot substitute for.
- Limitations of CBDCs:
  - CBDCs will not solve underlying credibility problems stemming from fiscal profligacy or weak institutions; digital central bank money is only as strong and credible as the issuing institution.

### Governments’ and central banks’ roles and policy trade-offs
- Policy choices:
  - Governments and central banks must decide whether to resist new technologies, passively accept private-sector innovations, or embrace potential efficiency gains.
- Regulatory imperatives:
  - Regulation is essential to maintain payment-system and market integrity, ensure investor protection, and promote financial stability (highlighted by recent cryptocurrency boom and bust).
  - The policy challenge is balancing financial innovation with mitigation of risks to uninformed investors and systemic stability.
- Distributional effects:
  - Financial-technology innovations could democratize finance by expanding access for indigent households.
  - Alternatively, benefits could accrue mainly to the wealthy and incumbent institutions, exacerbating income and wealth inequality.
  - Economically marginalized people—limited digital access and financial literacy—face risks of being pushed into investments they do not understand or cannot tolerate.

### Centralization versus fragmentation: resilience and fragility
- Decentralization and fragmentation:
  - Pros: reduce centralized points of failure, increase resilience via redundancy.
  - Cons: fragmented systems may perform well in good times but lack confidence resilience in crises; without backing by a central bank or government, confidence could evaporate quickly.
- Societal implications:
  - Displacement of cash by digital payments could eliminate privacy in commercial transactions.
  - Cryptocurrencies’ promise of anonymity and government-free commerce may be undermined by changes that compromise privacy and expand governmental oversight.
  - Risks include greater concentration of power among large economies and major corporations (for example, firms controlling both commerce and finance).

### Key policy implications and recommendations (implicit in analysis)
- Design CBDCs carefully to mitigate risks to banking systems, financial stability, and privacy while preserving public payment options.
- Implement robust regulation of cryptocurrencies and stablecoins to protect investors and ensure market integrity.
- Ensure institutional foundations—central bank independence and rule of law—remain strong to sustain confidence in digital central bank money.
- Balance encouragement of private-sector payment innovations with protections against market concentration and threats to competition.
- Address digital access and financial literacy gaps to prevent technological innovations from worsening income and wealth inequality.
- Strengthen cross-border regulatory cooperation to manage illicit flows and the systemic implications of faster, cheaper international payments.

*Source: prasad-new-era-money (September 2022), Finance & Development*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/september/prasad-new-era-money.pdf_