## Central Bank Monetary Policy in the Age of Cryptocurrencies

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**Canonical URL:** [Central Bank Monetary Policy in the Age of Cryptocurrencies](https://www.imf.org/en/publications/fandd/issues/2018/06/central-bank-monetary-policy-and-cryptocurrencies-he)

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## Bibliographic details
- Authors: DONG HE
- Published: June 1, 2018
- Volume: 55

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### Overview
- Publication: F&D Magazine, "Monetary Policy in the Digital Age" by DONG HE.
- Date and issue: June 2018, Volume 55 | Number 2.
- Core question: How should governments and Central Banks regulate the use of cryptocurrencies and cryptoassets, and what role should central banks play in crafting monetary policy fit for the digital economy?
- Context: Crypto assets challenge the paradigm of state-supported currencies and central banks' dominant role in the financial system; they derive value from exchangeability, payment use, and store-of-value expectations rather than legal-tender backing.

### Future of money — key findings and risks
- Crypto assets may reduce demand for central bank money if they become widely used as payment media or units of account.
- Current limitations of crypto assets:
  - Too volatile and risky to pose a material threat to fiat currencies today.
  - Do not enjoy the same degree of trust as fiat currencies due to fraud, security breaches, operational failures, and association with illicit activities.
- Deflation and policy-function risks:
  - Some crypto assets (e.g., Bitcoin) have limited inflation risk because supply is limited.
  - Crypto assets 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.
- Potential stabilizing developments:
  - Longer track records could reduce volatility.
  - "Smart" issuance rules (possibly based on artificial intelligence) could make valuation more stable.
  - "Stable" coins already appear: some pegged to existing fiat currencies; others attempt issuance rules that mimic inflation- or price-targeting policies (“algorithmic central banking”).

### Payment shift, technology, and economic implications
- Advantages of crypto assets as medium of exchange:
  - Offer much of the anonymity of cash while enabling long-distance transactions.
  - Greater divisibility, attractive for micro payments in sharing and service-based digital economies.
  - Faster clearing and settlement without intermediaries; cross-border payments can be reduced from days to seconds by bypassing correspondent banking networks.
- Shift from account-based to value- or token-based payment systems:
  - Account-based systems: transfer of claims recorded in an account with an intermediary (e.g., a bank).
  - Value- or token-based systems: transfer of a payment object whose authenticity/value can be verified without trust in intermediaries.
- Monetary-creation implications:
  - Crypto assets resemble commodity money rather than credit money; could lead to declining demand for central bank money if adoption rises.
  - If central bank money ceases to define the unit of account for most activities, the effectiveness of central bank monetary policy may be undermined—parallels drawn to dollarization scenarios.

### Monetary policy challenges and theoretical concerns
- Central banks typically conduct policy by setting short-term interest rates in interbank markets for reserves.
- Concern: losing monopoly supplier status of central bank reserves could impair ability to conduct monetary policy (King 1999).
- Debate points:
  - Whether massive adjustments in central bank balance sheets would be necessary in a crypto-dominated world.
  - Whether central bank interest rates would become disconnected from interest rates and asset prices that matter for ordinary transactions (Friedman 2000).
- Core question summarized: “The only real question about such a future is how much the central banks’ monetary policies would matter” (Woodford 2000).

### Central bank responses and policy recommendations
- Continue to make fiat currencies better and more stable units of account:
  - Modern monetary policy, monetary policy committees, and central bank independence remain central to maintaining stable units of account.
  - Monetary policymaking can benefit from technology: big data, artificial intelligence, and machine learning can improve economic forecasts.
- Regulate crypto assets to prevent regulatory arbitrage and unfair competitive advantage:
  - 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:
  - Consider issuing central bank digital currency (CBDC) as digital tokens to supplement physical cash and bank reserves.
  - CBDC could be exchanged peer to peer in a decentralized manner, similar to crypto assets.

### Central bank digital currency (CBDC) — trade-offs and potential benefits
- Potential benefits of CBDC:
  - Counter monopoly power arising from network externalities of private payment networks.
  - Reduce transaction costs for individuals and small businesses with limited or costly banking access.
  - Enable long-distance transactions and remove denomination limits inherent in physical cash.
  - Interest-carrying CBDC could help transmit policy interest rates when demand for reserves diminishes.
  - Continued use of central bank liabilities could help central banks earn income from currency issuance, 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 choices and risks:
  - Need careful consideration to avoid increasing the risk of bank runs due to the convenience of digital cash.
  - Views on benefits and risks will differ across countries depending on financial and technological development.

### Conclusion — strategic stance for central banks
- Central banks face both challenges and opportunities in the digital age.
- To remain relevant, central banks must:
  - Maintain public trust in fiat currencies.
  - Provide more stable units of account than crypto assets.
  - Make central bank money attractive as a medium of exchange in a digital, sharing, and decentralized service economy.
- Policy mix: effective monetary policy, appropriate regulation, and consideration of CBDC design to preserve monetary policy effectiveness and central bank independence.

### References
- Friedman, Benjamin M. 2000. “Decoupling at the Margin: The Threat to Monetary Policy from the Electronic Revolution in Banking.” International Finance 3 (2): 261–72.
- Goodhart, Charles. 2000. “Can Central Banking Survive the IT Revolution?” International Finance 3 (2): 189–209.
- He, Dong, Ross Leckow, Vikram Haksar, Tommaso Mancini Griffoli, Nigel Jenkinson, Mikari Kashima, Tanai Khiaonarong, Céline Rochon, and Hervé Tourpe. 2017. “Fintech and Financial Services: Initial Considerations.” IMF Staff Discussion Note 17/05, International Monetary Fund, Washington, DC.
- King, Mervyn. 1999. “Challenges for Monetary Policy: New and Old.” Speech delivered at a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, WY, August 27.
- Woodford, Michael. 2000. “Monetary Policy in a World without Money.” International Finance 3 (2): 229–60.

*Source: Central Bank Monetary Policy in the Age of Cryptocurrencies — F&D Magazine, June 2018, DONG HE.*

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_Source: https://www.imf.org/en/publications/fandd/issues/2018/06/central-bank-monetary-policy-and-cryptocurrencies-he_