According to a functionary of the International Monetary Fund (IMF), the fiat currencies need new ideas to compete with the cryptocurrencies. New ideas are necessary to make them more attractive for the users in the digital era.
Dong He, the Deputy Director of the Monetary and Capital Markets Department at the International Monetary Fund, published an article in which he suggests the way to make the fiduciary currencies more attractive and therefore more attractive when compared to the cryptocurrencies. According to He, there are three ways to tackle the potential competition between the fiduciary currencies and the cryptocurrencies. He said the fiduciary currencies in the hands of the central banks need to become better and more stable units of account. Deng referred to an earlier statement given by Christine Lagarde, the Managing Director of the IMF: “The best response by central banks is to continue running effective monetary policy, while being open to fresh ideas and new demands, as economies evolve.”
Dong He also talked about the other two ways to make the fiduciary currencies more attractive: “Second, government authorities should regulate the use of crypto assets to prevent regulatory arbitrage and any unfair competitive advantage crypto assets may derive from lighter regulation. That means rigorously applying measures to prevent money laundering and the financing of terrorism, strengthening consumer protection, and effectively taxing crypto transactions.
Third, central banks should continue to make their money attractive for use as a settlement vehicle. For example, they could make central bank money user-friendly in the digital world by issuing digital tokens of their own to supplement physical cash and bank reserves. Such central bank digital currency could be exchanged, peer to peer in a decentralized manner, much as crypto assets are.”
Lagarde had a positive attitude towards the cryptocurrencies in the last months, although a cautious one. In the last couple of weeks, the managing director of the IMF said the “crypto-condemnation” and the “crypto-euphoria” should be replaced with a clear and rational focus when it comes to the regulation of the cryptocurrencies. Lagarde said: “Just as a few technologies that emerged from the dot-com era have transformed our lives, the crypto-assets that survive could have a significant impact on how we save, invest and pay our bills. That is why policymakers should keep an open mind and work toward an even-handed regulatory framework that minimizes risks while allowing the creative process to bear fruit.”
Dong He echoed the opinion of Christine Lagarde by saying the regulation of the cryptocurrencies was necessary, but he also added that there should be a way to guarantee that light regulations of the cryptocurrencies would not provide them with an unfair competitive advantage. According to the deputy director, this scenario should be avoided. He said: “That means rigorously applying measures to prevent money laundering and the financing of terrorism, strengthening consumer protection, and effectively taxing crypto transactions.”
He also mentioned the risk of deflation associated with Bitcoin and other cryptocurrencies on the market: “Some crypto assets, such as Bitcoin, in principle have limited inflation risk because supply is limited. However, they lack three critical functions that stable monetary regimes are expected to fulfill: protection against the risk of structural deflation, the ability to respond flexibly to temporary shocks to money demand and thus smooth the business cycle, and the capacity to function as a lender of last resort. But will they be more widely used in the future? A longer track record may reduce volatility, boosting further adoption. And with better issuance rules— perhaps, “smart” rules based on artificial intelligence— their valuation could become more stable. “Stable” coins are already appearing: some are pegged to existing fiat currencies, while others attempt issuance rules that mimic inflation- or price-targeting policies (“algorithmic central banking”).”
On the other hand, Dong He also expressed some of the advantages of the cryptocurrencies: “As a medium of exchange, crypto assets have certain advantages. They offer much of the anonymity of cash while also allowing transactions at long distances, and the unit of transaction can potentially be more divisible. These properties make crypto assets especially attractive for micro payments in the new sharing and service-based digital economy.
And unlike bank transfers, crypto asset transactions can be cleared and settled quickly without an intermediary. The advantages are especially apparent in cross-border payments, which are costly, cumbersome, and opaque. New services using distributed ledger technology and crypto assets have slashed the time it takes for cross-border payments to reach their destination from days to seconds by bypassing correspondent banking networks.
So we cannot rule out the possibility that some crypto assets will eventually be more widely adopted and fulfill more of the functions of money in some regions or private e-commerce networks.”
When it comes to the influence of the cryptocurrencies on the payment systems, He said: “More broadly, the rise of crypto assets and wider adoption of distributed ledger technologies may point to a shift from an account-based payment system to one that is value or token based (He and others 2017). In account-based systems the transfer of claims is recorded in an account with an intermediary, such as a bank. In contrast, value- or token-based systems involve simply the transfer of a payment object such as a commodity or paper currency. If the value or authenticity of the payment object can be verified, the transaction can go through, regardless of trust in the intermediary or the counterparty. Such a shift could also portend a change in the way money is created in the digital age: from credit money to commodity money, we may move full circle back to where we were in the Renaissance! In the 20th century, money was based predominantly on credit relationships: central bank money, or base money, represents a credit relationship between the central bank and citizens (in the case of cash) and between the central bank and commercial banks (in the case of reserves). Commercial bank money (demand deposits) represents a credit relationship between the bank and its customers. Crypto assets, in contrast, are not based on any credit relationship, are not liabilities of any entities, and are more like commodity money in nature.”
The deputy director continued by saying the emission of a central bank digital currency (CBDC) could reduce the costs of the transactions for individuals and small companies, as well as allow long-distance transactions to be executed. According to He, this could “make their money more attractive for use as a settlement vehicle. Central bank digital currency could help counter the monopoly power that strong network externalities can confer on private payment networks. It could help reduce transaction costs for individuals and small businesses that have little or costly access to banking services, and enable long-distance transactions. Unlike cash, a digital currency wouldn’t be limited in its number of denominations.”
The deputy director concluded by saying the following: “From a monetary policy perspective, interest- carrying central bank digital currency would help transmit the policy interest rate to the rest of the economy when demand for reserves diminishes. The use of such currencies would also help central banks continue to earn income from currency issuance, which would allow them to continue to finance their operations and distribute profits to governments. For central banks in many emerging market and developing economies, seigniorage is the main source of revenue and an important safeguard of their independence.
To be sure, there are choices and policy trade-offs that would require careful consideration when it comes to designing central bank digital currency, including how to avoid any additional risk of bank runs brought about by the convenience of digital cash. More broadly, views on the balance of benefits and risks are likely to differ from country to country, depending on circumstances such as the degree of financial and technological development.
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 in the game in a digital, sharing, and decentralized service economy. They can remain relevant by providing more stable units of account than crypto assets and by making central bank money attractive as a medium of exchange in the digital economy.”
