Crypto assets could reduce demand for central bank money
The International Monetary Fund believes the role of central banks is likely to diminish over the coming years if cryptocurrencies become more stable and deeply established.
Dong He, deputy director of the IMF’s monetary and capital markets department, says in the organisation’s June 2018 Finance and Development Report, that the scepticism born of central bank bailouts during the financial and credit crises fuelled the rise of cryptocurrencies.
Too volatile to threaten fiat
While crypto assets remain too volatile to pose a threat to established monetary norms, if they ever gain the public trust and become established and stable assets they could serve as an alternative means of payment, reducing the demand for fiat currencies and, therefore, central bank money.
“Cryptocurrencies have been afflicted by notorious cases of fraud, security breaches, and operational failures,” says Dong. “But continued technological innovation may be able to address some of these deficiencies.”
Meanwhile, 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
- The capacity to function as a lender of last resort
Should cryptocurrency acceptance drive a rise in their use, it could be a different story, however, says Dong.
A longer track record for stable crypto transactions would be needed to convince many potential users that digital currency is the way forward. But if it is, what future for central banks if the power of fiat currencies is diminished?
Dong says the dollarisation of some developing economies could provide a useful analogy.
“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,” he says.
In other words, if central bank money no longer defines the unit of account for domestic economies then the central bank’s monetary policy becomes irrelevant.
Make fiat currencies better
Dong says that the best response central banks can adopt is to ensure fiat currencies remain a better, more stable unit of account than cryptos.
Christine Lagarde, IMF managing director, said in a speech at the Bank of England in 2017: “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.”
Meanwhile, governments and their regulators must tightly control the use of crypto assets to prevent any unfair competitive advantages being established – cracking down on fraud and use of cryptos for illegal activities, and establishing a fiscal regime where crypto use can be effectively and fairly taxed.
“There are both challenges and opportunities for central banks in the digital age,” Dong says.
“Central banks must maintain the public’s trust in fiat currencies and stay in the game in a digital, sharing, and decentralised service economy.”
This might even mean that central banks should issue digital tokes of their own that can be exchanged in a decentralised manner, establishing global payment networks free of transaction costs, just as digital currencies doing right now.