Executive Summary
This policy contribution tries to answer two main questions: can cryptocurrencies acquire the role of money? And what are the implications for central banks and monetary policy?
Key Insight: Money is a social institution that serves as a unit of account, a medium of exchange and a store of value. With the emergence of decentralised ledger technology (DLT), cryptocurrencies represent a new form of money: privately issued, digital and enabling peer-to-peer transactions.
Key Data Points
Key Insights Summary
Cryptocurrencies as Speculative Assets
Currently, cryptocurrencies resemble speculative assets rather than money, primarily because of their inherent volatility which limits their widespread use as a medium of exchange.
Conditions for Successful Currencies
Historically, currencies fulfill their main functions successfully when their value is stable and their user network sufficiently large. Cryptocurrencies currently fall short against these criteria.
Limited Threat to Central Banks
The risks of cryptocurrencies becoming serious contenders remain small as long as fiat currencies issued by major central banks continue to deliver effectively the three traditional functions of money.
Potential for Improvement
Cryptocurrency protocols could theoretically evolve to limit their volatility and correct current deficiencies, potentially increasing their popularity as alternatives to official currencies.
Systemic Risks of Widespread Adoption
Widespread substitution of central bank currency for cryptocurrencies could create parallel currencies, posing risks to monetary policy effectiveness and financial stability.
Accountability Challenges
Cryptocurrencies lack a system of checks and balances to keep the issuer accountable to society, which is a fundamental requirement for stable currency management.
Content Overview
Document Contents
Introduction
The emergence of cryptocurrencies enabled by the development of intelligent digital technologies could be a challenge to the monopoly of official central bank-controlled currencies. This policy contribution addresses two main issues:
- What are the main characteristics of money and to what extent do cryptocurrencies have these characteristics?
- How could the emergence of cryptocurrencies change the nature of monetary policy, and whether currency management can be done by algorithms within the system of checks and balances required in democratic societies?
Cryptocurrencies: A Role as Money?
Money is traditionally defined by three functions: unit of account, medium of exchange, and store of value. Cryptocurrencies represent a new combination in the money taxonomy:
- Privately issued: Unlike bank deposits, they are not a liability and cannot be redeemed
- Digital: Similar to electronic money but with no intrinsic value
- Decentralized settlement: Using DLT for peer-to-peer transactions without central authority
The novelty of cryptocurrencies lies in the feasibility of peer-to-peer digital transactions with potential advantages including transaction anonymity, protection from political influence, and global accessibility.
Conditions for Currencies to Fulfill Money Functions
Historically, two key features characterize successful currencies:
- Price stability: The value must be relatively stable over time
- Large user network: A critical mass of users is essential
These features are complementary and mutually reinforcing. Today's fiat currencies issued by major central banks perform all three traditional functions of money well, supported by institutional arrangements that provide stable purchasing power.
The state has been instrumental in ensuring the ascendance of fiat money through legal tender laws and tax obligations. Central banks provide an elastic supply of currencies within accountable but discretionary institutional setups.
Evaluating the Money Role of Cryptocurrencies
Currently, cryptocurrencies are more speculative assets than functional currencies due to:
- Inherent volatility: Resulting from inelastic supply protocols
- High transaction costs and time: Energy-intensive validation processes
- Borderless nature: Creating challenges for optimal currency areas
- Market concentration risks: Potential for manipulation and falsification
Despite current limitations, developers are working on "stablecoins" with supply protocols that expand and contract with demand to maintain stable value. However, even with improved protocols, cryptocurrencies would still lack the institutional backing and legal tender status that support official currencies.
Cryptocurrencies and Monetary Policy
The coexistence of cryptocurrencies and official currencies could have several implications:
- Limited threat to monetary control: As long as central bank money retains the unit of account role
- Potential disciplining effect: Cryptocurrencies could pressure central banks to maintain price stability
- Financial stability risks: Cryptocurrency bubbles could reverberate into wider financial instability
- Accountability challenges: Algorithmic management lacks the checks and balances of democratic oversight
In a full cryptocurrency regime, fractional reserve banking would face challenges without a lender of last resort, potentially leading to credit squeezes detrimental to the economy.
Conclusions
The evidence suggests that cryptocurrencies are not real contenders for currency substitution at present. Their protocols are primitive relative to modern financial system requirements, and official currencies benefit from natural monopolies due to years of good practices, price stability, legal status, and strong user networks.
Control over money value is a significant power that requires systems of checks and balances. Taking this power outside such systems through anonymous, automatic algorithms could threaten societal stability.
While cryptocurrencies could evolve into legitimate private payment means, they are unlikely to challenge official currencies. As potential competitors, they could have a positive effect by disciplining central banks, especially in countries with histories of lax monetary policy.
Note: The above is only a summary of the report content. The complete document contains extensive data, charts, and detailed analysis. We recommend downloading the full PDF for in-depth reading.