August 21, 2020

Central Banks want to issue their own cryptocurrency

Obviously, in recent decades, new technologies have changed everything completely, and it is happening faster and faster. More and more users are paying in various ways, and in many countries, the use of cash is decreasing, making it easier to use digital payment methods, such as cards or mobile payments.

This makes central banks, which are responsible for issuing a country’s currency and bills, consider whether they should adapt to the new needs of their citizens and start issuing their own digital currency. This decision must be made consciously, because everything has its advantages and disadvantages.

We could ask ourselves: what impact will it have if a central bank decides to launch its own cryptocurrency?

There are proponents and detractors of central banks issuing their own digital currencies

The Bank of England, the Bank of China or the Bank of Sweden have opened the door to the creation of public digital currencies.

As in all international affairs, there are advocates and detractors of central banks issuing their own digital currencies, some people believing that this can improve the functioning of the payment system as well as the management of monetary policy, while others believe that these benefits cannot be offset by the high risks of technology and financial stability.

The Banco de España stated that the advantages and disadvantages will depend largely on the modality chosen for the issuance of public digital currencies, i.e. whether anonymity is respected and whether this type of currency will be remunerated.

The advantages and disadvantages of issuing digital coins for central Banks

Reducing the demand for cash: Payment by card or mobile phone has become a daily routine and the demand for cash is decreasing more and more, so it can have a positive impact on this issue. However, it can also have a negative effect because seigniorage can occur, i.e. the benefit that the central bank derives from the issue of banknotes is transferred to the Treasury, and if it is reduced due to the lack of issue of coins and bills, this can lead to an increase in taxes or a decrease in public spending.

Possible improvement in certain aspects of payment system performance: the introduction of digital currency can generate greater productivity, although it is not clear whether these improvements stem from the introduction of public digital currency, rather than from the extension and improvement of the current private digital currency.

Possible improvements in the management of monetary policy: If the public digital currency is remunerated, its interest rate will become a key tool for the implementation of monetary policy because it will directly affect (through the payment of funds) the savings and investment decisions of households and firms. Deposit at the central bank and indirectly (by setting a lower limit on bank deposit payments). This will allow the transmission of monetary policy to banks, which can be quite beneficial in times of financial crisis.

In the case of a public digital currency economy, the interest rate would be the one that marks the lower limit of interest rates. This breaks the current asymmetry in monetary policy management around zero interest rates. It would be necessary to allow further reductions in nominal interest rates if deemed appropriate.

It would make it possible to combat tax fraud, money laundering and improve financial inclusion: if digital currencies do not remain anonymous, they can play an important role in combating fraud when the central bank has a record of all transactions (if not anonymous, it will mean loss of personal privacy and requires the central bank to invest in infrastructure to monitor each transaction at all times).

Combating tax fraud will require the complete elimination of cash to prevent its later use for illegal activities. However, replacing coins and bills with non-anonymous digital coins would not mean the end of such criminal activities. These activities will still have assets for their purpose, such as foreign currency, gold, etc.

Will the digital currency of the central banks be used to displace Bitcoin?

Another reason why public entities want to issue digital coins is because of the force they are taking the cryptocurrencies such as Bitcoin, Ethereum or Litecoin.

They fear that cryptocurrencies will eventually gain acceptance and displace legal tender from countries. Therefore, it is believed that the central bank should take action by issuing digital currency to avoid losing control of monetary policy management over the real economy, which could destabilize prices.

The Banco de España believes that this reason is still of little weight, given that the market value of cryptocurrencies is not representative and their methods of exchange are still limited.

But for now, we must remember that there are often fluctuations, which makes them unattractive as a unit of account or store of value. But the truth is that this will change over time.

What are the possible problems that banks will face?

The consequence of the introduction of the digital currency is that, if a path of non-remuneration is chosen, the remuneration of commercial financial institutions’ reserves at the central bank will continue to constitute the floor for short-term interest rates in the interbank market, which is a key variable in the management of monetary policy decisions.

If the remuneration of the public digital currencies is chosen. This will affect the profitability of the banking industry and may encourage depositors to withdraw funds, leading to panic incidents in the banking industry, which will make such incidents more likely and more intense.

In this case, banks will be forced to increase the remuneration of deposits to a level above the interest rate, which will reduce the profit margin in the medium term, which may lead to a reduction in the supply of credit and an increase in value, and of course a reduction in the intermediation capacity of the country’s banking system.