Digital finance without cryptocurrencies by Shang-Jin Wei
Digital payments and financial transactions promise greater convenience, stronger competition, and greater savings for society. But when it comes to digital currencies, central banks – not floating cryptocurrencies or stablecoins – should lead the way.
NEW YORK – When Tesla CEO Elon Musk promoted the Dogecoin and Bitcoin cryptocurrencies, their prices have skyrocketed. While some countries are adopting a wait-and-see attitude towards private digital currency, El Salvador has kissed bitcoin as official currency. And the New York State Department of Financial Services (NYDFS) has been busy licensing (and charge fees) to people who want to create and trade cryptocurrencies. Taking the opposite path, China recently banned both mining cryptocurrencies and using them as a medium of exchange.
Given the various policy responses, how should we assess the social costs and benefits of different types of digital currency? Consider floating cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).
The prices of floating cryptocurrencies – of which Bitcoin is the most famous example – are not pegged to any other asset. Despite their rapid growth, it is important to remember that cryptocurrencies do not have intrinsic fundamental value and are therefore vulnerable to price drops.
The recent momentum in the prices of cryptocurrencies recalls the seventeenth century tulip price bubble in the Netherlands, when a first price increase attracted more buyers to the market, pushing prices even higher. But, as with the tulip mania, some seemingly random news in the future could end the cryptocurrency boom, triggering a downward price spiral as existing owners rush to exit.
One of the attractions of cryptocurrencies for investors and speculators is that they look like a lottery ticket – while the potential loss is limited to what you pay for it, the potential gains could be huge. Although we lack precise data on who trades cryptocurrencies, research on lottery tickets suggests that less wealthy investors are more likely to be drawn to this market. Crypto exchanges like Coinbase have made buying cryptocurrencies as easy as buying a lottery ticket, with the minimum trade. as low as $ 2. This means that any future price collapse is likely to hurt the segment of society least able to afford a fall in their savings.
Unlike floating cryptocurrencies, the value of stablecoins is linked either to an official currency such as the US dollar or Japanese yen, or to a valuable commodity such as gold or oil, and therefore has a natural anchor for their price. But investors should first consider whether a stablecoin issuer is fully backing their coin with the equivalent amount of underlying assets. Otherwise, the intrinsic value of the stable coin should reflect the risk that, during a major market crash, the coin supplier will not have sufficient reserves to convert all of its coins into high-quality assets without imposing a discount on the coin. promised value.
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Even providers of stable coins who promise to hold full collateral should have their reserves audited regularly and independently. Entities such as NYDFS that issue operating licenses to parts suppliers typically do not perform such a function.
In countries with a history of high inflation or hyperinflation, such as some in Latin America and Africa, it may make sense to use stablecoins as a medium of exchange. But for most countries with reasonably well-managed monetary policies, stablecoins could undermine policy effectiveness by making the overall liquidity of the economy less controllable by central banks. Additionally, stablecoins and floating cryptocurrencies can and have been used for money laundering and other illicit financial transactions.
Last but not least, national interests can clash. In December 2020, for example, NYDFS approved GYEN, a stablecoin indexed to the yen. GYEN is viewed by New York State as a digital financial innovation that generates income and jobs for the state. But if this stable coin were to gain traction as a medium of exchange in Japan, then its potential costs – including lost seigniorage income and reduced effectiveness of Japanese monetary policy – would be felt there.
CBDCs are a much better bet. For starters, they can save governments billions of dollars by removing the need to circulate and hold banknotes and coins. The United States, for example, currently spends more than $ 1 billion each year on the minting, printing and maintenance of coins and paper notes. The savings that would result from the introduction of an official digital dollar could be used for other socially useful programs, such as providing free Medicaid to people. 31.1 million Americans that are not covered by any health insurance program, or that fund the National Foundation for the Arts five times more.
Since CBDCs are also a payment method that could be used in place of a credit card, they can put pressure on existing payment providers to become more efficient and lower their transaction fees. Both consumers and businesses will benefit.
Moreover, since official digital currencies are issued by central banks, they do not compromise the effectiveness of monetary policy. And while all digital payment and transaction systems raise questions about data security and the protection of personal information, CBDCs are just as likely as their private sector alternatives to address these concerns.
While CBDCs will help improve the efficiency of the financial system, floating cryptocurrencies do not have a bright future and carry the risk of financial instability. Stablecoins fall somewhere in between. For these reasons, we shouldn’t be surprised to see more and more countries over the next few years ban floating cryptocurrencies as a medium of exchange, roll out official digital currencies, and impose strict regulations on stablecoins.