(Editor’s note: This is the second in a two-part series exploring banks and cryptocurrency.)
Cryptocurrencies promise to disrupt and transform the financial system — a promise that grows as central banks around the world experiment with the idea of issuing their own cryptocurrencies.
The Bank of England, the Bank of Canada, Sveriges Riksbank, Deutsche Bundesbank, the European Central Bank, Bank of Japan and the People’s Bank of China are actively exploring the concept of issuing central bank cryptocurrencies, or CBCCs.
So far, the experts agree on one thing: There are more questions than answers.
Even the most recent quarterly report from the Bank for International Settlements — which told central banks that they’ll have to decide individually whether to issue CBCCs — emphasized that “… making sense of all this is difficult. There is confusion over what these new currencies are, and discussions often occur without a common understanding of what is actually being proposed.”
Gallup research shows the majority (53 percent) of Americans make “only some or none” of their purchases using cash, signaling a further shift toward mobile payment apps and electronic payment methods. So what makes CBCCs different?
The Bank for International Settlements defines a cryptocurrency as “an electronic form of central bank money that can be exchanged in a decentralized manner known as peer-to-peer, meaning that transactions occur directly between the payer and the payee without the need for a central intermediary” — making it unlike all existing forms of electronic central bank money, which rely on an intermediary.
At the heart of the BIS report are two main needs to use cryptocurrency: anonymity for customers and increased efficiency for financial institutions. The BIS also identifies two main possible types of CBCC: retail (available to the public as a sort of decentralized digital cash) and wholesale (available only to financial institutions, to streamline settlements of transactions between them).
Retail CBCCs do not yet exist anywhere. Farida Khan, chair and associate professor of economics at UCCS, said they “are likely to be successful because people have confidence in the Central Bank’s ability to create money.”
But consumers who are motivated to use cryptocurrencies because they mistrust the government might be less enthusiastic, said William Craighead, assistant professor in Colorado College’s Department of Economics and Business.
“[Cryptocurrency] appeals to that suspicion of the government and the Federal Reserve, to have a way of doing transactions that is outside of using currency that is controlled by the central bank …,” Craighead said. “Some of the people who are anti-government or who want to avoid the government would not find [government-backed cryptocurrency] appealing; that might defeat the purpose for them.”
Are we looking at a cashless future? The consensus, for now, is no — there are just too many reasons to keep cash.
Colorado’s legal marijuana industry alone offers about 1 billion reasons each year. Because marijuana is illegal under federal law, most retailers cannot use federally insured banks or access their electronic payment systems, so they fall back on cash.
There are many other transactions, legal nationwide, that people prefer to keep anonymous — liquor stores do a lot of cash business, for example. People also turn to cash for small transactions, during natural disasters and even as a budget-enforcer during financial downturns.
And according to the FDIC, one quarter of American households are unbanked or underbanked, relying heavily on cash.
One of the BIS report’s co-authors, University of California, Santa Barbara economics professor Rod Garratt, signaled larger risks involved in abandoning cash completely.
Garratt said a cryptocurrency available to all consumers “opens up a whole host of issues” and would challenge makers of monetary policy.
“First, there’s the question of who, exactly, should verify the transactions and maintain the distributed ledger,” Garratt said. “Even if that’s solved, the new system would be, in a sense, too streamlined, making it easier for bank runs to occur in a moment of crisis or panic.”
The blockchain technology that underpins CBCCs would allow central banks to provide a digital cash substitute as anonymous as cash — but would they allow that anonymity?
“The central bank would need to decide whether or not to require customer information (the true identity behind the public address),” the BIS report noted. “While it may look odd for a central bank to issue a cryptocurrency that provides anonymity, this is precisely what it does with physical currency, i.e. cash.”
Craighead questioned whether the government would want to maintain anonymity — “and even if they said they were maintaining the anonymity, would you trust it?”
“If law enforcement gets a court order to look at somebody’s cryptocurrency wallet, would that be different if it was a government-backed currency? It probably would be,” he said.
Eric Weissmann, founder of Modern Tender, the operating company that manages one of the 17 Bitcoin teller machines in Colorado, told Denver’s TalkRadio 630KHOW that privacy in cryptocurrencies is an evolving issue.
“I personally believe … part of our fundamental freedom is to be able to spend a buck or a Bit with nobody knowing what you spent it on,” Weissmann said. “The federal government doesn’t like privacy in money; some governments around the world are actually trying to get rid of cash because it can’t be traced, and they want to have their fingers on it.”
In addition to determining privacy, central banks issuing CBCCs would have the ability to adjust their cryptocurrency’s interest rate — an important part of how central banks manage existing currency. CBCCs would also avoid the wild fluctuations characteristic of decentralized cryptocurrencies like Bitcoin.
The value of one Bitcoin reached an all-time high of $5,013 on Sept. 1 and has dropped 20 percent since then. It’s been prone to crashing, including a precipitous drop from $266 per coin to $50 per coin in early 2013. WorldCoinIndex, which shows the lastest crypto coin trade prices and market cap, shows Bitcoin up a massive 669.97 percent over the past 365 days.
“[Bitcoin] is an interesting example for economists to talk about because it gets us back to thinking about the fundamentals of ‘What is money? What characteristics does it have?’” Craighead said.
“A good money is supposed to have the characteristic that it’s a store of value, and a unit of account, and that those depend on its value being predictable over time. …
“I feel pretty comfortable predicting that inflation in the United States will be between 1 and 3 percent for the next 10, 20, 30 years, so I have an idea of what the dollars in my bank account are going to buy, whereas if I were holding Bitcoin, it’s been too volatile.
“Part of the argument for [decentralized cryptocurrency] is if you don’t trust the government to manage the value of the currency, to have it be managed by this algorithm has some appeal. But the truth is that you need for the money supply to be managed in order to keep the value stable.”
In May, academics Michael Bordo and Andrew Levin told the Hoover Institution Policy Conference on The Structural Foundations of Monetary Policy that CBCCs could “transform all aspects of the monetary system and facilitate the systematic and transparent conduct of monetary policy.”
In particular, they said, “we find a compelling rationale for establishing a [CBCC] that serves as a stable unit of account, a practically costless medium of exchange, and a secure store of value. …[The CBCC] should be interest-bearing, and the central bank should adjust that interest rate to foster true price stability.”
With CBCCs, Khan said, “there is a new form of money still backed by the central bank [like cash]. This would reduce the role of other banks in providing liquidity and everyone could use cryptocurrencies the way that they use cash.”
Khan said CBCCs would also reduce the use of checking deposits and the role of the commercial banking system, centralizing the banking system even further.
According to the Massachusetts Institute of Technology’s Technology Review, increasing the central bank’s control over money in circulation and digital transactions is a plus: Traceable digital transactions would help reduce corruption, and policymakers would gain real-time economic insights. A national digital currency would also lower the cost of financial transactions, boost the reach of financial services and increase transparency.