Should Central Banks Adopt Digital Currencies?

Cryptocurrencies are moving from the fringe world of libertarian geeks to the mainstream of economic, financial and political thought. Some central bankers are trying to create blockchain-based mediums of exchange that might serve as a “next-generation currency.”

The top decision makers at the People’s Bank of China (PBOC) view the emergence of a digital legal tender as inevitable. The PBOC’s Vice Governor, Fan Yifei, even wrote a Bloomberg Voices piece urging central banks to take the lead in developing a digital currency.

The replacement of paper money with digital currencies is a necessary evolution of the monetary system, PBOC Governor Zhou Xlaochuan told Caixin Weekly. Zhou even called paper bills a “last-generation currency” that will have to be replaced.

To that end the PBOC is hiring encryption, block-chain and other experts to design a cryptocurrency, Cryptocoin News reported. Fan suggested that the currency should be created by the central bank but distributed through private banks much like paper money is today.

The PBOC is in a rush to develop a digital currency because of China’s experience with bitcoin. China is the world’s largest market for bitcoin because the cryptocurrency allows the country’s residents to easily bypass its’ rigid currency controls.

The central bankers apparently hope that issuing their own cryptocurrency will give them some control over the situation. Some control is better than no control which is what they have right now.

The World’s First Central Bank Issued Cryptocurrency is Here

Interestingly enough the PBOC will not be the first central bank to issue a cryptocurrency. The Monetary Agency of Singapore is planning to test a blockchain based digital that will be used for interbank payments.

That currency will be backed by cash banks deposit in the central bank, Bloomberg reported. That sounds a great deal like early banknotes which were theoretically redeemable in gold or silver at the central bank. Another reason for that will be to raise money for the central bank by selling the cryptocurrency on the open market.

Currently central banks make a lot of money by selling paper currency to other banks. The Monetary Agency may hope that there will also be a market for its cryptocurrency. The PBOC might want to replace the US Federal Reserve as the world’s top central bank by selling a digital cryptocurrency to compete with the US dollar.

At least one other central bank; the Bank of England, is researching the possibility of a cryptocurrency. Two of its economists; Michael Kumhoff and John Barrdear, published a staff working paper that proposed a “Central Bank Issued Digital Currency” in July 2016. Interestingly enough their currency would be interest-bearing so it would serve as an investment like a bond.

The Old Lady of Threadneedle Street has also established a FinTech Accelerator; which might serve as a laboratory to develop a cryptocurrency. One reason why the Bank of England is interested in such a product is the decline of pound sterling which threatens Britain’s position as a global financial center.

Bank-Issued Digital Currencies

Not to be done a number of major private banks are developing their own cryptocurrencies. Goldman Sachs (NYSE: GS) is developing SETLCoin and Citigroup (NYSE: C) is reportedly working on Citicoin.

A consortium of banks that includes UBS (NYSE: UBS), Deutsche Bank (NYSE: DB), Santander (NYSE: SAN) and Bank of New York Mellon (NYSE: BK) is developing the Utility Settlement Coin (USC), Crowdfund Insider reported. The USC will be an asset backed investment that can be used by central banks. It sounds like a market-traded instrument designed for smaller nations to take advantage of.

The USC and Singapore proposals came just as two major efforts to bring bitcoin to mainstream trading venues were announced. These might be attempts to cash in on a major new futures market.

Cryptocurrency Market Developing

The CME Group Inc.; which operates futures and derivatives exchanges in New York and Chicago, unveiled two gauges designed to track bitcoin prices, Geek Crunch Reviews reported. The CME Bitcoin Reference Rate and CME Bitcoin Real Time Index could serve as the basis for bitcoin futures.

A proposal for a bitcoin-based exchange-traded fund (ETF) that will be distributed through State Street has been filed with the Securities and Exchange Commission (SEC) by the Winklevoss twins of Facebook (NASDAQ: FB) fame. The ETF would allow people to invest in bitcoin traded by the twins’ exchange Gemini Trust Company.

It looks as if a large market for cryptocurrency futures is about to develop. Banks and central banks want in on that market because it might become a major cash cow for them.

Are Central Bank Issued Cryptocurrencies a Good Idea?

There would be many advantages to central bank issued cryptocurrencies. The most obvious of these would be more control over the money supply.

The central bank would be in a position to instantly expand or contract the money supply by turning on and off the spigot. This might work like quantitative easing in the United States; through which the Federal Reserve has softened the effects of the Great Recession that began in 2008.

Another would be to reduce the cost of bank operations because the expense of printing all that cash and distributing it would disappear. The use of cryptocurrencies would also hasten the demise of paper money; particularly large denomination bills. Legitimate businesspeople that need cash would simply the cryptocurrency instead.

The European Union and India are already trying to get rid of large denomination bills. The European Central Bank has stopped printing the €500 note which was a favorite medium of exchange for gangsters, drug dealers and tax cheats. India has eliminated its two largest bills in an attempt to control counterfeiting and terrorism.

There are practical and ethical problems here, what about all the people that will refuse to use electronic currency. Groups like the Amish; who regard technology as sinful, senior citizens, and the uneducated might find themselves shut out of the economy.

The rich and the educated would still be in a position to avoid taxation via cryptocurrency. They might be able to send all their assets off to their overseas account by tapping on an app. Meanwhile working people would see their protection from the taxman; the cash under the mattress – lose all its’ value.

This just happened in India where Prime Minister Narenda Modi declared the nation’s two largest bills; the 500 and 1,000 rupee notes, were no longer legal tender. That destroyed the value of 84% of the currency circulating on the subcontinent.

Such questions will have to be faced because the first central bank cryptocurrencies will probably be available within a year. Once they are here, cryptocurrencies might replace paper money as the world’s dominant medium of exchange.