Cryptocurrency as a National Currency? One too many steps
New digital forms of money have the potential to provide cheaper and faster payments, improve financial inclusion, improve resilience and competition among payment providers, and facilitate cross-border transfers.
But doing it is not easy. It requires significant investment, as well as difficult political decisions, such as clarifying the role of the public and private sectors in the provision and regulation of digital forms of money.
Some countries may be tempted by a shortcut: adopt crypto assets as national currencies. Many are in fact safe, easily accessible and cheap to transact. We believe, however, that in most cases the risks and costs outweigh the potential benefits.
Crypto assets are privately issued tokens based on cryptographic techniques and denominated in their own unit of account. Its value can be extremely volatile. Bitcoin, for example, peaked at $65,000 in April and fell to less than half that value two months later.
And yet, Bitcoin lives on. For some, it’s an opportunity to trade anonymously, for better or worse. For others, it is a means to diversify portfolios and hold a speculative asset that can create riches but also significant losses.
Therefore, crypto assets are fundamentally different from other types of digital money. Central banks, for example, are considering issuing digital currencies: digital money issued in the form of a central bank liability. Private companies are also pushing the frontier, with money that can be sent via mobile phones, popular in East Africa and China, and with stablecoins, whose value depends on the safety and liquidity of supporting assets.
Crypto assets as legal tender?
Bitcoin and its peers have mostly remained on the fringes of finance and payments, yet some countries are actively considering giving crypto assets legal tender status, and even turning them into a second (or potentially sole) currency. National currency.
If a crypto asset were granted legal tender status, creditors would have to accept it as payment for monetary obligations, including taxes, similar to notes and coins (currency) issued by the central bank.
Countries can even go further by passing laws to encourage the use of crypto assets as a national currency, that is, as an official monetary unit (in which monetary obligations can be expressed) and as a mandatory means of payment for daily purchases.
Crypto assets are unlikely to catch on in countries with stable inflation and exchange rates and credible institutions. Households and businesses would have little incentive to price or save on a parallel crypto asset like Bitcoin, even if it were given legal tender or currency status. Its value is too volatile and is not related to the real economy.
Even in relatively less stable economies, using a globally recognized reserve currency such as the dollar or euro would probably be more attractive than adopting a crypto asset.
A crypto asset could become a vehicle for unbanked people to make payments, but not to store value. It would be immediately exchanged to real currency upon receipt.
On the other hand, actual currency may not always be available or easily transferable. Also, in some countries, laws prohibit or restrict payments in other forms of money. These could tip the balance towards the widespread use of crypto assets.
Proceed with caution
The most direct cost of widespread adoption of a crypto asset like Bitcoin is to macroeconomic stability. If goods and services were priced in both a real currency and a crypto asset, households and businesses would spend a lot of time and resources choosing what money to keep instead of engaging in productive activities. Similarly, government revenues would be exposed to foreign exchange risk if taxes were quoted upfront in a crypto asset while expenditures were held primarily in the local currency, or vice versa.
In addition, monetary policy would lose strength. Central banks cannot set interest rates in a foreign currency. Typically, when a country adopts a foreign currency as its own, it “imports” the credibility of foreign monetary policy and hopes to align its economy and interest rates with the foreign business cycle. Neither of these is possible in the case of widespread adoption of crypto assets.
As a result, domestic prices could become very unstable. Even if all prices were quoted in, say, Bitcoin, the prices of imported goods and services would still fluctuate wildly, following the vagaries of market valuations.
Financial integrity could also suffer. Without robust anti-money laundering and combating the financing of terrorism measures, crypto assets can be used to launder ill-gotten money, finance terrorism, and evade taxes. This could pose risks to the financial system, fiscal balance and relationships with foreign countries and correspondent banks of a country.
The Financial Action Task Force has established a standard for how virtual assets and related service providers should be regulated to limit financial integrity risks. But the application of that standard is not yet consistent across countries, which can be problematic given the potential for cross-border activities.
More legal problems arise. Legal tender status requires that a means of payment be widely accessible. However, internet access and the technology needed to transfer crypto assets remain scarce in many countries, raising concerns about fairness and financial inclusion. In addition, the official monetary unit must have a sufficiently stable value to facilitate its use for medium to long-term monetary obligations. And changes in a country’s legal tender status and monetary unit generally require complex and widespread changes in monetary law to avoid creating a disjointed legal system.
Additionally, banks and other financial institutions could be exposed to massive fluctuations in the prices of crypto assets. It is unclear whether prudential regulation against foreign currency exposures or risky assets at banks could be sustained if Bitcoin, for example, were granted legal tender status.
Furthermore, the widespread use of crypto assets would undermine consumer protection. Households and businesses could lose wealth due to large changes in value, fraud or cyber attacks. While the technology underlying crypto assets has proven to be extremely robust, technical failures could occur. In the case of Bitcoin, recourse is difficult as there is no legal issuer.
Finally, mined crypto assets like Bitcoin require an enormous amount of electricity to power the computer networks that verify transactions. The ecological implications of adopting these crypto assets as the national currency could be dire.
Striking A Balance
As a national currency, crypto assets, including Bitcoin, carry substantial risks to macro-financial stability, financial integrity, consumer protection, and the environment. The benefits of its underlying technologies, including the potential for cheaper and more inclusive financial services, should not be overlooked. However, governments must step up to provide these services and take advantage of new digital forms of money while preserving stability, efficiency, equality and environmental sustainability. Attempting to make crypto assets a national currency is an ill-advised shortcut.