CHALLENGES OF CRYPTO CURRENCY TO THE CASH FINANCIAL SYSTEMS
Crypto currency enables the citizens of a country to undermine government authority by circumventing capital controls imposed by it. It also facilitates nefarious activities by helping criminals evade detection. Finally, by removing intermediaries, crypto currency can potentially throw a wrench in the existing financial infrastructure system and destabilize it
crypto currency is a favored conduit for criminals for financial transactions. The most famous example of a crime involving the cryptocurrency bitcoin was the Silk Road case. Briefly, Silk Road was a marketplace for guns and illegal drugs, among other things, on the Dark Web. It allowed users to pay in bitcoins. The cryptocurrency was held in escrow until the buyer confirmed receipt of goods. It was difficult for law enforcement to trace parties involved in the transaction because they only had blockchain addresses as identification. Eventually, however, the FBI was able to take down the marketplace and seize 174,000 BTC.
Bitcoin has become a touchstone for controversy since it was introduced to the world in the aftermath of the financial crisis. Governments have become wary, even fearful, of Bitcoin, and have alternated between criticizing the cryptocurrency and investigating its use for their ends.
While it has the potential to decentralize and change the workings of the existing financial infrastructure, the cryptocurrency’s ecosystem is still rife with scandals and criminals. Until the time that its ecosystem matures and a significant use case for it is found, Bitcoin will continue to provoke distrust and criticism from established authorities.
More than 85% of central banks are now investigating digital versions of their currencies, conducting experiments, or moving to pilot programs, according to PwC. China is leading the charge among major economies, pumping more than $300 million worth of a digital renminbi into its economy so far, ahead of a broader rollout expected next year. The European Central Bank, Bank of Japan, and Federal Reserve are investigating digital currencies. A “Britcoin” may eventually be issued by the Bank of England. Sweden is lining up an e-krona and might be the first cashless nation by 2023.
“The private sector is throwing down the gauntlet and challenging the central bank’s role.”
— Ed Yardeni
Crypto-Currencies: Five big implications for central banks
Why Governments Are Wary of Crypto
Why Are Governments Wary of Crypto/Bitcoin?
The Effect of Cryptocurrency on the Banking System
How Do Crypto Currencies Affect Monetary Policy?
Why Cryptocurrencies Are a Threat to Central Banks
Crypto-Currencies: Five big implications for central banks
1. A lot of money is already electronic.
Although physical currency is still widely used in most countries (with the exception of Sweden, where the use of cash is shrinking rapidly), consumers around the world routinely conduct transactions without physical currency, using credit cards or mobile phones to pay. Further, much of the money that central banks (bank reserves) issue exists only in electronic form. So in some sense, the idea of digital currencies is not completely new.
2. Cryptocurrencies aren’t likely to replace government-backed currency soon.
Bitcoin and other cryptocurrencies are popular, but most people don’t trust them the way they trust the U.S. dollar, the euro, or the Japanese yen, all of which are backed by a central bank. Despite the erosion of confidence in government institutions, most people still prefer money backed by a central bank, and this is unlikely to change anytime soon.
3. Still, digital currencies could change the financial system in big ways.
Digital currencies and other innovations in payment systems could increase the speed of domestic and cross-border transactions, reduce transaction costs, and eventually broaden access to the financial system by poor and rural households.
4. But these new technologies bring some big challenges too.
Digital currencies and related technologies are likely to reduce transactions costs and decrease the price of acquiring and sharing information, which sound good but can destabilize financial markets and intensify contagion from one market to another. They could undermine the business models of conventional banks and their role in the financial system, making it hard for central banks—which operate largely through the banking system—to maintain financial stability.
5. Should central banks issue their own digital currencies?
Very few central banks are seriously considering issuing their own digital currencies—that is, allowing the public to have electronic deposits at the central bank—but many central banks are talking about this option. So far, only a couple central banks have issued their own digital currencies, Ecuador and Tunisia among them. Sweden, where the use of cash is evaporating faster than almost any other sizeable economy, is contemplating whether to issue an e-krona.
Issuing its own digital currency would prevent a central bank from losing market share to bitcoin, and it could make it easier for a central bank to pursue negative interest rates (charge a fee to depositors rather than pay interest) during an economic downturn. But an official digital currency could reduce the role of traditional banks as intermediaries and lenders, and could pose big problems during a financial crisis, if depositors pull money out of traditional banks to deposit it at the (safer) central bank.
The post above discusses answers offered by Agustin Carstens, General Manager of the Bank of International Settlements; Stefan Ingves, Governor of Sveriges Riksbank; Urjit Patel, Governor of the Reserve Bank of India; and Benoit Coeure, member of the Executive Board of the European Central Bank, to these and other questions. It draws primarily from a conference, “Digital currencies: Implications for central banks,” hosted by the Hutchins Center on Fiscal and Monetary Policy in April 2018 and a report, “Central Banking in a Digital Age: Stock-Taking and Preliminary Thoughts,” by our Brookings colleague, Eswar Prasad.
Digital-currencies-five-big-implications-for-central-banks
Why Governments Are Wary of Crypto
Since its introduction in a 2008 whitepaper, Bitcoin (BTCUSD) has generated controversy and news. Its enthusiasts herald the cryptocurrency’s launch as the advent of a new and equitable monetary system. Critics point to the cryptocurrency’s role in criminal activities and the absence of legal recognition as proof that it is “rat poison squared”.1 The reality, probably, lies somewhere in between.
Meanwhile, governments around the world are eyeing Bitcoin’s advance warily. Some, like El Salvador, have adopted it as currency. But major economies, including the United States, refuse to recognize it as legal tender. They have good reasons for doing so.
Key Takeaways
- Governments around the world are eyeing Bitcoin's advance warily because it has the potential to upend the existing financial system and undermine their role in it.
- In its current form, Bitcoin presents three challenges to government authority: it cannot be regulated, it is used by criminals, and it can help citizens circumvent capital controls.
- Until the time that Bitcoin's ecosystem matures, it will continue to be viewed with distrust by established authorities.
In What Do We Trust?
Fiat refers to conventional currencies issued by governments. Fiat money is backed by the full faith and credit of a government. This means that governments promise to make the borrower of a currency whole, in case of a default.
The U.S. government relies on the Federal Reserve, a central bank on which Congress only has partial authority, to print or create money for its economy. The cycle of transactions in the US economy—one that involves borrowers, lenders, and consumers—relies on a chain of trust between transacting parties. The Federal Reserve, which is also known as a lender of the last resort, is the final leg of that chain.
Bitcoin advocates charge the Fed with creating money out of thin air i.e., the currency is not backed by tangible assets. By manipulating the supply of money in the US economy, the central bank also manufactures asset bubbles and crises, they say.
Governments facilitate the role of central banks in an economy. While central banks are involved in making policy related to money, they do not have authority to regulate its use. That responsibility lies with the government. Through a series of intermediaries, such as banks and financial institutions, governments distribute and regulate the flow and use of money in an economy. Thus, they can dictate how it is transferred, sectors where it is distributed, and trace its utility.
They also earn revenue from it by taxing earnings of individuals and corporations.
Bitcoin Undermines the Cycle of Trust
Bitcoin’s decentralized system has the potential to dismantle the system described above. Its network does away with intermediaries and, by extension, the elements of a government’s system.
A central bank is no longer required because Bitcoin, the currency, can be produced by anyone running a full node. Peer-to-peer transfers between two parties on Bitcoin’s network means that intermediaries are no longer required to manage and distribute currency.
The chain of trust underpinning the current financial infrastructure becomes an algorithmic construct in Bitcoin’s network. A transaction is not included in the central ledger unless it is approved by all full nodes. Even a single disagreement or error in a transaction entry can result in its rejection.
Theoretically, at least, the streamlining of operations between individuals and between various actors on Bitcoin’s blockchain can rearrange the current system.
The financial infrastructure is decentralized and the power to increase or decrease currency supply is not appointed with a single or group of authorities. Thus, in the new setup, the role of governments in managing and regulating economic policy through intermediaries may become superfluous.
Why Are Governments Wary of Crypto/Bitcoin?
I, Bitcoin can circumvent government-imposed capital controls
Governments often institute capital controls to prevent outflows of a currency because exports could debase its value. For some, this is another form of control exerted by governments on economic and fiscal policy. In such instances, the state-less nature of bitcoin comes in handy to circumventing capital controls and exporting wealth.
One of the more well-known instances of capital flight using Bitcoin has occurred in China. The country’s citizens have an annual limit of $50,000 to purchase foreign currency. A report by Chainalysis, a crypto forensics firm, found that more than $50 billion moved from China-based bitcoin wallets to wallets in other countries in 2020, meaning Chinese citizens may have converted the local currency to Bitcoin and transferred it across borders to sidestep government regulation.
II, Bitcoin ties to illegal activity
The ability to bypass existing financial infrastructure for a country is a blessing in disguise for criminals because it enables them to camouflage their involvement in such activities. Bitcoin’s network is pseudonymous, meaning users are identified only by their addresses on the network. it is difficult to trace the provenance of a transaction or the identity of an individual or organization behind the address. Besides this, the algorithmic trust engendered by Bitcoin’s network obviates the need for trusted contacts at either end of an illegal transaction.
Not surprisingly, Bitcoin is a favored conduit for criminals for financial transactions. The most famous example of a crime involving bitcoin was the Silk Road case. Briefly, Silk Road was a marketplace for guns and illegal drugs, among other things, on the Dark Web. It allowed users to pay in bitcoins. The cryptocurrency was held in escrow until the buyer confirmed receipt of goods. It was difficult for law enforcement to trace parties involved in the transaction because they only had blockchain addresses as identification. Eventually, however, the FBI was able to take down the marketplace and seize 174,000 BTC.
In recent times, infecting popular applications with ransomware and demanding payment in bitcoin has also become popular with hackers. The 2021 Colonial Pipeline hack, which resulted in energy supply disruptions in various states, demonstrated the degree to which such attacks can become national security issues.5
III, Bitcoin is not regulated
More than a decade after Bitcoin was introduced, governments around the world are still trying to figure out ways to regulate the cryptocurrency. There are multiple strands to bitcoin’s regulation problem.
For example, changing narratives about Bitcoin utility has complicated questions relating to the appropriate government agency to oversee the cryptocurrency, definitions to be used for lawmaking or, even, the approach for formulation of laws.
Is Bitcoin a currency to be used in daily transactions or a store of value that is primarily used for investment purposes? Is Bitcoin a safe haven asset during the times of global economic turmoil? Neither the so-called Bitcoin expert nor the average bitcoin investor seem to know.
It could be argued that the use of Bitcoin in investing products like futures is proof of its attractiveness to traders. However, the underlying markets for such derivatives are unregulated because none of the major cryptocurrency exchanges, used to set Bitcoin’s price for futures markets, are registered with the Securities and Exchange Commission (SEC).
An Opaque Ecosystem
While Bitcoin has the potential to upend established dynamics of the existing financial ecosystem, it is still plagued by several problems. Government wariness about the cryptocurrency can be partly attributed to fear and partly to the lack of transparency about its ecosystem. Those latter concerns are not misplaced.
Not much is known about the cause-and-effect relationship between Bitcoin price and global developments.6 That is an important sticking point in light of the cryptocurrency’s volatile price swings. Numerous scams have pervaded its development as an asset class. As the SEC outlined in a January 2018 letter, there are several issues, from an absence of transparency to the presence of bitcoin whales, related to the workings of cryptocurrency exchanges.7
James McWhinney Why-governments-are-afraid-bitcoin
The Effect of Cryptocurrency on the Banking System
Cryptocurrency and the Banking System
Cryptocurrency was invented in 2009 with the creation of bitcoin by an unknown engineer with the pseudonym Satoshi Nakamoto. Cryptocurrencies are entirely digital and decentralized – no state or central authority supports cryptocurrencies (Burlacu, 2021). The decentralized nature of cryptocurrencies is made possible through the innovation known as the blockchain. The blockchain is a public database (or ledger) that contains records and details about cryptocurrency transactions (Nicoleta, 2021). The blockchain database is copied and updated on all of the computers on the cryptocurrency’s network. This distributed network creates both trust and redundancy. Most cryptocurrencies are open source, so anyone can become part of the blockchain network by running software on their computer or other devices (Raj, 2019). Since the blockchain database has so many copies that are the same, it is nearly impossible to introduce a false version of the database without detection. Also, the distributive nature of the blockchain database means that it does not rely on any central authority, and it does not have any single point of failure.
A Brief History of Cryptocurrency and the Current State of Adoption
Cryptocurrency adoption has evolved since the recording of the first bitcoin transaction was made on January 12, 2009 (Raj, 2019). Bitcoin, being the first mover, has the highest adoption rate of any cryptocurrency. Bitcoin accounts for a substantial percentage of the entire cryptocurrency market. Early adopters of bitcoin included tech-savvy individuals who were able to see potential early on. Later, bitcoin became popular with libertarians who viewed cryptocurrency as a possible method to avoid central government and corporate power. Today, bitcoin and other cryptocurrencies are seen by many as a method to store value and a valid alternative to traditional fiat currency. The financial press routinely reports on bitcoin’s value, and many high-profile public companies use cryptocurrencies as a basis for innovation and profitability. Approximately 2% of financial institutions are currently interested in offering crypto-related services (Shelvin, 2021).
Cryptocurrency Regulation can Mitigate the Impact
The nature of cryptocurrencies puts it at odds with the traditional, centralized banking system. Traditional banking systems rely heavily on banks and on a central government that can control fiscal policy. Since cryptocurrency is outside of the control of any single entity, there has been speculation that governments will heavily regulate or even outlaw the use of cryptocurrency. These concerns have eased somewhat because governing bodies like the US Security and Exchange Commission (SEC) have indicated that they intend to enact regulations to protect investors (Gura, 2021) instead of implementing laws that severely restrict cryptocurrencies. If heavy regulation is enacted, however, the adoption of cryptocurrencies could be hampered, minimizing the impact of cryptocurrency on the existing financial system.
Central Bank Digital Currency Implementation
Government-sponsored alternatives to cryptocurrencies are called Central Bank Digital Currencies (CBDCs) (Broby, 2021). The digital nature of CBDCs gives them some of the advantages of cryptocurrency while avoiding decentralization and anonymity. There are privacy concerns with CBDCs since the currencies can be programmed to track all transitions and gather consumer purchasing data. CBDCs could be programmed to restrict purchases to certain items and even collect taxes automatically during transactions. Some governments are attracted to the potential for enhanced power over financial systems and consumers. Government adoption of CBDCs could ensure that an evolved form of banks and the central banking systems remain strong.
Acceptance of Cryptocurrency within the Traditional Banking Industry
As stated previously, approximately 2% of financial institutions are investigating cryptocurrency services. Large financial institutions like Fidelity and Bank of America are facilitating the trade of financial instruments that mirror the value of bitcoin and other cryptocurrencies. The banking industry is accustomed to change and has been evolving since 1472 (Broby, 2021). To date, however, most large and small baking institutions have not fully embraced cryptocurrency. Some companies such as Coinbase, PayPal, Square, and others are capitalizing on the need for cryptocurrency exchanges and services such as crypto credit cards (Forbes, 2021). The demand for these services will likely increase if the cryptocurrency adoption rate trend continues. The existing banking industry may capitalize on its strengths and financial stability to profit from cryptocurrencies. Offerings could range from trading and lending cryptocurrencies to enhanced services and rewards (Forbes, 2021).
Complete Disruption of Traditional Banking
Since the original intent of bitcoin and other cryptocurrencies is to remove the need for banks and a centralized financial system, the impact on the existing systems could be severe. In the extreme, traditional banking systems might collapse if consumers avoid using fiat currency in mass and rely solely on cryptocurrency for purchases and as a store of value. Cryptocurrencies can be sent, received, and traded directly without the need for a third party. Cryptocurrency users can store the currency locally in cold wallets without the need for banks to provide security. Mass adoption of cryptocurrency could significantly impact financial institutions because many of the traditional banking services they provide will become obsolete.
Donald Korinchak, Getting Started in CYBER SECURITY - The Complete Guide Cryptocurrency-and-the-banking-system
How Do Crypto Currencies Affect Monetary Policy?
Bitcoin’s continued market and cultural presence prompts many to ask questions about how cryptocurrencies may affect the undertaking of established monetary policy. Some worry that distributed digital currencies may undermine the ability of central banks to manage national economic policy goals. On the other end of the spectrum, some suggest that central banks may actually be aided by issuing their own national cryptocurrency.
Does Bitcoin pose any threat to the Federal Reserve’s ability to conduct monetary policy?
Many people believe that cryptocurrencies like Bitcoin can co-exist within the current monetary system, whether individuals purchase units as an alternative kind of investment or for their targeted technological applications. But others fear that if cryptocurrencies are adopted on a wide enough scale, it could have a negative externality, or spillover effect, on the economy as a whole in the form of monetary instability.
It should first be pointed out that cryptocurrencies currently constitute a miniscule fraction of the world’s financial assets. A rough sketch of the current state of the market is clear: Bitcoin’s roughly $100 billion market capitalization constitutes a mere 1.3% of the $7.6 trillion in all global coins and bank notes, 1.3% of the world’s $7.7 trillion in gold, 0.13% of the $73 trillion in total global stocks, and a puny 0.11% of the world’s $90.4 trillion broad money supply.
Perhaps this may change in the future, which could indeed affect the menu of options available to central bankers in certain economic situations, as we will soon discuss. But the world’s monetary managers can for the present breathe a sigh of relief that their day-to-day operations will hardly be hindered by the existence of cryptocurrency.
A good example of the argument that Bitcoin will thwart monetary mechanisms was put forth by a vice chair of the U.S. Federal Reserve Bank, Randal Quarles, at a financial conference in 2017. Quarles explained, “While these digital currencies may not pose major concerns at their current levels of use, more serious financial stability issues may result if they achieve wide-scale usage.” His comments specifically concern the Fed’s range of remedies in the case of a crisis situation. He argues that the existence of an alternative asset like Bitcoin during times of economic adversity may frustrate efforts to stem price and credit risk because the exchange rate for the US dollar may become unstable.
But this argument could be applied to any kind of asset that may become an attractive alternative to the dollar in the event of a financial crisis. Yet no serious policymaker today would suggest limiting the exchange of, say, gold because of the scenario that Quarles outlined. The only difference between existing assets like gold and cryptocurrencies in an emergency event is perhaps that cryptocurrency may be easier for people of all economic backgrounds to hold.
This property is arguably one of cryptocurrency’s chief virtues in the case of countries that exhibit poor monetary management. Individuals who have the misfortune to live in a nation that irresponsibly manages its money supply have traditionally lacked accessible forms of protection or escape from periods of extreme inflation and all of the ills that come with it.
Consider the case of Venezuela, where monetary mismanagement has brought misery and insecurity to its people. In the past, Venezuelans would have had very few options through which to attempt to save some kind of value. And those options would have been unevenly distributed, with wealthier individuals more able to protect their assets than those in the lower classes.
Today, many Venezuelans of all classes turn to Bitcoin and other cryptocurrencies to protect themselves against the ravages of extreme inflation and bad governance. Venezuela has already suffered major shortages in critical household goods, and public protest against government policies has grown to sometimes violent levels. In this kind of economic climate, cryptocurrencies can be a godsend to families that need a more stable store of value.
The Venezuelan government has unsurprisingly attempted to crack down on cryptocurrency activity within its borders, most recently seizing mining equipment that people try to take into the country. In a somewhat tragicomical move, the Venezuelan government has changed tactics to try to trick their citizens into purchasing a state-controlled and ostensibly oil-backed “Petrocoin,” which is not a real cryptocurrency at all but a mostly worthless decoy. But this has done little to stem the surge of true cryptocurrency activity undertaken by Venezuelans to protect their financial assets. In this kind of situation, it is a very good thing that Bitcoin has undermined the Venezuelan central bank’s authority to wreak havoc on its citizens.
Fortunately, many people do not live in a monetarily backwards country like Venezuela. But Venezuela was not always this way. The existence of cryptocurrencies as an alternative safe haven during times of financial crisis may prompt central banks to behave in a more responsible way than they otherwise would. Responsible central bankers should therefore welcome the flourishing of cryptocurrencies as a way to bind their institutions to the mast of prudent monetary policy.
Should central banks just issue their own cryptocurrencies?
Not all central banks have been immediately antagonistic toward cryptocurrencies. There is a diversity of opinions even within the Fed, and the leaders of several central banks have commissioned research and formed exploratory committees to determine how their institutions can best leverage these much-discussed technologies.
These officials recognize that cryptocurrencies can serve a very similar function to cash; that is, as a semi-anonymous medium of exchange accessible not only to banks but to the population as a whole. The digital nature of cryptocurrencies is attractive because it may be cheaper and easier to manage than a cash system.
Some central banks have gone as far as to consider launching their own cryptocurrencies as a substitute or even replacement for their current money base. The governor of the Bank of England has publicly expressed interest in the idea of a cryptocurrency backed by a central bank, with the caveat that such a possibility would be quite a ways off in the future. Sweden’s Riksbank, meanwhile, is actively pursuing an “e-krona” cryptocurrency that could be launched within the next decade.
While it is laudable that these officials are keeping an open mind with regards to the promise of distributed digital currencies, they will likely find that these projects simply do not meet the requirements that they hold for a central bank-created monetary base.
The monetary supply of a distributed cryptocurrency with a public ledger, such as Bitcoin, cannot be controlled by any one party. Rather, it is “mined” at a predictable rate, as coded into that project’s protocol, by the miners that run and maintain the network. A central bank that is used to tightening or loosening the money supply in response to changing economic conditions will be quite frustrated to find that their official cryptocurrency is rigid to their policy needs. (Indeed, this monetary rigidity is the source of much theoretical economic debate within the cryptocurrency community, with some offering suggestions for digital currencies that change the rate of supply in response to certain economic targets.)
Central bankers interested in adopting cryptocurrency technology may instead decide to issue a digital currency whose monetary issue is centralized in the hands of the bank. Yet this is not really a cryptocurrency, merely a kind of e-currency. This may yield the benefits of lower costs and increased access, but it does not ensure the kind of censorship-resistance and increased privacy that cryptocurrencies offer. Furthermore, it would require central bankers to significantly increase their security prowess, as such an undertaking would prove irresistible to cybercriminals.
One element of cryptocurrency technology that central banks are already experimenting with to some success is the distributed ledger technology at its heart. Rather than adopting cryptocurrencies wholesale as a new kind of official money, the Bank of Canada and Monetary Authority of Singapore are simulating real-time gross settlement systems using a blockchain-like structure. While these projects are only in their early phases, they may yield useful tools for forward-looking central banks.
It is also possible that central banks may decide to buy and hold existing cryptocurrencies as a part of their reserves just as they do for gold and other assets. If Bitcoin and other leading cryptocurrencies achieve a significant enough level of value and stability, bankers may find it prudent to add it to their portfolio of assets. Some have gone so far as to suggest that Bitcoin’s properties as money are such an improvement over the current system that it central banks may switch over to a Bitcoin-based reserve system entirely, echoing the former global gold system.
Andrea O’Sullivan How-do-cryptocurrencies-affect-monetary-policy
What is “DeFi”?
Cryptocurrencies and blockchains have given rise to a new constellation of “decentralized finance” or DeFi businesses and projects. Essentially the cryptocurrency version of Wall Street, DeFi aims to offer people access to financial services—borrowing, lending, and trading—without the need for legacy institutions such as banks and brokerages, which often take large commissions and other fees. Instead, “smart contracts” automatically execute transactions when certain conditions are met. DeFi is surging in popularity, with investors pouring tens of billions of dollars into the sector.
Most DeFi apps are built on the Ethereum blockchain. Because of its usefulness in tracking transactions, blockchain technology has a range of potential applications beyond cryptocurrency, experts say, such as facilitating real estate deals and international trade [PDF].
What challenges has this created?
Cryptocurrencies have also given rise to a new set of challenges for governments to contend with. The anonymity and portability of cryptocurrencies make them appealing to bad actors such as criminal groups, terrorist organizations, and rogue states. There are also uncertainties about the regulatory treatment of emerging financial technologies.
In addition, crypto mining can require enormous amounts of electricity, which has led to concerns about its environmental effects. Meanwhile, the rise of DeFi and crypto payments has raised questions about consumer protection, market volatility, and the ability of central banks to carry out monetary policy.
Illicit activities.
In recent years, cybercriminals have increasingly carried out ransomware attacks, by which they infiltrate and shut down computer networks and then demand payment to restore them, often in cryptocurrency. Drug cartels and money launderers are also “increasingly incorporating virtual currency” into their activities, according to the U.S. Drug Enforcement Agency’s (DEA) most recent annual assessment. U.S. and European authorities have shut down a number of so-called darknet markets—websites where anonymous individuals can use cryptocurrency to buy and sell illegal goods and services, primarily narcotics.
Terrorism and sanctions evasion.
The primacy of the U.S. dollar has provided the United States unrivaled power to impose crippling economic sanctions. However, sanctioned states including Iran and North Korea are increasingly using cryptocurrency to evade U.S. penalties. Meanwhile, terrorist groups such as the self-proclaimed Islamic State, al-Qaeda, and the military wing of the Palestinian organization Hamas also traffic in crypto.
Environmental harms.
Bitcoin mining is an enormously energy-intensive process: the network now consumes more electricity than many countries. This has sparked fears about crypto’s contributions to climate change. Cryptocurrency proponents say this problem can be solved using renewable energy; El Salvador’s president has pledged to use volcanic energy to mine Bitcoin, for example. Environmental concerns reportedly prompted Ethereum’s move to a proof-of-stake model, which uses less energy.
Unregulated finance.
The rapid rise of cryptocurrencies and DeFi enterprises means that billions of dollars in transactions are now taking place in a relatively unregulated sector, raising concerns about fraud, tax evasion, and cybersecurity, as well as broader financial stability. If cryptocurrencies become a dominant form of global payments, they could limit the ability of central banks, particularly those in smaller countries, to set monetary policy through control of the money supply.
What are governments doing about this?
Many governments initially took a hands-off approach to cryptocurrencies, but their rapid ascent and evolution, coupled with the rise of DeFi, has forced regulators to begin crafting rules for the emerging sector, a process that could take years. Regulations vary widely around the world, with some governments embracing cryptocurrencies and others banning them outright. The challenge for regulators, experts say, is to develop rules that limit traditional financial risks without stifling innovation.
In the United States, policymakers have indicated they are moving to regulate cryptocurrencies and the emerging DeFi sector. However, cryptocurrencies do not fit neatly into the existing regulatory framework, creating ambiguity that lawmakers will likely have to resolve. U.S. Securities and Exchange Commission (SEC) Chairman Gary Gensler has called the cryptocurrency sector a “Wild West,” and urged Congress to give the SEC greater powers. Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen have both called for stronger regulations of stablecoins.
To limit illicit activities, authorities have targeted the exchanges that allow users to convert cryptocurrencies to U.S. dollars and other national currencies. Under pressure from regulators, major exchanges including Coinbase, Binance, and Gemini adhere to “know your customer” and other anti–money laundering requirements. Law enforcement and intelligence agencies, meanwhile, have learned to leverage the traceability of most cryptocurrencies by using blockchains to analyze and track criminal activity.
For example, some of the ransom paid to the Colonial Pipeline hackers was later recovered by the FBI. In September 2021, the Treasury Department announced a crackdown on the use of cryptocurrencies in ransomware attacks, issuing its first sanctions on a crypto exchange.
China, which accounts for most of the world’s Bitcoin mining, has moved aggressively to crack down on cryptocurrencies. In September 2021, Chinese authorities announced a sweeping ban on all crypto transactions and mining, causing the price of some cryptocurrencies to fall sharply in the immediate aftermath.
A handful of other countries, including Bolivia, Nigeria, and Russia, have also moved to limit the use of crypto, and others are considering restrictions. Still, most governments have so far taken a relatively limited approach.
What is a central bank digital currency?
In an effort to assert sovereignty, many central banks, including the U.S. Federal Reserve, are considering introducing their own digital cash, known as central bank digital currency (CBDC). For proponents, CBDC promises the speed and other benefits of cryptocurrency without the associated risks. Dozens of countries—together representing more than 90 percent of the global economy—are exploring CBDC.
China is moving ahead quickly: it piloted a digital yuan in late 2019 that is now used for billions of dollars of transactions. In the United States, there is reportedly disagreement among Fed officials over the need for a digital dollar.
Experts say interest in CBDC intensified in 2019 when Facebook announced it would create its own digital currency called Libra, potentially offering a new payment option for its more than two billion users. (The company has since scaled back the project, renamed Diem.)
China is another motivating factor: A digital yuan could give Beijing even more control over its economy and citizens, and threaten the U.S. dollar’s status as the favored international reserve currency, experts say.
One way to implement CBDC would be for citizens to have accounts directly with the central bank [PDF]. This would give governments powerful new ways of managing the economy—stimulus payments and other benefits could be credited to people directly, for example—and the central bank’s imprimatur would make CBDC a safe digital asset to hold. But their introduction could also create new problems, CFR’s McIntosh and other experts say, by centralizing an enormous amount of power, data, and risk within a single bank and potentially compromising privacy and cybersecurity.
Some experts say the potential for CBDC to cut out commercial banks as intermediaries carries risks, because these banks perform a critical economic role by creating and allocating credit (i.e., making loans). If people chose to bank directly with the Fed, that would require the central bank to either facilitate consumer borrowing, which it might not be equipped to do, or find new ways of injecting credit. For these reasons, some experts say private, regulated digital currencies are preferable to CBDC.
Ankit Panda . [email protected]. Cryptocurrencies-digital-dollars-and-future-money
Why Cryptocurrencies Are a Threat to Central Banks
Money already flows through electronic circuits around the globe, of course. But central bank digital currencies, or CBDCs, would be a new kind of instrument, similar to the digital tokens now circulating in private networks. People and businesses could transact in CBDCs through apps on a digital wallet. Deposits in CBDCs would be a liability of a central bank and may bear interest, similar to deposits held at a commercial bank. CBDCs may also live on decentralized ledgers, and could be programmed, tracked, and transferred globally more easily than in existing systems.
New cryptocurrencies and payment systems are raising pressures on central banks to develop their own digital versions. Bitcoin, while popular, isn’t the main threat. It’s highly unstable—more volatile than the Venezuelan bolivar. Many investors sock it away rather than use it, and the underlying blockchain network is relatively slow.
But the cryptocurrency market overall is gaining critical mass—worth $2.2 trillion in total now, with half of that in Bitcoin. Central bankers are particularly concerned about “stablecoins,” a kind of nongovernmental digital token pegged at a fixed exchange rate to a currency. Stablecoins are gaining traction for both domestic and cross-border transactions, particularly in developing economies. Technology and financial companies aim to integrate stablecoins into their social-media and e-commerce platforms. “Central banks are looking at stablecoins the way that taxi unions look at Uber—as an interloper and threat,” says Ronit Ghose, global head of banks research at Citigroup .
While many stablecoins are now circulating—the largest is Tether, with $51 billion in circulation, versus $2.2 trillion for the dollar—a big one may be arriving soon in Diem, a stablecoin backed by Facebook (ticker: FB). Diem may launch this year in a pilot program, reaching Facebook’s 1.8 billion daily users; it’s also backed by Uber and other companies. The potentially rapid spread of Diem is raising the ante for central bankers. “What really changed the debate is Facebook,” says Tobias Adrian, financial counsellor at the International Monetary Fund. “Diem would combine a stablecoin and payments platform into a vast user base around the world. That’s potentially very powerful.”
The broader force behind CBDCs is that money and payment systems are rapidly fracturing. In the coming years, people might hold Bitcoin as a store of value, while transacting in stablecoins pegged to euros or dollars.
“Central banks need to create digital currencies to maintain monetary sovereignty.”
— Princeton economist Markus Brunnermeier
The dollar won’t disappear, of course—it’s held in vast reserves around the world and used to price everything from computers to steel. But every fiat currency now faces more competition from cryptos or stablecoins. And stablecoins in widespread use could upend the markets since they aren’t backstopped by a government’s assets; a hack or collapse of a stablecoin could send shock waves as people and businesses clamor for their money back, sparking a bank run or financial panic. And since they’re issued by banks or other private entities, they pose credit and collateral risks.
As commerce shifts to these digital coins, along with other cryptocurrencies and peer-to-peer networks, governments risk losing control of their monetary policies—tools that central banks use to keep tabs on inflation and financial stability. “Central banks need to create digital currencies to maintain monetary sovereignty,” says Princeton University economist Markus Brunnermeier. The Fed, for instance, manages the money supply by buying or selling securities that expand or contract the monetary base, but “if people aren’t using your money, you have a big problem,” says Rutgers University economist Michael Bordo.
It isn’t all about playing defense, though. Proponents of CBDCs say there are economic and social benefits, such as lower transaction fees for consumers and businesses, more-effective monetary policies, and the potential to reach people who are now “unbanked.” CBDCs could also help reduce money laundering and other illegal activities now financed with cash or cryptos. And since central banks can’t stop the rise of privately issued digital money, CBDCs could at least level the playing field.
While CBDCs have bounced around academia for years, China’s pilot project, launched last year, was a wake-up call. Analysts say China aims to get its digital renminbi into circulation for cross-border transactions and international commerce; the standard renminbi now accounts for 2.5% of global payments, well below China’s 13% share of global exports, according to Morgan Stanley .
In China, transactions on apps like Alipay and WeChat now exceed the total world volume on Visa (V) and Mastercard (MA) combined. The Chinese apps have also become platforms for savings, loans, and investment products.
CBDCs could help regulators keep tabs on money flowing through the apps, and help prevent stablecoins from usurping the government’s currency. “That’s why the People’s Bank of China had to claim its property back—for sovereignty over its monetary system,” says Morgan Stanley chief economist Chetan Ahya.
Momentum for digital currencies is also building for “financial inclusion”—reaching people who lack a bank account or pay hefty fees for basic services like check cashing. About seven million U.S. households, or 5% of the total, are unbanked, according to the Federal Deposit Insurance Corp. Democrats in Congress recently proposed legislation for a digital-dollar wallet called a FedAccount, partly to reach the financially disadvantaged.
Governments could also target economic policies more efficiently. Stimulus checks could be deposited into e-wallets with digital dollars. That could bypass checking accounts or apps that charge fees. It could be a way to get money into people’s hands faster and see how it’s spent in real time. Digital currencies are also programmable. Stimulus checks in CBDC could vanish from a digital wallet in three months, incentivizing people to spend the money, giving the economy a lift.
Researchers at the Bank of England estimate that if a digital dollar went into widespread circulation, it could permanently lift U.S. output by 3% a year. That may be a stretch, but central banks, including the Fed, are now building systems for banks to settle retail transactions almost instantly, 24/7, at negligible cost. CBDCs could slide into that infrastructure, cutting transaction fees and speeding up commerce. That could reduce economic friction and lead to productivity gains for the economy.
Some economists view CBDCs as a monetary-policy conduit, as well. Deposits of $1 million or more in CBDCs, for instance, might incur a 0.25% fee to a central bank, disincentivizing people and institutions from hoarding savings in a protracted slowdown. “It’s costly for the economy if wealthy people shift money into cash or equivalent securities,” says Dartmouth College economist Andrew Levin. “This would disincentivize that from happening.”
Digital currencies aren’t without controversy, though, and would need to overcome a host of technological issues, privacy concerns, and other hurdles. For one, they could make it easier for governments to spy on private-party transactions. Anonymity would need strong safeguards for a CBDC to reach critical mass in North America or Europe. Chinese officials have said their CBDC will preserve privacy rights, but critics say otherwise. The country’s new CBDC could “strengthen its digital authoritarianism,” according to the Center for a New American Security, a think tank in Washington, D.C.
Challenges For Commercial Banks
Central banks could compete with commercial banks for deposits, which would erode banks’ interest income on assets and raise their funding costs. Various proposals address those concerns, including compensating banks for services in CBDCs. Deposit rates would have to be competitive so that central banks don’t siphon deposits. But even in a two-tier financial model, commercial banks could lose deposits, pushing them into less stable and higher-cost sources of funding in debt or equity markets.
More disconcerting for banks: They could be cut out of data streams and client relationships. Those loops are critical to selling financial services that can generate more revenue than lending. “CBDCs will pose more competition to the banking sector,” says Ahya. “It’s about the loss of data and fee income from financial services.”
Banks in the U.S., Europe, and Japan don’t face imminent threats, since regulators are going slow. As incumbents in the system, banks still have vast advantages and could use CBDCs as a means of cross-selling other services. Most of the advanced CBDC projects are for wholesale banking, like clearing and settlement, rather than consumer banking. The ECB, for instance, has said it may limit consumer holdings to 3,000 euros, or about $3,600, in a rollout that may not kick off until 2025.
A timeline for a digital dollar hasn’t been revealed by the Fed and may take congressional action. More insights into the Fed’s thinking should be coming this summer: The Boston Fed is expected to release its findings on a prototype system. One compromise, rather than direct issuance, is “synthetic” CBDC—dollar-based stablecoins that are issued by banks or other companies, heavily regulated, and backed by reserves at a central bank.
Whatever they develop, central banks can’t afford to be sidelined as digital tokens blend into social-media, gaming, and e-commerce platforms—competing for a share of our wallets and minds. Imagine a future where we live in augmented reality, shopping, playing videogames, and meeting digital avatars of friends.
Daren Fonda [email protected] 7-tax-tips-for-seniors-to-make-the-most-of-your-deductions
Conclusion
Cryptocurrencies hold much promise to expand the range of monetary options available to all classes of people and secure a degree of security and liberty not offered by some of the world’s government-backed currencies. They currently exist in a small and experimental corner of the world’s financial markets, and are therefore unable to restrain central bank’s monetary policy levers. But they do provide a needed escape for individuals living in desperate economic situations. It is laudable that a few central banks are showing interest in using cryptocurrency technology to update their monetary administration. Still, it is unlikely that a central bank will adopt a state-backed distributed digital currency wholesale because it would fully remove their ability to manage the national money supply. It is more likely that central banks will experiment with distributed ledger technologies to aid in settlement services, or even begin buying existing distributed cryptocurrencies as a part of their reserve portfolio.
The invention and adoption of cryptocurrency and blockchain technology have the potential to disrupt the current banking system. The adoption rate of bitcoin and other cryptocurrencies is increasing. Stringent regulation of the cryptocurrency could slow its adoption and mitigate any disruptive effect on banking. The creation and implementation of Central Bank Digital Currency might also reduce the impact of cryptocurrency. Banks may offer new crypto services and products that will allow them to profit from cryptocurrency. An extreme scenario is that cryptocurrency could entirely disrupt the banking system by rendering it obsolete.
Resources
In this 2008 paper [PDF], pseudonymous engineer Satoshi Nakomoto proposes Bitcoin, the first cryptocurrency.
In this free Massachusetts Institute of Technology class, SEC Chair Gary Gensler explores Bitcoin, blockchains, and money.
The Economist examines the potential benefits and risks of DeFi.
At this CFR virtual meeting, experts discuss the prospects for central bank digital currencies.
In this August 2021 speech, Federal Reserve Governor Christopher J. Waller questions the need for a digital dollar.
References
Broby, D. (2021, June). Financial technology and the future of banking. Financial Innovation, (7,1), 1-19
Gura, D. (2021, August 20). Tougher rules are coming for bitcoin and other cryptocurrencies. Here’s what to know. NPR. https://www.npr.org/2021/08/20/1029436872/tougher-rules-are-coming-for-bitcoin-and-other-cryptocurrencies-heres-what-to-kn
Nicoleta, V. B. (2021, June) Cryptocurrencies, money of the future or the future of money. EIRP Proceedings, 6(1), 286-290
Raj, K. (2019) Foundations of blockchain:The pathway to cryptocurrencies and decentralized blockchain applications Packt Publishing. https://web-b-ebscohost-com.libauth.purdueglobal.edu/ehost/ebookviewer/ebook/bmxlYmtfXzIwMTM4NzJfX0FO0?sid=9d1347c9-006a-4919-ba45-9ad5db39bdbf
Shelvin, R. (2021, April 19). The coming bank bitcoin boom: Americans want cryptocurrency from their banks?Forbes. https://www.forbes.com/sites/ronshevlin/2021/04/19/the-coming-bank-bitcoin-boom-americans-want-cryptocurrency-from-their-banks/?sh=236702a24908
|
|
|
Home/ Info/ Products/ BIG TECH Metaverse Metaverse Vs. Virtual Reality PC Buyers Guide/ IEEE 802 Standards Social Media Platforms Technology Videos/ Computer & IT Certifications Processor Generations Memory SSD Vs. HDD SAS vs. SATA HTML 5G Android Tips and Tricks STEM Business Intelligence Tools Web Intelligence Quantum Computing Artificial Intelligence (AI) Robotics Internet of Things (IOT) Web Of Things (WoT) Renewable Energy Nano Technology Windows Run Commands Mac Keyboard Shortcuts Linux CLi Commands Venus Project/ Computer Security and Law Techno Lingo Encyclopedias Search Engines Glossary Online Jobs Contact
Active Components Passive Components Test Electrical Components Electronics Classification
AWS Certification Google Certification Oracle Certifications cisco certifications Huawei Certification Microsoft Certifications Linux Certification Business Certifications
Google-Cloud-Platform-Guide Amazon-Web-Services-Guide Global-Cloud-Infrastructure-Of-AWS Amazon-Web-Services-Cli-Guide AWS-Cloudformation Devops Microsoft-Azure Oracle-Cloud Digitalocean-Cloud Openstack-Cloud Security Topics
Certified Enterprise Blockchain Professional (CEBP) Web 3.0 Satoshi Nakamoto Cryptocurrency Dark Web Ethereum NFT Merkle Tree El-Salvador eNaira
Web C++ JAVA Python Python Glossary Angular.js Scala
Copyright BICT Solutions Privacy Policy. | Terms and Conditions apply | All rights reserved.