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The financial landscape is changing, and central banks are adapting to it. In his blog, Gabriel Makhlouf, Governor of the Central Bank of Ireland, shared his thoughts and understanding of cryptocurrencies. He believes that work on the digital euro, the continued development of the EU regulatory framework, and broader international developments will help better understand the benefits and risks of introducing central bank digital currencies. He also believes that as public policymakers, it is their responsibility to provide clear rules for cryptocurrencies and ensure that innovation serves the public interest. The Institute of Financial Technology at Renmin University of China compiled the core content of the article.
Money plays a key role in society and the economy. It performs three key functions: a medium of exchange for purchasing goods and services, a unit of account, and a store of value. People must have confidence in the money they hold to perform these functions, and also have confidence in the work of the central bank responsible for managing the money. Earlier this month, the ECB decided to continue its study of the potential for issuing a digital euro. This is a preliminary analysis on the topic, following our report last year. A key goal of our work is to protect the public benefits that the euro provides to citizens (free access to a simple, universally accepted, risk-free, trusted means of payment) while being prepared to respond to the decline in the use of cash and the increase in digitalization. We have a responsibility to consider these issues to ensure that central bank money remains fit for purpose as a public good.
Although we have not yet decided whether or not we will introduce a digital euro, I think it is very likely to happen. In my opinion, it is not a question of "if", but a question of "how and when". To be clear: cash will not disappear, and the digital euro will serve as a supplement to cash.
Whether it is coins, banknotes or digital currencies, the three functions of money apply. Now, you might think that digital currencies already exist, as you may be used to paying bills via bank transfer using your computer or phone, or paying with a card or mobile phone app in a shop. However, these experiences highlight the growing digitalization and technological advances in the payments sector and do not represent a full-fledged digital currency. Technology has improved the efficiency and ease of use of payments, but the introduction of a digital euro would represent a fundamental shift in the euro area's financial architecture. Cryptocurrencies Of course, a digital euro (or dollar, pound or yuan) is not the only issue in the increasing digitalization of finance. In addition to central banks and existing private sector financial service providers, other players are increasingly involved in the payments space.
The most notable development is probably the rise of what are sometimes called “cryptocurrencies”. I have no doubt that this is an unhelpful and misleading description – the “currency” label implies that the characteristics of money are present, but in reality cryptocurrencies do not: for example, the value of Bitcoin has experienced huge fluctuations (driven at least in part by speculation, see chart below) making it unsuitable as a store of value. Nor is it a useful medium of exchange or unit of account, given the limited number of businesses and individuals willing to transact with it. There are a wide variety of cryptocurrencies, including subcategories such as tokens and stablecoins. (By one estimate, over 8,000 cryptocurrencies have been created in the last decade or so.) Figure 1: Monthly changes in the S&P 500 and Bitcoin
Several issues have been identified in the cryptocurrency space. First, the anonymity they offer makes them attractive to criminals. Cash, of course, also offers anonymity, but managing large amounts of physical currency is much more difficult than transacting in cryptocurrencies. Second, there are well-founded concerns about the energy consumption used to issue and use certain types of cryptocurrencies. Third, there are also concerns about financial stability and consumer protection, which I will discuss in more detail later.
As it stands today, the negatives surrounding cryptocurrencies far outweigh any benefits. But we shouldn’t lose sight of the positives of the underlying technology. Distributed ledger technology (DLT), essentially a secure, decentralized way of storing records of information across a network, is a key architecture for some types of cryptocurrencies. It has the potential to reduce transmission costs in the financial system because it can eliminate the need for intermediaries in certain transactions. It can also be loaded with smart contracts, which can speed up specified actions in a contract once agreed-upon criteria are met. The use of DLT has increased in recent years — and it certainly has potential — although how widespread it becomes remains to be seen.
Why Cryptocurrency Matters to Policymakers Speaking of the specific interests of public authorities, including central banks, cryptocurrencies have not yet raised financial stability issues because of their relatively limited role for most financial system participants and most of the public. However, central banks, regulators are considering their risks (for example, the Basel Committee on Banking Supervision recently issued a public consultation on how to deal with crypto exposures on banks' balance sheets), and these risks are interlinked with consumer protection considerations.
When considering these questions, it is helpful to distinguish between different types of cryptocurrencies.
Some cryptocurrencies are not linked to any underlying asset and therefore have no "anchor" that provides stability of value, show extreme price volatility and are very risky for investors. On the other hand, some people do like to collect and use them, just as some people like to collect other things (such as stamps). Purchasing such items can be profitable, but it can also result in losses (the recent interest in cryptocurrency purchases does have some characteristics similar to the buying craze generated by tulips in the 17th century). From a macro perspective, if these types of cryptocurrencies become important in the financial system, their volatility could lead to losses, which could have implications for financial stability, especially if they are associated with leverage.
Stablecoins are a different type of cryptocurrency and claim to offer conversion to currencies such as the US dollar or euro at a fixed exchange rate. Given the link to an underlying stable asset such as the euro, this would appear to address the issue of extreme price volatility and could be useful from a payments perspective and as a medium of exchange. However, this of course means that they are only as good as the governance behind them. If a widely used stablecoin is not properly managed and consumers are unable to fully convert their holdings into the underlying currency - for example, if the assets invested by the stablecoin issuer are illiquid - this could also have implications for financial stability.
As the public considers putting some of their money into cryptocurrencies, the risks are increasing (although it remains limited for most people at the moment). In addition to the inherent risks of cryptocurrencies, people may also be exposed to scams and fraud given the opaque nature of the products. The European Commission has proposed a new regulation, the Regulation of the European PARLIAMENT and the Council on Markets in Crypto-assets, and amending Directive Markets in Crypto-assets, and amending Directive (MiCA), which is legislation that claims to provide greater legal certainty and consumer protection (and support financial stability). Currently, there is no regulatory protection for consumers in the world of cryptocurrencies.
Figure 2: EU regulations on crypto asset markets Conclusion The financial landscape is changing, and central banks are adapting to it. Our work on the digital euro, the ongoing development of the EU regulatory framework, and wider international developments will help us better understand the benefits and risks of introducing central bank digital currencies. More generally, as public policymakers, we have a responsibility to ensure that innovation serves the public interest by providing clear rules to innovators while engaging with a wide range of stakeholders, notably households, businesses, and the payments industry.
Source | BIS |
