The cryptocurrency hype may be fading, but central banks look better placed to make use of blockchain technology
The crypto-bubble may have burst. But one lasting effect has been to force central banks to have a fresh look at their core functions of issuing money and conducting monetary policy. In this article, we focus on the potential for central banks to use technology to issue new forms of money. We see an increased probability that central banks will issue their own ‘digital currency’ in the medium term – say within the next five to 10 years.
Peer-to-peer cryptocurrencies such as Bitcoin were often explicitly aiming to disrupt the existing monetary order – central banks will aim for an evolutionary approach. In many ways, central bank digital currencies (CBDC) would simply be the latest in a long line of technological upgrades that central banks have been through over the years.
One clear example of “New Money” is cryptocurrency, which fits into the broader category of crypto-assets. The market suffered huge losses last year casting some doubt on the future of alternative currency regimes. But we offer two reasons why the crypto debate is not going away and explain how it fits within the current economic and monetary discussion
There is no doubt that 2018 was a reality check for crypto enthusiasts. Q4 2018 saw a strong contraction in the cryptocurrency market, which led to a 45% loss of almost $100 billion in market capitalisation. This is hardly surprising: the value of peer-to-peer cryptocurrencies has no clear economic or legal basis. As we argued elsewhere, they do not satisfy the three basic functions of money: store of value, means of exchange and unit of account. Therefore, the steep increase in the exchange rate in the early stage of their adoption was simply unsustainable. However, although the hype around Bitcoin is rapidly fading away, the debate around crypto remains quite active and far from over, so here are few reasons why you do need to keep watching this space.
The value of money is a “social construct”, a collective agreement between citizens that is always changing. As such, debates about alternative monetary systems are multi-layered, with questions about the impact on business and society at large
Why does money have value? Unlike the gold coins of the past, most forms of money we use today lack inherent value: they are just a piece of paper, some scraps of metal, or a few pixels on a screen representing some number. So it is clear that modern money does not derive its value from its physical, or otherwise objective, properties. In fact, the concept of “value” is a very human one. Would gold have value in a world without people? The value of money is based on its collective acceptance as a means of exchange. In other words, money is a “social construct”.
This means there is no fundamental difference between bitcoin and the euro. Both are accepted by their respective communities. Of course, there is an immense practical difference. The euro’s community is a lot bigger. Also, it certainly helps that eurozone governments are part of it, requiring their citizens to pay taxes in euro, while disallowing bitcoin tax payments. Yet governments, and the law designating the euro as the eurozone’s legal tender are themselves social constructs, implicit collective agreements between citizens that are evolving over time. In the end, most of the human world functions the way it does because we all collectively agree that it should function like this.
If money is a social construct, its physical or digital appearance really does not matter, as long as basic requirements about scarcity and reliability are met. Which is why cans of mackerel, pieces of paper, bits and bytes moved around by banks, as well as tokens logged on a blockchain can, in principle, all function as money.
Exploring the changing role of money and financial services, we look at not only the way people pay but also how they finance their homes and how businesses manage their cash
The money we deal with on a daily basis may very well undergo radical change in the not-too-distant future. We aim to discuss these changes in our “New Money” series. Why? Because rich or poor, money is one of the greatest sources of stress for people around the world. It touches every aspect of our lives from what we eat to where we live to how we think.
The ongoing digital revolution, led by big tech companies, is affecting payments, money and the wider financial system, and it could have major repercussions for the way we all go about our financial business. We will return to this in later articles.
But let's zoom in first on money itself. It is surprising that there is, in fact, no consensus among economists as to the exact nature of money. Just what is it precisely? A voucher issued by an online retailer? Bitcoin? A tin of mackerel!? Most people, economists included, consider a bank deposit to be money. Yet in a strict legal sense, it’s not.
To be sure, the function of money is not in dispute: most economists agree that it acts as a medium of exchange, a unit of account and a store of value.
But its inherent characteristics are far more unclear. There are deeper questions to answer. And these are becoming increasingly important as new strides in technology enable new forms of money to move from the realm of fiction to reality.
In our 'New Money' series, we explore the changing role of money and financial services in society. Cryptocurrencies and crypto-assets, full-reserve banking and central bank digital currencies are the three key areas around which the monetary debate is centred. We take a look at these in detail