Abstract
Whether a novel tool for monetary policy or simply a new factor in domestic and global markets, digital currencies present Central Banks with opportunities and challenges that are not well understood. This chapter begins with a contextual discussion of the declining use of physical currency, highlighting important distinctions between digitized currency, digital currency, and distributed ledger technology, followed by a taxonomy of the six different digital currency types. The remainder of the chapter examines opportunities and challenges topically. Some, such as privacy and anonymity concerns or trade-offs between centralized and decentralized issuances, exist for all digital currency types. Others are more immediately relevant to Central Banks, such a competition between monies, programmable money, and the impact of digital currencies on the global economy, and monetary policy.
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Notes
- 1.
It should be noted that, in both economies, cash in circulation as a share of GDP has been decreasing. This should not be interpreted as evidence that a digital currency will necessarily encourage economic growth.
- 2.
I use “account” to refer to the method by which the storage system identifies a holder to of some amount of digital currency. An account could be as informal as a unique alphanumeric sequence that, when combined with a password, grants the user access to the funds associated with that sequence, or it could be as formal as presenting proof of identity to conform to AML/KYC standards.
- 3.
Double-spending is when the same unit is spent twice. Consider a store issuing coupons: double-spending would occur if a person could create photocopy of a coupon they received and continuously use it.
- 4.
Blockchain refers to data that is grouped and sorted, with a consensus mechanism for harmonizing the records across multiple ledgers. This does not inherently require that the consensus mechanism is decentralized or permissionless. The technology underlying both Blockchain and DLT is discussed in (Rauchs et al. 2018), while an example focused only on Blockchain can be found in (Koch and Pieters 2017).
- 5.
VISA has one of the largest centralized electronic payment networks in the world, processing over 24,000 transactions per second. In contrast, Bitcoin processes 7 transactions per second, slower than Ethereum (15 transactions per second) or Ripple (one of the fastest at 1500 transactions per second can process less than 10% of VISA’s speed).
- 6.
For a full list of announced projects by Central Banks see Appendix A in (Prasad 2018).
- 7.
Centralized power over accounts means that there are scenarios under which an account can be shut down or denied. A decentralized account system exists in a system like Bitcoin, where anyone can download the software and anonymously establish a unique identification number.
- 8.
The true identity of the creater of Bitcoin, Satoshi Nakomato, is famously unknown, and could represent an individual or group of individuals. This is in contrast to companies such as Ripple that have created and maintain their own cryptocurrencies.
- 9.
- 10.
For the purpose of this chapter, unless explicitly noted otherwise, I will treat all blockchains as fully functional and uncompromised.
- 11.
The problem this action faces is that a decentralized DLT-based currency can fork—issuing users an equivalent amount of digital currency on the new network which is also decentralized but not under government control—meaning that any intervention can be bypassed through a new digital currency. This is key to the effective decentralization of a cryptocurrency. A blockchain, or DLT system, is necessary but not sufficient to guarantee decentralization.
- 12.
The black-market value of the physical currency may differ from the government decreed value.
- 13.
Bitcoin transaction records are contained on the blockchain and are viewable: all records of Bitcoin transactions between accounts are public information. For an example, see blockchain.info.
- 14.
Transactions that use intermediaries, such as exchanges, may require that users disclose identification information as part of their Anti-Money Laundering (AML)/Know Your Customer (KYC) procedure. Under these circumstances, the activity of the users of the platform can be tracked by the platform. This results in differences in behavior between exchanges that adhere to AML/KYC and those that do not (Pieters and Vivanco 2017).
- 15.
This argument is examined in (Rogoff 2016).
- 16.
- 17.
Proposals for Central Bank savings accounts assume that the Central Bank does not extend loans: this is to reduce incentive problems and ensure system stability. This means that the standard financial system retains the responsibility of extending loans to private ventures and individuals.
- 18.
An example of such a policy could be a fee that is incurred if an account does not engage in a sufficient volume of transactions or purchases each month.
- 19.
Moin et al. (2019) introduce a classification framework for stablecoins based on their design elements.
- 20.
The Bitcoin blockchain, for example, can record that you sent 1 bitcoin to someone, it cannot record that you received US$10,000 in return. Both sides of the transactions are needed to deduce that the price of 1 bitcoin is $10,000.
- 21.
- 22.
The whitepaper for the Petro can be found here: https://whitepaperdatabase.com/venezuela-petro-cryptocurrency-ptr-english-whitepaper/.
- 23.
Announced in a tweet by the minister of petroleum and the president of the state-owned oil company https://www.coindesk.com/venezuela-to-present-petro-at-opec-as-the-digital-currency-for-oil/.
- 24.
Many stories circulate on online forums, such as Reddit or Twitter. A more formal examination can be found in (A.F. 2018).
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Pieters, G. (2021). Digital Currencies and Central Banks. In: Rau, R., Wardrop, R., Zingales, L. (eds) The Palgrave Handbook of Technological Finance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-65117-6_6
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