A coming crypto storm for central banks? Focus on digital money intensifies

Representations of virtual cryptocurrencies are placed on US dollar bills in this illustration taken on November 28, 2021. REUTERS / Dado Ruvic

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NEW YORK, June 2 (Reuters) – Digital money, a curiosity just a few years ago, is emerging as a major concern among central banks with the potential to erode the power of monetary policy, and even in the best of worlds it can do . control of interest rates more difficult, according to the new Federal Reserve and other research.

A New York Fed symposium this week exposed the puzzles central bankers face when dealing with emerging digital technologies ranging from new ways of processing payments to new asset classes such as cryptocurrencies and stable currencies.

The underlying technology has advantages, including better transaction speed, lower cost, and easier access to banking services, and even with recent declines and volatility, it is expected to continue to advance. Ignore it, in other words, and systems developed by incoming private companies could capture higher levels of funding and make “central bank cash” less relevant, diminishing central bank control over interest rates.

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Create a digital currency substitute for the central bank and new instabilities could arise, including the potential for a digital dollar or euro to replace conventional bank deposits and compete with money market funds and other key financial instruments. In a crisis, the process could mimic a banking race, leave the system illiquid and force the Fed, for example, to increase lending to commercial banks or strengthen its own holdings of Treasury bonds and similar securities to keep the system stable.

Banks that lose deposits would have to compete for new ones and “depending on the intensity … the general level of short-term interest rates … could increase” as a result, a Fed document concluded this week outlining possible results in case EE. the central bank adopts a digital currency at the retail level, open to households. “A retail CBDC could increase the stress on the financial sector, forcing the Federal Reserve to provide more liquidity to banks through existing tools … The long-term footprint of the Federal Reserve in certain asset markets, such as Treasury bonds The United States could become more pronounced. “

The Fed is debating whether to develop a digital currency, like most central banks around the world. No decision has been made, and officials say congressional approval would be needed to move forward.

The point of tension may seem far away as the market value of cryptocurrencies and stable currencies remains a small portion of the financial system. But payment processors, such as PayPal and Apple Pay, are growing rapidly, and earlier this year they were handling scale transactions from major credit card companies. Between cryptocurrencies and stable currencies, it was noted at the New York conference, some of the agreements involve exotic lending schemes – the creation of credit – which, if extended, could involve greater risks.

“What if the central bank no longer has relevant money in either retail or wholesale? In that case, the central bank could start to lose traction,” Eswar Prasad, a professor at Cornell University and author of the book, said in his monetary policy. recent book “The Future of Money” on the subject, he said on the sidelines of the conference.

“In some countries it is becoming a problem today. China, more and more India or Sweden: the use of central bank money in retail payments has fallen into almost nothing,” as private payment providers have intervened.


The implications of central bank digital currencies for monetary policy are just one part of a broader view of institutions like the Fed on how emerging technologies will change the financial system. As these technologies have become more prominent, the implications for financial stability and the risks it poses to individual investors have become a higher priority for research and regulation.

In the United States, President Joe Biden, citing the growth of cryptographic assets over five years from $ 14 billion to $ 3 trillion as of November, issued an executive order in March detailing the Treasury and other agencies to begin with. looking for the best way to regulate the industry. .

Given the stakes, central banks around the world are quickly stepping out of the margin.

A survey by the Bank for International Settlements published last month by 81 central banks in countries representing almost all global economic output found that more than 90% were exploring the idea of ​​a central bank digital currency.

More than a quarter are actively developing a digital currency or running pilot programs, a share that has nearly doubled from 2020 to 2021. The explosion of electronic payments and investment in cryptography during the pandemic is speeding up work, respondents said. 60.% of banks claim that cash use is declining.

Adoption may not necessarily be disruptive.

In a presentation at the New York Fed conference, Andrew Hauser, chief market officer of the Bank of England, said that “although the technology for any future CBDC may be new … the use of the central bank balance sheet to provide the state-backed transactional money … is one of the oldest functions of central banks. “

But it can come fast.

“The innovation that occurs in money and payments has the potential to alter the existing monetary system … on which the current monetary policy implementation frameworks are designed,” said Lorie Logan, executive vice president of the New York Fed and newly appointed to lead Dallas. Fed. “It’s not known how things evolve from here, and the impact of these innovations could be revolutionary or more evolutionary.”

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Report by Howard Schneider; Edited by Andrea Ricci

Our standards: the trustworthy principles of Thomson Reuters.

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