Final: Digital Currency Flashcards
Cryptocurrency is not
A debt contract or liability
Issued by a business
Or government
Why are Cryptocurrencies Valued?
Supply constraints: Very low chance for human error/interference. Minimizes time-inconsistency, public choice considerations, etc.
Anonymous/Pseudoanonymous
Anonmyous (Monero)
Pseudoanonymous (Bitcoin)
Applications:
Finance under a hostile regime (Belarus)
Avoids debanking
Stablecoins and dollar denominated payments
Cross border payments
Remittances
BIS project Atlas finds that Bitcoin is increasingly being used for cross-border payments/remittances
In comparison to going through the banking system
Lower fees
Relatively faster
More privacy
DLT
Data can be chained, but doesn’t use blocks
Can be encrypted
Can be permissioned (private) or permissionless (public)
Can be immutable
More suited to private use.
Blockchain
Data is stored in chained blocks
Always encrypted
Generally public and permissionless
Always immutable
More suited to public use (hence crypto)
DLT. Consensus mechanism (how transactions are approved)
Proof of work: Miners compete to solve complex math problems to validate transactions, and be paid in new blocks (currency)
Proof of stake: Validators hold a stake in the network equal to their share of coin ownership. They are chosen to validate transaction based on the amount of the stake they hold.
Less environmental costs (no competition in mining) but does bear the risk of a 51% attack.
The rules could be changed, people could be defrauded, etc. This is unlikely with large cryptocurrencies, but a problem for small ones.
Constantly evolving, some combine elements of both.
Other Uses of DLT
Collect votes: Ledger is open and transparent (could reduce fraud)
Enter contracts
Smart contracts
Automatically execute once pre-specified conditions are met. i.e, If the dollar depreciates x amount against the Euro, sell X amount of dollar-denominated stable coin
Nearly infinite applications
Demonstrate ownership
Transparent record of various transactions
Tamper-proof
Smart Contracts
when X occurs do Y
Problems with cryptocurrencies
Perfectly inelastic supply (Generally)
Supply is not responsive to changes in price
This means that the price is determined solely by movements in demand, which results in a lot of volatility
Though not always
Ethereum (Semi-elastic)
Dogecoin (Fixed increases)
Not a CAMOE
Used for some transaction, but not widely.
Slow, fees
Think of most cryptocurrencies as “cryptoassets”
If demand collapses, coin value/market cap can fall to zero
And has in many cases
Network effects
Redeemable Digital Currencies
Fiat-Backed
Stablecoins
Commodity-backed
Gold
Silver
Platinum
Baskets of goods
Marijuana
Financial instruments
Bonds
Stablecoins
A private digital currency which is pegged to the value of a fiat money
Mostly USD/Euro
Redeemable in the reserve currency
Problems with algorithmic stablecoing
Weakness of seigniorage-based operating system
When facing upward pressure on the price, increase the supply of coins (easy)
When facing downward pressure on the price??
Convince token holding to liquidate in exchange for an IOU (digital bond)
To be repaid with future seigniorage once demand picks up
Low-no collateral, therefore no redemption in the reserve medium
When demand collapses, a run begins on the coin, price collapses
Deposit Tokens
Emerging stablecoin variant used by commercial banks
JP Morgan
USDF Consortium
Tokenized deposit
I.e., a claim on a deposit account
Faster and less costly interbank payments
Clearing and settlement
Closed and permissioned blockchain system
Account Based systems
Account based systems would work much like the current commercial bank deposit system for the user.
Accounts could be held directly at the central bank or with private banks, and transactions would be managed by a centralized ledger.
For the central bank, an account based CBDC would very closely resemble the way electronic reserves are already implemented
Token Based
Tokens represent a true digital form of cash that would enable peer to peer payments through wallets.
A token based CBDC would by nature be more decentralized than account based CBDC, but the degree of privacy would depend on how heavily regulated the wallets would be, and how transactions are monitored.
A token based CBDC could also operate on distributed ledger technology (DLT), or on a centralized ledger, depending on how the trade-offs between efficiency and privacy are valued (Auer and Bohme, 2020).
Method of issue: direct
Direct: Issued by the central bank
Most likely an account-based CBDC
Method of issue: indirect
Indirect: Issued by commercial banks
Most likely a token CBDC
Commercial banks already beginning to look at deposit tokens
Method of issue: synthetic
Synthetic:
No CBDC directly issued
Allow other non-bank institutions to access digital reserves
Potential benefits to money-holders
Financial Inclusion
Cross-Border Payments
Crime/Monitoring
Perfectly safe asset
Instantaneous payments
what is CBDC
Central Bank Digital Currencies
Problems CBDC won’t/dosen’t need to solve
Financial inclusion
Financial inclusion is not a noteworthy concern in most developed countries, where only very small percentages of the population are unbanked.
In a developed country, being unbanked is a choice
Using FDIC survey data,top reasons cited by unbanked people are privacy concerns along with not trusting banks/government
In either developing or developed countries, it is hard to justify CBDC as a solution to under banking.
Physical cash is the clear monetary alternative for unbanked people.
More Problems CBDC won’t/dosen’t need to solve
Cross border payments
Cross border already being handled by private digital currencies and stablecoins
And other payment services
Perfectly safe asset
Bank disintermediation
Instantaneous payments
Banking
ACH (private)
Fednow (public)
Stablecoins
CBDC and Monetary Policy
Account-based CBDC can be interest-bearing
Interest on the CBDC would enhance MP transmission
The rate could allow velocity to be tampered with by the central bank, not just M.
If cash/near money-substitutes were banned or sufficiently regulated, the CB could take the interest rate on the CBDC negative to stimulate economic activity
Interest-bearing CBDC
Could better feasibly transmit policy rates to the economy.
Could potentially alter the velocity of money
Would induce direct interest rate competition with deposits.
Question as to whether there will be a differential between IOR and CBDC IR’s.
Implications for Seigniorage
Interest Bearing account-based CBDC
If contractionary MP is necessary, a positive interest on CBDC will reduce seigniorage in comparison to cash.
As has happened with high rates paid on reserves in recent years (negative remittances)
In contrast, negative rates would generate seigniorage, but it is infeasible that this could be a policy goal.
Especially if expected, a negative interest rate bearing CBDC would face serious competition from near money substitutes.
Even if cash was banned
Helicopter Money
Monetary policy tool
Instead of OMO injecting reserves to the accounts of commercial banks, what if OMO injected CBDC to all money-holders?
Argument: A more direct way for the Fed to alter the money supply, instead of relying on bank lending and the money multiplier.
Problems of Helicopter Money
Can still be accomplished with fiscal transfers (covid checks)
Rare use cases. Only makes sense to combat deflation, which is a relatively rare occurrence.
Unidirectional MP
Ok for expansionary MP, but would people feel about have CBDC destroyed with contractionary MP?
Problems CBDC creates
Privacy
CB/Government would have access to all financial transactions/data
They already do now (outside of cash), but it is more costly to get from the commercial banking sector
Destabilization of the financial sector
Runs and disintermediation
Costly for the CB to implement (especially account-based)
User-interface, customer support, etc.
Depending on the variant implemented, it may require draconian policies:
The banning of cash
The banning of monetary alternatives or near-monies (such as private digital currency)
